The Basel Committee on Banking Supervision has adopted two technical changes to regulations regarding capital adequacy when it comes to trade finance. The Basel Committee on Banking Supervision, located at the Bank for International Settlements in Basel, Switzerland, provides a forum for discussion and cooperation on bank supervisory issues. It is best known for setting international standards on capital adequacy, among other activities. Members come from the U.S. and several dozen other countries.
These changes are explained in the report, “Treatment of trade finance under the Basel capital Framework.” As the report notes, the Committee consulted with the World Bank, the World Trade Organization and International Chamber of Commerce before making its changes.
As a starting point, the Committee agreed to waive the one-year maturity floor for some trade finance instruments, under what's known as the advanced internal ratings-based approach (AIRB) for credit risk. The report notes that, the average trade finance transaction is significantly less than a year. Waiving the floor for issued and confirmed letters of credit (LOC) reduces capital requirements for banks engaged in trade finance and that use the AIRB. This will be particularly helpful for lower-income countries importing goods.
The Committee also agreed to waive what's referred to as the “sovereign floor” for certain trade-finance related claims on banks using the standardized approach for credit risk. Here's how this work: when a bank confirms an LOC, it is exposed to the risk of the bank issuing the LOC. When a lower-income country is importing goods, the issuing bank often lacks an external credit rating. Under the previous regulations regarding the capital framework, claims on an unrated bank are subject to a risk weighting of 20 percent for short-term claims, and 50 percent for others.
That's not all. Under current rules, this weightin can't be lower than the risk weighting of the issuing bank's country. For lower-income countries, this often is 100 percent. “Waiving this floor to allow the risk weighting to move below 100 percent will help reduce capital requirements for banks engaged in trade finance and thus foster the import of goods for low income countries,” according to the report.
The previous rules placed “an onerous burden on trade finance which — even in places where governments are considered barely creditworthy — has been shown to be the safest form of finance, since it is backed by the value of the merchandise,” according to this article in the Zimbabwe Guardian.
The move heads in the right direction, said World Bank President Robert B. Zoellick and World Trade Organization Director-General Pascal Lamy in a statement on the decision. “This is a useful step that will help promote trade with low income countries.” They added that look forward to continuing discussions with the Committee, and that efforts to strengthen standards for the financial industry need “to take account of the low risk nature and the pro development impact of trade finance.”