basel 3 and trade finance - aimp: meeting document...
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2013/FMP/WKSP4/004 Session: II
Basel 3 and Trade Finance
Submitted by: International Finance Corporation
Workshop on Trade FinanceLombok, Indonesia
1 July 2013
Anurag Mishra
Regional Head, APR
Global Trade and Supply Chain
International Finance Corporation
July, 2013
Basel 3 and Trade Finance
• Basel 3 Aims at Improving Resilience of Banking Sector
• In the process it has come up with set of recommendations - as
far as Trade Finance is concerned it has made people nervous.
• Trade is also an important pillar of Economic Growth.
• Global Crises resulted in 23% decline in Trade volume in 2009.
• Present set of recommendations could have a similar impact on
Trade Finance.
• This could have a crippling impact on the Transformational shift
predicted in Trade Flows and in turn impact the role of Trade in
Global Economic growth and Global Economic Growth itself.
Background
Basel III – Strengthened pillars
Basel III focuses on bringing stability to financial markets by having
Stricter Capital, Leverage and Liquidity Requirements.
Basel III – Capital Requirements
Quality of Capital
— Minimum Total Capital Ratio retained at 8%.
— Tier 1 Capital Ratio increased from 4% to 6%
— Tier 2 – now constitutes only 2% of total capital
— Tier 3 instruments phased out
— Common Equity Tier 1 Capital Ratio increases from 2% to 4.5%
Additional Capital
Conservation Buffer - Additional common equity requirement of 2.5% to
withstand periods of financial and economic stress
Countercyclical Capital Buffer – 0 to 2.5% of common equity or other
fully loss-absorbing capital.
Global systemically important financial institutions
— Additional 1 – 2.5% capital charge to be met with common equity
Phases of Basel III capital requirements
2
3.5 4 4.5 4.5 4.5 4.5 4.5
2
1
1.51.5 1.5 1.5 1.5 1.5
4 3.52.5 2 2 2 2 2
0.6251.25
1.8752.5
0.625
1.25
1.875
2.5
0
2
4
6
8
10
12
14
<=2012 2013 2014 2015 2016 2017 2018 >=2019
CET 1 Additional Tier 1 Tier 2 Capital conservation buffer Countercyclical buffer
8% 8% 8% 8%
9.25%
10.5%
11.75%
13%
Basel III – Leverage and Liquidity Ratios
Leverage Ratio - Non-risk based
— Tier 1 capital / Total exposure >= 3%
— Exposure includes credit risk adjustment of 10% for undrawn
credit facilities and 100% for other off-balance sheet items
Liquidity Ratios
Liquidity coverage ratio (LCR) requires maintenance of high-quality
liquid assets to equal or exceed highly-stressed one-month net
cash outflows
Net Stable Funding Ratio (NSFR) requires a sound funding structure
on an ongoing structural basis. Focus is on Asset Liability
Mismatch, Funding Concentration, etc.
Additional liquidity monitoring metrics
— Maturity classification of contractual cash and security inflows &
outflows
— Identification of sources of wholesale funding critical for liquidity
Basel III regulations will have significant effect on trade finance
Quality of Capital – Most of the Capital Requirement needs to
be met through Common Equity – it will increase cost of
doing business including Trade Finance.
Amount of Capital - In addition to Tier1 and Tier 2 Capital –
the Capital Conservation Buffer plus Counter Cyclic Buffer
and Additional Capital requirement for G-SIBs can add up to
15.5% - which again adds to cost.
However non G-SIBs will also suffer on account of higher cost
of funds as they typically borrow from G-SIBs who will have
no choice but to lend at higher rates to recover their cost.
It will also impact trade business denominated in non G3
currencies as local banks will be more liquid and therefore
competitive than the G-SIBs in this space.
Impact of Basel III on Trade Finance
Impact of Basel III on Trade Finance (cont.)
Leverage Ratio – Universal Credit Conversion Factor for Trade Finance
does not do justice to short term, self liquidating , well documented
trade transactions.
This mechanism also fails to recognize the credit enhancement
through ECAs, Multilaterals like IFC, ADB, MIGA etc.
Also it is important to note that trade is a self generating activity /
business and does not grow exponentially in a leveraged scenario.
Impact of Basel III on Trade Finance (cont.)
• Liquidity Ratios – Liquidity Coverage Ratio (LCR) and Net Stable
Funding Ratio (NSFR) – While on one hand Trade assets do not
fall under Liquid Asset category - on the other hand deposit
from Cash and Trade (they go hand in hand) will not be part of
NSFR Calculation.
Deposit run-off factors are not based on internal modeling
methodology which defeats the purpose of applying the
Deposit run off factor.
Net Stable Funding Ratio (NSFR) - existing percentage of
short term and long term assets that needs to be funded by
long-term stable funding will result in Cost of funds going up
significantly and at the same time make the Financial
Institutions Deposit least attractive – a main stay of all banks.
Impact of Basel III on Trade Finance (cont.)
Counterparty Credit Risk - Basel 3 has come up with a higher Asset
Value Correlation (AVC) for large financial institutions (FI) (US$100
billion worth of assets) and unregulated FI through an AVC multiplier of
1.25. Standardized AVC places all Bank to Bank Exposures at par.
Therefore trade finance will attract came capital as other riskier and
more correlated products such as syndicated loans and bonds.
1.25 AVC multiplier for Trade Finance should not be applied.
Impact of Basel III on Trade Finance (cont.)
Level Playing Field – Given the fact that not all G-SIBs will have to
hold same amount of capital will lead to Geographical Arbitrage
which in turn will result in Concentration. Priority for all
governments, including Basel Committee, to promote consistency of
Basel III implementation world wide will be critical to prevent such a
situation.
One Year Floor - Tenor of instruments when measuring effective
maturity (to calculate RWA) – this is a step in the reverse direction
as market and regulators do differentiate between 3 mt./ 6 mt / 12
mt risk.
Conclusion
Bottom Line is that Trade Finance is a relatively low risk business.
The Short Term, Self Liquidating and Well Documented nature of
Trade Finance makes it inherently safer.
There is sufficient empirical data to establish the same.
Therefore Regulators need to look at Trade Finance with a
perspective that is fair and takes into account the inherent
nature of the business.
Also regulators need to try and keep the rules of the game
uniform or else it will lead to arbitrage.
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