ICC Register Report 2010
This report provides an analysis of the main features of this data relevant to the calculation of regulatory capital requirements for five trade finance product types.
Historically, trade finance has been considered an extremely low-risk, routine operation. This perception—which is reflected in much of the specialist literature on the subject—has developed partly as a result of the anecdotal experience of practitioners over the past half century; but also on the basis of a theoretical understanding of the specific mechanics of trade financing.
At its most basic, bank-intermediated trade finance provides structure, security and fluidity to the exchange of goods or services between a willing buyer and a willing seller. The underlying presence of two (or more) parties keen to “do business”, suggests that the completion rate on trade finance transactions should be extremely high. Moreover, in theoretical terms, the risk of a bank incurring a defaulted exposure is further reduced by, inter alia, the fixed, short-term maturity of trade finance products, and the fact that exposures are usually liquidated by cash upon maturity.
There has historically been relatively little empirical evidence to support this argument, however. This lack of data has been particularly problematic given the concern that has been raised in recent years that the capital requirements for trade finance transactions under the Basel II framework do not reflect the low risk-profile of the activity.
In this context, the ICC-ADB Register on Trade & Finance (the “Register”) was established to enable banks to pool performance data for trade finance products. At this initial stage, nine banks provided portfolio-level data comprising 5,223,357 transactions, with a total throughput between 2005 and 2009 of USD2.5 trillion.
ICC recognises that this data collection exercise is the first step in examining the risk profile of trade finance products, and that this process will most likely require further enhancement to meet regulatory requirements for data collection. In the second phase of the project, ICC will work to enhance and expand the data collected, thus creating a compelling base of information for the Trade Finance Industry. In this context, it is ICC’s overarching objective to ensure that the treatment of trade products is fully consistent with the Basel Committee’s macro-prudential objective to promote financial stability, as well as the current imperative to support international trade as an engine of economic growth.
This report below provides an analysis of the main features of this data relevant to the calculation of regulatory capital requirements for five trade finance product types—(i) import letters-of-credit (“L/Cs”) issued; (ii) export confirmed L/Cs; (iii) guarantees and standby L/Cs; (iv) import loans; and (v) export loans.
The data set presented in this report provides an initial, “high-level” indication of the risk-profile of trade financing. In this connection, particularly notable features of the data (from a regulatory perspective) include:
a) the short tenor of trade transactions
The fixed, short-term maturity of trade finance products is confirmed by looking at the “churn” rate of transactions within the data set. The average tenor of all products within the data set is 115 days, with all of the off-balance sheet products covered by the Register (import L/Cs; export confirmed L/Cs; standby L/Cs and guarantees) exhibiting average tenors of less than 80 days.
b) low default across all product types
Only 1,140 defaults have been reported within the full data set of 5,223,357 transactions. Reported default rates for off-balance sheet trade products are especially low—i.e. 110 defaults from a total of 2,392,257 transactions. Using a standard calculation, we estimate that the average rate of default within each product type over the five years is: import L/Cs, 0.058%; export confirmed L/Cs, 0.282% (or 0.008%)1 ; standbys and guarantees, 0.010%; import loans, 0.124% (corporate risk) and 0.293% (bank risk); export loans, 0.168% (corporate) and 0.023% (bank).
c) relatively few defaults through global economic downturn
Only 445 defaults were reported in 2008 and 2009, out of a total of over 2.8million transactions written through this period. Indeed, the number of defaults reported on some products (e.g. import loans, guarantees and standby L/Cs) remained negligible through this period, in spite of prevailing economic conditions and higher transaction volumes.
d) good recovery rates for all product types
Looking at recoveries from written-off transactions, we observe from the data set an average recovery rate of 59.7% across all product types, with the highest recovery rate recorded on exposures to export loans (bank risk) 81.5%, and a low of 28.1% (export confirmed L/Cs). This latter figure may, however, be obscured by uncompleted recoveries as a result of ongoing bank restructurings in two jurisdictions.
e) limited credit conversion from off- to on-balance sheet
Counterparty default—unlike, for instance, in credit default swaps—does not in itself automatically crystallize the conversion of contingent trade products from off- to on-balance sheet. We observe from the data, documentary and (implied) performance contingencies inherent to trade products, which mitigate against potential defaulted on-balance sheet exposures.
In the case of import L/Cs, for instance, an average of 50% of document sets presented to banks to make drawings under import L/Cs contained discrepancies on first presentation. In these cases there is no obligation on the bank to waive the documentary discrepancies and make payment, unless they provide reimbursement or the discrepancies are corrected within the L/C validity . A significant proportion of L/Cs facilities also expire utilised—this may occur, for instance, where an export chooses not to ship the goods stipulated in the L/C as a result of concerns about the creditworthiness of its customer.