More Regulatory Capital, less Trade Finance?

The Fed, in keeping with its movement to make banks regulated utilities, has finalized tougher rules on capital, liquidity and leverage for Foreign Banks operating in the U.S.

The rules will require about 100 foreign banks with at least $50 billion in assets to follow tighter capital and liquidity standards that also apply to 24 U.S. bank holding companies of that size.

What exactly does this mean in layman’s terms?  Regulatory capital is set aside to cover the risks in lending.  Regulatory capital, governed by the Basel Accord, is the mandated capital that bank regulators require and is proportional to the size and scope of underlying risk of the lending instruments.

Before Basel II, Banks were governed by Basel I.  What Basel II and now the transition to Basel III has effectively done is tied capital to aggregate loss history. So a A- rated corporate would have much lower capital allocated to a loan transaction than a CCC+ rated one.   What Basel II did was effectively charge significantly higher capital to those non rated or low rated corporations.

Why is this important?  Well, if you are Walmart or P&G, its not that important since you can mostly disintermediate the banks and fund yourselves in the Capital Markets.  But, and this is the crux of the issue, small and middle market businesses are served through a large numbers of small banks many of which are not well positioned to provide international services like trade finance.  Basel II and III make serving these customers less profitable given significant increases in regulatory capital.  That's the crux of the issue.  The second point is banks lack historical data to prove to regulators that trade is less risky, ie, if Kmart fails, does their trade loans get recovered better than other lending products?  If banks can prove this, they have competitive advantage.  Few have.

This is an extremely important topic and one of the structural drivers impacting trade finance credit available to the market.  We will be doing more indepth updates.

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