Concerns are growing that mooted changes to banking regulations could restrict the availability of trade finance and potentially lead to a drop in global trade flows – something that could be particularly detrimental to smaller companies and emerging market banks. Dominic Broom discusses how local global partnerships can help these institutions overcome the challenges presented by regulatory compliance
Times are tough for banks operating in global transaction services (GTS). Soaring costs and shrinking margins are challenges faced by all, though some banks – most notably smaller and regional banks in Europe that have already seen their revenue streams depleted by stringent regulations – have been hit harder. Should this dilemma remain unreconciled, the potential danger is that smaller names may be pushed out of international trade, with trade flows and local expertise negatively impacted as a result.
This is in stark contrast to the post-crisis intentions of regulators and politicians. While a return to localised banking to increase competition, a focus on technology to increase efficiency (an area where local banks are already struggling), and the creation of a so-called ethical culture to encourage closerelationship banking are very much what regulators want in the post-crisis world, excessive regulation could threaten this by inadvertently forcing smaller and emerging market players out of the game.
Of course, the adequate and appropriate regulation of financial markets and institutions is undoubtedly crucial to the efficient functioning of the industry. Yet there is a fine line between the adequate and the detrimental, and this is a key issue as Basel III approaches.
Pitfalls of regulation
The overriding aim of the Basel III accords is to increase the quality and quantity of capital, strengthen liquidity standards and discourage excessive risktaking. While this undoubtedly necessary, given the causes of the credit crunch and its ongoing consequences, the yet-to-be-finalised decisions surrounding the minimum required ratio of tier-one capital to risk-weighted assets and the off-balancesheet treatment of trade finance, are potentially cause for concern.
The focus seems to have shifted from delivering trade solutions with an eye to the balance sheet, to delivering the balance sheet with an eye to trade finance solutions.
By extension, this is also a worry for corporates, as customers would be forced to support the burden of business becoming more expensive. Indeed, lending – or the potential lack of – is not the only problem on the horizon. The Basel II requirements for the increased provision of historic data (covering five to seven years of trade deals) to calculate default probabilities on trades is another issue.
The majority of smaller and emerging market institutions do not have sufficient data – or the technological means to manage such statistics – to validate claims of the low-risk nature of trade finance, thus leaving themselves at risk from higher capital requirements. As a result, real damage could be done to the nascent recovery in world trade and to small-medium sized enterprises, who are the real drivers of international commerce.
Such dangers have led many to feel that there is a discrepancy between what regulators want and the needs of banks and their client base in the GTS arena. Ironically, these concerns are also at odds with the political promotion of greater trade and business ties between developed and emerging markets, which is universally acknowledged as a positive step.
As many smaller banks struggle to reconcile the increasing cost of data and capital management, with growing corporate demands for global-standard technology and innovation, the established local bank-client relationships are at risk of unravelling – especially in emerging markets.
Yet with the banking sector under increasing scrutiny, regulatory compliance is an issue that is not going to go away. As a result, it is becoming apparent that only larger institutions with size and scale, or smaller banks that partner with them, can hope to retain a viable GTS offering.
Manufacturer-distributor’ model
This challenging combination of regulatory and economic forces is conducive to local-global collaboration, but it is clear that the established models, such as service outsourcing, are no longer viable. While conventional cost-driven outsourcing models aid efficiency and deal effectively with process concerns, their inflexible nature does little to increase competition and the value-chain flows in one direction only. As a result, they fail to reflect the role that smaller banks can play in the working capital cycle and neglect the value that can be gained from a two-way local-global exchange of knowledge, rather than of products.
A potential solution is a type of collaboration that BNY Mellon is calling the “manufacturerdistributor” model. This is a form of strategic partnership that is based on the concept of local financial institutions – “distributors” – leveraging the global transaction processing capabilities and extensive geographical reach of specialist “manufacturer” institutions. Crucially, the model is underpinned by two-way knowledge transfer, with knowledge being power in the business of trade.
The strength of this approach is that its emphasis on shared knowledge – something that had often been lost pre-crisis – means that it strives towards best practice by being solutions-drive. This involves taking a holistic approach to the needs of end-user clients, rather than centred on “product-pushing” and, as a result, the best of both worlds are combined to create real value.
By bringing together the global banks’ IT platforms – which help refine cash-flow management, enhance risk management and generate greater transactional visibility – with local banks’ domestic market knowledge, value can be brought though the very operational efficiency, transaction clarity and efficient risk-pricing that governments and regulators seem to be striving for.
In addition, smaller banks will be able to remain key players in international commerce by being able to make use of the global providers’ facilities in a way that best suits their domestic market. This means that they can offer clients bespoke cash management and trade finance solutions, while retaining core competencies and generating cost efficiencies.
Dominic Broom is managing director and head of market development for BNY Mellon Treasury Services EMEA. The views expressed herein are those of the author only and may not reflect the views of BNY Mellon. This does not constitute treasury services advice, or any other business or legal advice, and it should not be relied upon as such.