Basel more

Blog | 17 January 2017


The role of banks in the essential business of providing finance for trade has been overlooked in the wake of the international financial crisis. Irresponsible lending, incompetent risk management and, inevitably, bankers’ bonuses have dominated public attention. The Basel Committee on Banking Supervision (BCBS) is a serious body (it’s effectively, but not officially, a bit of the Bank for International Settlements) and it has put its focus on lending and risk – you wouldn’t expect the bankers on the banks’ bank to be bothered about bonuses.

At the moment it’s looking at “Basel Four” – the nickname for the successor to Basel III which is still waiting to take over from Basel II – and the debate is between the risk-based capital guidelines of Basel III and new proposals on leverage ratios which are crude but efficient measurements – much as was Basel I.

But the BCBS is between two stools – they are big and far apart. The US approach is largely in favour of leverage while the Europeans like their own internal risk-based models. That’s because European banks have big assets such as mortgages on their balance sheets as well as big trade assets. US banks securitise their home loans (they are already government guaranteed) and only a handful have foreign trade assets.

All good stuff, but where’s the trade? Things – like food, cars and aircraft – exist in the real world just as do houses. Banks lending to banks or buying government debt will not feed, house or transport you.

Banks themselves are learning that the cost of Basel III implementation – the fundamental review of the trading book – is going to be as much, if not more than double, some of their projections a year ago (according to consultants Oliver Wyman quoted in the Financial Times who polled 20 of the largest trading banks).

“Last year, banks were in the early stages of costing. Some of them clearly misunderstood how big the effort would be,” Oliver Wyman’s Aude Schonbachler told the FT.

There has been some breathing space in the form of a delay to the meeting between the Group of Central Bank Governors and Heads of Supervision (GHOS), which was due to be held on 8 January.  Regulators in the US and Europe cannot agree on the insertion of an “output floor” that would stop banks from using risk estimates that are below the outputs of a standard model developed by the GHOS.   

But a breathing space is very different from a reprieve.  Mario Draghi, chairman of the GHOS and president of the European Central Bank is adamant. “Completing Basel III is an important step towards restoring confidence in banks' risk-weighted capital ratios, and we remain committed to that goal,” he said.

Some of the big trade banks and the export credit agencies (ECAs) that work with them are not quite as confident as Draghi, and they don't trust his understanding of how trade finance works.

In particular, the treatment of the non-risk weighted Leverage Ratio (LR) does not adequately differentiate between the high quality low risk (lower margin) features associated with ECA covered exposures, versus non-trade related higher risk (higher margin) alternatives. As the European Banking Authority said, “By design, the non-risk based leverage ratio may incentivise financial institutions with low-risk business to diversify asset portfolios into high-risk business.”

On 23 November 2016, the EU proposed that institutions reduce the LR exposure measure by the amount of officially guaranteed export credits. Such an exemption from LR calculations will be consistent with the low risk characteristics typical of ECA business. For banks to experience loss, there needs to be a double-default of the end-borrower and the ECA guarantee. Possible exemption is subject to the outcome of discussions in the European Parliament and the Council. If there is no final EU agreement to exclude export credits from the LR measure, participants expect banks to be less keen to fund all forms/tenors of export credit loans.

Other Basel III measures, notably the Net Stable Funding Ratio, affect the banks’ appetite for long term buyer credits. And the Liquidity Coverage Ratio ‘stress test’ unavoidably penalises export credit loans because they are relatively illiquid compared with bonds.The final details of Basel III remain to be seen and the timing of changes is uncertain. As a result the net impact on bank provision of export finance is unclear.

Basel III, Basel IV, Basel more – call it what you will. Many ECAs are standing poised to step into some of the funding gap, but that gap is huge and the effect of Basel III on banks’ desire to lend, and the parallel effects of KYC regulations (and KYCC) on correspondent banking mean that provision of export finance is in a troubling period. Watch this space.


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