A convergence of trends in the global trade environment is spurring many transaction banks to action. On a macro scale, a number of previously flourishing regions are seeing reduced demand for trade finance. The use of traditional bank-mediated trade finance instruments such as letters of credit is on the wane while open account transactions wax in lieu. Meanwhile, necessary regulatory and due diligence measures are adding further costs onto many banks’ P&L statements.
Many transaction banks are responding by reviewing strategies and operating models at every level. Internal efficiency gains are of course an important step, but a more thorough re-examination of current approaches to client service and fintech collaboration is leading to the emergence of holistic and client-focused digital solutions that will ensure improved and sustainable services in the future. Good news, then, for corporates – who will enjoy a greater availability of digital solutions, at better prices, and with enhanced functionality.
RWA modelling concerns
Regulatory requirements – and the associated costs – are significant drivers of change, with many transaction banks upgrading their back-office systems in an effort to improve efficiency. Another trend we are witnessing – specific to trade finance – stems from the Basel Accord’s capital adequacy ratio (CAR) requirement, which aims to ensure that banks can absorb losses and protect against insolvency. The CAR measures a bank’s capital in relation to its risk-weighted assets (RWA), but a lack of historical and performance data means that internal bank models used to calculate RWA do not currently reflect the low-risk status of trade finance as an asset class, even though market prices do.
However, many transaction banks value trade finance as a way to maintain and build new client relationships, so these low returns are often deemed acceptable.