There is an interesting piece on voxeu.org calling for a fair treatment of trade finance under the upcoming Basel III rules.
A majority of practitioners view Basel II as unfairly and dangerously tough on Trade Finance in terms of capital requirements under the Standardised Approach, compared to the "one size fits all" approach of Basel I (with its 20% credit conversion factor for
trade finance). Well, it seems that Basel III might actually make things worst...
As was reported extensively throughout 2009 including at a G20 summit, the issues around Basel II under the Standardised Approach are primarily tied to the rigidity of its one-year maturity floor for all lending facilities, which unfortunately include traditional
trade instruments such as Letters of Credit (despite their short-term nature).
Even the Advanced Internal Ratings-based approach proves tricky for many banks that have difficulties retrieving historic data on performance, hence hampering their ability to build a custom RWA model potentially more favourable to trade finance... Arguably
only the biggest trade banks can actually circumvent this, mainly because they can bear the cost and sophistication of an advanced approach and are also likely to have the vast amount of historic data readily available which the custom risk models would demand.
It is very positive to see the regulator striving to improve the banking system and great that it is aiming to tackle nasty excessive leveraging, one of the focus of Basel III. This all sounds good except for the fact that trade finance might end up being an
unexpected casualty in the end again because it also enjoys an off-balance sheet treatment which would now have to bear a flat 100% credit conversion factor.
Will we end up with a fair treatment in the final version of the revised rules or is trade finance doomed?
© Finextra Research 2015