The pressures of the post-crisis environment are signalling a return to a more traditional localised banking model.
DOMINIC BROOM managing director and head of market development for BNY Mellon Treasury Services EMEA, discusses how a new approach to localglobal bank partnership can help banks in emerging markets overcome the hurdles presented by this shift .
The many challenges presented by the global credit crisis mean that international trade – and by extension trade finance – has reached a tipping point. The first of these challenges is the growing threat to supply-chain management. The universal drying up of credit lines has resulted in conflict between suppliers and buyers: the former increasingly requiring payment in advance/on demand, while the latter are calling for more relaxed payment terms.
Rather than being a mere “supply-chain headache”, any situation that could result in the failure of a key supplier would – especially in these days of just-in-time inventory – be a supply-chain disaster. Today’s weak link is tomorrow’s broken chain.
Of course, this tension on the supply-chain is not helped by the overall increased focus on credit and transactional risk profi les, and the resulting atmosphere of extreme caution. The absence of market liquidity and the type of political and economic unrest that we have seen in the Middle East is leading to an uptick in the use of traditional trade instruments, such as the time-honoured letter of credit (LC).
While the LC has long fulfilled good and important work for local and emerging banks, many lack the resources to manage corporate credit risk, information channels and transaction processing effectively and effi ciently – particularly as the burden of regulation increases.
Indeed compliance – and particularly the upcoming Basel III accord – is a chief cause for concern for global trad
e and trade finance in particular. as admirable as its aims are – to increase the quality and quantity of capital, strengthen liquidity standards and discourage excessive risk-taking – there are potential downsides.
Specific concerns abound over the yet-to-befinalised decisions surrounding the minimum required ratio of tier-one capital to risk-weighted assets and the off-balance-sheet treatment of trade finance. One of the consequences of these decisions could be that customers are forced to shoulder the burden of business becoming more expensive, which could prove to be the final nail in the coffin for struggling small-medium sized enterprises, which form the backbone of international commerce.
The many challenges presented by the global credit crisis mean that international trade – and by extension trade finance – has reached a tipping point. The first of these challenges is the growing threat to supply-chain management. The universal drying up of credit lines has resulted in conflict between suppliers and buyers: the former increasingly requiring payment in advance/on demand, while the latter are calling for more relaxed payment terms.
Rather than being a mere “supply-chain headache”, any situation that could result in the failure of a key supplier would – especially in these days of just-in-time inventory – be a supply-chain disaster. Today’s weak link is tomorrow’s broken chain.
Of course, this tension on the supply-chain is not helped by the overall increased focus on credit and transactional risk profiles, and the resulting atmosphere of extreme caution. The absence of market liquidity and the type of political and economic unrest that we have seen in the Middle East is leading to an uptick in the use of traditional trade instruments, such as the time-honoured letter of credit (LC).
While the LC has long fulfilled good and important work for local and emerging banks, many lack the resources to manage corporate credit risk, information channels and transaction processing effectively and efficiently – particularly as the burden of regulation increases.
Indeed compliance – and particularly the upcoming Basel III accord – is a chief cause for concern for global trade and trade finance in particular. As admirable as its aims are – to increase the quality and quantity of capital, strengthen liquidity standards and discourage excessive risk-taking – there are potential downsides.
Specific concerns abound over the yet-to-befinalised decisions surrounding the minimum required ratio of tier-one capital to risk-weighted assets and the off-balance-sheet treatment of trade finance. One of the consequences of these decisions could be that customers are forced to shoulder the burden of business becoming more expensive, which could prove to be the final nail in the coffin for struggling small-medium sized enterprises, which form the backbone of international commerce.
Changes in trade flows
Yet despite this seemingly negative outlook, the future for trade and trade finance is far from doom and gloom. Trade continues even in times of turmoil, and trade finance has the ability to adapt to economic, political and regulatory pressures.
Certainly the difficulties of the current situation, rather than being the direct consequence of the downturn, are the end result of a gradual process that has mirrored the changing trends in trade flows and payment terms. The evolution of trade has witnessed the LC’s fall from grace – and its subsequent return – as well as the step-by-step displacement of local banks from what was becoming an increasingly international game.
In order to examine these developments, let us begin at the beginning. Historically, and largely in recognition of the fact that global trade has its roots at local company level, local banks played the crucial role of relationship manager and, by definition, assessor of local risk. Given their unrivalled knowledge of their corporate clients and domestic markets, this made perfect sense.
In addition, the vast majority of exporters were keen to use local banks for the issuance of documents in order to be sure that the consigned LC – the trade instrument of choice – was valid and in many cases to support their working capital finance needs. Local banks were, therefore, key players in trade, and could count on a secure and predictable revenue-stream from document-issuance, checking and financing.
Then the tides turned. The increasing globalisation of commercial networks led to the rise to prominence of open account (OA) settlement – namely payment terms that are not backed by bank-issuedLCs. The efficiency and convenience of OA trading, which was stipulation-free and required no thirdparty involvement or fee, meant its popularity grew rapidly among trusted counterparties, swift ly making it the settlement term of choice – especially as any risk was perceived to be off -set by free-flowing market liquidity.
Such a shift in payment terms acted as a catalyst for a head-offi ce style transaction banking model that favoured the making of lending decisions on an industrialised/global basis. as a result many local banks had – other than where the transfer of money was concerned – largely been removed from the global trade arena.
This proved to be bad news for several reasons. Th e displacement of local banks led to their becoming disengaged from their domestic client base, thus rendering many of them incapable of accurately assessing the risk of their domestic corporates, and leaving many corporates without local access to the trade finance solutions they needed.
Working together
Of course, the absence of market liquidity means that we have now come full circle. a growing lack of trust and aversion to risk means that the traditional trade instruments are making a comeback and the value of the market knowledge and long-established corporate connections possessed by local banks is increasingly recognised and respected. These factors, combined with the retrenchment of some of the global players following the crisis, has resulted in a return to the localised, close relationship banking model of days gone by.
Yet this growing emphasis on the importance of “the local” is something of a double-edged sword for local banks. While it unquestionably works to their advantage by putting them back where they belong, the majority lack the necessary capabilities to resume this role in the closely monitored postcredit crunch environment.
Given the heavy demands of regulation, and the working capital constraints that the majority of organisations now face, many local banks simply lack both the fi scal and staff resources to invest in proprietary state-of-the-art risk-management and transaction processing systems.
With in-house development out of the question, one option available to local banks is to enter into a partnership with a global provider of trade fi nance and supply-chain management solutions. Yet such partnerships can take many forms, and it is crucial to get the right one if it is to be successful and deliver real value.
For example, traditional partnership models, such as outsourcing, are often not all they appear to be, and can result in more negatives than positives from the local bank perspective.
While outsourcing can provide the end-to-end trade processing platforms that are needed, it usually offers little or no flexibility to allow local banks to offer tailored, market-specific solutions, or compete with the global players that operate in their home markets.
Outsourcing also creates inherent conf lict, which makes some smaller institutions understandably wary. regardless of the contractual agreement between the two parties involved, a local bank that gives a larger provider access to all areas of its domestic corporate business runs the potential risk of eventually losing that business to its so-called partner. Traditional outsourcing also rarely delivers a real exchange of value up and down the supply chain, so end users are frequently “short changed” in terms of service delivery.
The collaborative ecosystem
It is for these reasons that BnY Mellon advocates a non-compete, client-centric collaborative approach to local-global bank trade fi nance partnerships. One such approach, which is also more strategic in nature than conventional outsourcing, is the “manufacturer-distributor” model.