Recent headlines have been dominated by news about banks rethinking and limiting their Trade and Commodity Finance exposures to various degrees.
The law of unintended consequences
- Basel III rules for banks post-ﬁnancial crisis introduced the Leverage Ratio, penalising trade ﬁnance as a low-default market segment.
- Latest draft Basel IV supervisory slotting criteria propose a minimum 120% risk weighting for commodities ﬁnance, increasing capital required to support lending and ignoring low “Probability of Default” and high recovery rates.
- Basel Framework derecognises transactional goods as collateral, eliminating capital relief and leading banks to abandon or to offshore (to minimize cost) collateral management teams, leading to poor monitoring/ control of collateral even where notionally taken.
- Regulators instead emphasise forward-looking cashflow and balance sheet modelling, leading banks to prefer unsecured revolving credit facilities for commodity traders to traditional transactionally secured lending.
- Banks’ ‘Compliance’ departments have exploded into multiple overlapping teams.
- Banks’ costs for new client adoption effectively exclude taking on SMEs or one-off transactions.
- As a result of ever heavier balance sheet regulation, banks are no longer agile lenders opening the door to fresh competition.
Lessons from Singapore
- Banks’ over-reliance on forward-looking modelling leaves them blind-sided to transactional and operational risks.
- Years of cost cutting at banks impacts effectivness of due diligence and often reduces it to a ‘desk-top’ process (the ‘Google Test’).
- Collateral management at banks appears not to have been applied.
- This led to a failure of monitoring, control and knowledge of the transactions financed by banks.
- In the quest for revenues, banks’ financial exposures ballooned as they gave up on traditional risk mitigation techniques.
- Better technology and design can address these risk and compliance issues.