Basel Committee makes minor trade finance concessions
Concessions designed to minimise negative impacts in low-income countries but the much-maligned leverage ratio will still apply to trade finance instruments.
The Basel Committee on Banking Supervision has made some minor concessions to trade finance in the context of "low-income" countries, but the leverage ratio which applies to off balance sheet items such as letters of credit and trade guarantees will still apply, according to newspaper reports.
Banks have long argued that trade loans are off balance sheet due to the nature of trade transactions not because they are risky like Collatreralised Debt Obligations, for example. However the Committee stated that it decided not to change the 100% credit conversion factor (CCF) in calculating the leverage ratio for contingent trade-finance exposures.The Committee stated it would use the transition period to monitor banks’ leverage data on a "semi-annual basis" in order to assess whether the "proposed design and calibration of the minimum Tier 1 leverage ratio of 3% is appropriate over a full credit cycle and for different types of business models."
The International Chamber of Commerce submitted loss data to the Committee which demonstrated the low-risk nature of trade finance, however, in its statement the Committee said the so-called, "credit register", which was based on pooled performance data from nine banks, did not provide "sufficient analytical evidence" for reducing the CCF in the risk-based approach below the currently applied 20%. It stated that the data presented was more relevant for the probability of default of a trade finance instrument rather than its likelihood of becoming on-balance sheet.
The Committee, however, said it supports further work by the ICC, as well as the WTO to strengthen data on trade finance. The ICC is reportedly expanding its database of defaults on trade finance transactions and intends to publish a report based on new data.
Having evaluated the impact of Basel II and Basel III in low-income countries, the Basel Committee on Banking Supervision decided to "waive the one-year maturity floor for certain trade finance instruments under the advanced internal ratings-based approach (AIRB) for credit risk." It also agreed to waive the "sovereign floor" for certain trade-finance related claims on banks using the standardised approach for credit risk.
Waiving the one-year maturity floor for issued and confirmed letters of credit will reduce the capital requirements for banks that use the AIRB. This is particularly relevant to low-income countries that rely on letters of credit for imports.
With respect to the waiving of the sovereign floor, in low-income countries where the issuing bank of a letter of a credit may not have a credit rating, this means the risk weighting will be much less than the "typical sovereign floor" of 100%, thereby reducing capital requirements for banks.