Trade Finance – Why Banks argue this Product Suite is “Special”


Banks continue to sell Trade Finance as a great product line and one that is getting unduly punished by regulators. Their argument centers on a few key points.

First, Trade is Main Street, not Wall Street – We are different

Trade finance involves the production and movement of tangible goods. This is especially important with emerging and developing economies, where companies may not have the balance sheets to access credit or the leverage to achieve favorable payment terms from overseas suppliers.   This is where banks, insurance companies, export credit agencies and other government bodies (eg. Small Business Administration) step in to facilitate using credit guarantees, their own balance sheet via letters of credit, insurance products etc.

Second, Trade Finance relies on self-liquidating financial structures –We are different

What self-liquidating means, especially as applied to trade finance, is that the bank stipulates that all sales proceeds are to be collected, and then applied to payoff the transaction and or loan. Any remainder is credited to the exporter's account.

They even argue the risk is so low as to be nonexistent. Seriously. Daniel Schmand, chairman of the International Chamber of Commerce Banking Commission, stated,

Empirical data generated by the ICC's Banking Commission can help address these issues. For example, the 2014 ICC Trade Register what trade financiers always knew: that the discipline remains very low risk, with default rates averaging between 0.03% and 0.24%, depending on the instrument.

I’ve commented in the past on this analysis here but what their data is saying is that trade has a better loss rate than AAA rated bonds. Do you think that passes the institutional investor smell test? The ICC needs to make the data, including prior versions, available for institutional review.

Third, Trade Finance requires specialized expertise – we are different

Trade Finance is a much different product than for example commercial or mortgage lending. A product is bought or sold and must move across borders, therefore, it takes longer to get paid. Operating in different jurisdictions, with different laws, and different information available on buyers and sellers makes it challenging to always do due diligence on reliability and creditworthiness of counterparties. And like any buy-sell relationship, foreign buyers prefer to have longer terms to pay until they receive and resell the goods.

Despite the specialized knowledge, the fact is trade operations staff are some of the lowest paying jobs in banking according to a Robert Half study.

Banks and their lobbying advocates have been using the above to push back on more stringent capital rules. They have had some success (ie, not treating trade finance as a one year maturity, the rules' treatment of export credits, and contingent funding liabilities.)

But one point to bear in mind. Bankers who are involved in trade finance like to point to the positive contribution trade finance makes to the economy. And yes, having finance, no matter what its form, shadow bank, alternative finance, bank intermediated trade finance, that can marry to trade flows is good for jobs, it’s good for tax revenue, and growth. But the reason trade does have such low risk is because of the inherent nature of the product. Because it is short term and because in many cases self liquidating, by definition it is lower risk.  When a trade line goes bad, banks can shut it down pretty quickly. Not so true if you are tied up in a medium term commodity financing structure.

Hence as an asset class, there is much room for growth.

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