Does Regulatory Arbitrage impact Trade Finance?

Banks, in being the primary originators of trade finance assets, are facing challenges like never before. Revisions to capital based regulation (Basel Accords) as well as business model revision (Dodd Frank and FASB accounting regulations among others) are creating significant balance sheet pressures.

Under Basel III alone there are 11 different ratios, each being phased in over a period extending to January 2019. The interpretation of these rules by national regulators can create undo advantage or disadvantage in the marketplace. In Europe, Basel III is translated into law by the Capital Requirements Directive (CRD IV), although this is only partly a directive – which must be transposed into 28 different legislative systems – and partly a regulation, which applies directly in each member state.

A few examples will help readers assess differences:

Approach to calculating Risk Weighted Assets

Right now, large banks can use what is called the Advanced Approach versus a Standard Approach. The Advanced approach allows them to use their own data to risk adjust assets based on the regulators approving. The standard approach provides them outside data to use. It’s to the bank’s own benefit if they can use their own data if it shows lower losses and hence reduced capital charges. In the USA, banks can use the advanced approach only if they are larger than $250bn or have more than $10bn in foreign exposures. This is more stringent than EU rules.


Most trade instruments are under one year, with the vast majority under 120 days. Global Basel rules suggest a one year floor to calculate capital, except trade L/Cs. The EU proposal is for a broader definition of trade instruments that are exempt form a one year floor. The USA proposal appears to only exempt Trade L/Cs. To date, only the UK FCA (Financial Conduct Authority) has agreed to regard trade finance instruments differently to other types of assets.

Leverage Ratios

The global proposal is a minimum of 3% tier 1 capital of a combination of all on and off balance sheet assets. U.S. rules are 4% and the EU proposal is a minimum of 3%.

These are just some of the differences. I think we are left with more questions than answers:

  • So how are different rules by jurisdiction playing out in terms of creating disadvantages or advantages for certain banks?
  • And is this all moot anyway, as stress tests become the “defacto” capital tests for Federal regulators? In the U.S. the Fed would require eight of the largest U.S. banks to maintain more equity to pass the central bank's annual "stress tests, effectively, this will be a significant increase in capital. Federal Reserve officials signaled they will toughen big-bank capital requirements even further, most likely to drive them to shrink their balance sheet.
  • I continue to hear very thin pricing for investment grade corporates around supply chain finance and trade exposures, but is regulatory arbitrage having a big impact on non rated or non investment grade corporates?

So does the interpretation of global rules by different jurisdictions lead to regulatory arbitrage?  Has this transpired? I’ve reached out to several global trade bankers, who so far have refused comment. Perhaps they are busy shrinking their assets in light of the new rules.

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