Banks, Corporates Concerned EU Capital Requirements Shake-Up Will Hurt Trade Finance

Banks, Corporates Concerned EU Capital Requirements Shake-Up Will Hurt Trade Finance
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Planned changes in the treatment of trade finance in the EU’s capital requirements regulations could increase financing costs for businesses and let insurers take advantage of the guarantee market and banks.

Last October, The European Commission circulated the final text of its suggested changes to the Capital Requirements Regulation (CRR), which is a part of the bloc’s implementation of the Basel III banking reforms.

Lenders, banking associations and trade finance users influence the Commission, European Parliament and state members to scrap proposed modifications to the treatment of off-balance sheet instruments such as technical guarantees, warranties, performance bonds, and standby letters of credit.

The Commission suggested that the products can be categorized as medium risk for a specific credit conversion factor, which is used to calculate what a bank might have to pay for those instruments by considering the obligation of payout by materializing the risk they represent on its books.

The proposed change will increase the required credit conversion factor for those off-balance-sheet trade finance products to 50%, from 20% under the current CRR.

Recently, the persuading campaign has stepped up. Lenders, corporates and trade groups have sent a flood of written submissions to the Commission disagreeing that the increase is inappropriate with the low-risk profile of trade finance and high rates of recovery in the event of defaults.

In a paper that was published last December, the International Chamber of Commerce (ICC) says it is “deeply concerned” that the two modifications “may have extreme consequences for the provision of cost-effective trade finance to the real economy”.

The Bankers Association for Finance and Trade (Baft) states that default rates on technical guarantees are 0.24% only. In a submission to the Commission last week, the association said that changing the credit conversion factor to 50% is therefore unnecessary and does not seem justified or appropriate.

They further added that the European banks are likely to price technical guarantees at higher rates for clients. Disadvantaging small and medium enterprises and making European companies less competitive when bidding for major infrastructure projects, the submission says that the effect will discourage business activities and make it more expensive to offer trade finance to banks and their corporate clients. According to a joint submission from banking associations in Denmark, Finland and Sweden, changes in the submission will increase the capital charge on trade finance instruments by 150%.

They added that under this proposal, the cost of a €10mn performance guarantee for a corporate customer would rise from €50,000 to €125,000.

Infrastructure, energy and defense companies often use technical guarantees to achieve large contracts. Guarantees are answerable to the government if the company fails to deliver or meet its performance goals and often require firms to enter bid bonds when taking part in tender processes.

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The French utility giant, Engie, says in a submission that it has experience of bank guarantees amounting “to several billion” and that “the proposed revision would be implicit a huge increase in cost for Engie and possibly difficulties to get access to those guarantees, as banks may decide to prioritize activities with a higher return on equity”.

It further adds that some banks have already assumed the potential revision of Basel requirements to justify an increase of existing guarantee lines that have recently matured.

Airbus estimates its financing costs will increase by “several million” every year if the changes go ahead, including its parent company’s corporate undertakings with its subsidiaries. They say in a submission that the possible drying up of credit lines due to steeper capital requirements hampers its ability to meet contractual compulsions when its customers request technical guarantees and puts its supply chain at risk.

Christian Cazenove, who is the group head of trade oversight at Société Générale, said that it is essential to underline that they are in the real economy. The things that they are dealing with are goods and services which allow corporates to succeed abroad.

Cazenove, who has rallied other banks and clients to campaign on the issue, tells GTR that the extra capital costs may lead the banking sector to some extent to detach from the guarantee business. He further adds that trade finance by nature is still a paper-based industry and not very profitable.

Banks are also wary that the changes will help insurance companies at the expense of banks. Baft says its members are worried that the excessive credit risk pricing will highlight the current outflow of guarantee business from banks to insurance companies, which are allowed to internally model guarantee risk.

The ICC agrees that the raised revisions to the law could create “an uneven playing field” between banks and insurers.

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