With Western banks compelled to beef up their capital ratios, there has been a strong wave of efforts to reduce assets and pull back into home markets. This does not bode well for the emerging markets of Asia, which have traditionally been heavily dependent on credit from European and American financiers. In a study of 58 banks in Europe, released in April 2012, the International Monetary Fund (IMF) estimated that the banks have to further reduce a combined US$2.6 trillion worth of assets, and cross-border lending has been identified as the most vulnerable to this downsizing.
Impact on the Trade Finance Business in Asia
Being usually short term in nature, trade finance has been an area where Western banks find it relatively easy to reduce their exposure. This, coupled with the retreat to the havens of their home markets in Europe or America, has created a financing vacuum for corporates and small to medium-sized enterprises (SMEs) in Asia.
Fortunately, other lenders have stepped in to fill the void. Asian banks are looking to expand their focus regionally, and have been active in the trade finance space. Lenders include Singaporean Japanese and Australian banks, which are looking to expand loan growth further in Asia and take advantage of the retreat of Western banks.
However, with much international trade still denominated in US dollars and euros, the ability of regional Asian lenders to extend financing at affordable rates depends largely on their ability to obtain liquidity in these currencies. The Asian Development Bank (ADB) has estimated that 90% of foreign trade in Asia is denominated in US dollars. Although Asian lenders have been able to cover the shortfall of trade finance so far, further pullbacks of loans by Western banks, including the additional US$2.6 trillion in Europe, could, according to the IMF, potentially reduce the liquidity of US dollars and euros for Asian lenders, and translate into reduced levels of trade finance for Asian corporates and SMEs.
With regard to domestic trade, there are varying expectations between countries on the impact of the pullback by Western banks. While relatively independent economies such as China will continue to see trade finance growth, other markets where Western banks are more integrated into the economy, such as Taiwan and Malaysia, could experience a reduction.
Cushioning the Effects of Deleveraging
In response to the impending further deleveraging by Western banks, several international institutions have undertaken initiatives to help cushion its impact. The European Central Bank’s (ECB) Long-term Refinancing Operations (LTROs), which provides cheap financing to European banks, was carried out earlier this year. So far approximately €1 trillion have been injected into the financial system to allow European banks to continue lending and improve the economy. Evidence seems to suggest that some of this funding may have found its way into Asia. Bank for International Settlements’ (BIS) data shows that among those European banks reporting statistics to BIS, exposure to Asia-Pacific actually grew by 6.8% in Q112 after contracting by 10% in Q411.
In July, the ADB announced enhancements to its trade finance programme to include renminbi (RMB) and Indian rupee (INR) as supported currencies, to encourage the use of Asian currencies and reduce the dependency on US dollars. This move allows Asian lenders to expand their capacity in supporting trade, especially since intra-Asian trade growth has been outpacing the rest of the world. The initiative was recently extended indefinitely, from its scheduled expiry at the end of 2013.
Across the industry, banks are also carrying out several internal initiatives to improve capital efficiency and capacity to better serve corporates with trade finance needs. There is a push towards increasing the suite of value-added open account working capital solutions, to support clients in their end-to-end supply chain. Using factoring as a proxy, open account trade financing in Asia rose by over 40% to US$659bn in 2011, according to data released by Factors Chain International (FCI). Internal reviews of current portfolios, driving of deposits and balance sheet optimisation are also initiatives by banks looking to increase capacity.
Externally banks can ride on efforts by global institutions, such as IFC’s various trade finance programmes and ADB’s trade finance programme, to reduce risk-weighted asset (RWA) by leveraging on the AAA ratings of these financial institutions. Various trade credit insurance mechanisms offered by global insurers, such as Coface and Euler Hermes, and export credit agencies (ECAs) also allow banks to pass on capacity and achieve lower risk weighted asset (RWA). We are also seeing a potential emergence of co-operation models between banks, in contrast to the previous competitive models. Risk participation structures, such as forfaiting and various supply chain cooperation models, are also gaining momentum in the market as banks seek innovative ways to expand capacity.
Although regional lenders have the capacity to continue expanding loan growth, expertise in offering trade finance has to be built with regard to peoples’ skill sets, system enhancements, risk policies and process refining. This is especially pertinent in structured trade solutions for commodities where, according to the IMF, European banks have traditionally financed 80% of all trade. Local on-the-ground market knowledge also needs to be established over time, especially for emerging markets, which ADB defines as “frontier markets” that are known to be harder to establish credit in.
With banks needing to be complaint with the strictures of Basel III in the near future, we may yet see another wave of deleveraging by Western banks. In this respect, banks may choose to specialise in certain markets, or types of trade finance such as commodity financing, to conserve capital and become niche in their offerings.
In summary, Asian lenders have been able to cope with the deleveraging of Western banks so far, due to efforts by various international organisations and internal bank initiatives. However, with the push for continued deleveraging and banks having to cope with constrained capacity, we will continue to see banks seeking innovative ways to increase capacity and reduce RWA. It also remains to be seen how effective these measures have been in coping with the further deleveraging by Western banks.
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