Trade finance, which supports the bulk of world trade, has deteriorated during the crisis and will continue to worsen in 2009. This column says that the response of public-backed institutions has been insufficient to cover the gap between supply and demand of trade finance worldwide. The G20 has adopted a wider package for injecting some $250 billion in order to further support trade finance.
The collapse of world trade is partly due to insufficient trade credit financing. The global market for trade finance (credit and insurance) represents approximately 80% of 2008 trade flows, valued at $15 trillion. The World Bank estimates that the fall in the supply of trade finance has contributed some 10% to 15% of the decrease in world trade since the second half of 2008. Despite the overall fall in trade transactions, quantitative and qualitative surveys confirm a general increase in trade credit prices, as banks demand risk premiums in excess of other types of loans. In addition, banks argue that the implementation of Basel II rules, which are regarded as having a pro-cyclical effect on the supply of credit, is increasing the market gap.
The current credit crunch is having a direct negative effect on trade due to reduced access to trade finance, as I describe in greater detail in CEPR Policy Insight No. 35. According to the joint IMF-BAFT (Banker’s Association for Trade and Finance) survey – undertaken in the context of the WTO Expert Group Meeting – flows of trade finance from developing country banks appear to have fallen by some 6% or more between the end of 2007 and the end 2008. The fact that this number exceeds the reduction in developing country trade flows during the same period indicates that the lack of available trade finance is indeed an issue. Results from the survey undertaken by the International Chamber of Commerce (2009), were also released for the WTO Expert Group of 18 March 2009 and further updated before the G20 London Summit. This survey confirms a wider panel of banks and countries (122 banks in 59 countries) that trade has decreased both as a result of the recession and tight credit conditions.¹ It was derived from both surveys that the market gap was somewhere between $100 to 300 billion before the G20 London Summit.
Public and private players to boost supply of trade finance
Between fall 2008 and the G20 London summit in April, the WTO intensively advocated in favour of increasing the capacity of international financial institutions and export credit agencies to shoulder the risk with private sector partners. As a result, the following actions were taken:
» The regional development banks and the International Financial Corporation (IFC) have doubled on average capacity under trade facilitation programmes between November 2008 and the G20 Meeting.
» Export credit agencies have also stepped in with programmes for short-term lending of working capital and credit guarantees aimed at small and medium enterprises.²
» Central banks with large foreign exchange reserves have been able to supply foreign currency to local banks and importers generally through repurchase agreements.³ This has helped banks and importers in developing countries acquire scarce foreign exchange.
The G20 Summit in London: A trade finance “package”
The increased capacity provided by these programmes was not sufficient to ease the situation is market, as risk aversion vis-à-vis developing countries expanded. The trade finance “package” proposed during the G20 London Summit could be summarised as allowing greater co-lending and risk co-sharing between banks and international and national institutions.
As part of the G20 package, the IF reinforced its global trade finance facility through the introduction of a liquidity pool, allowing for a 40-60% co-lending agreement between the IFC and commercial banks. The IFC jump-started the fund with $5 billion, matched by $7.5 billion in commercial bank funding, hence financing up to $50 billion of trade transactions in two years.4 Another point of the package was to increase export credit agencies’ ability to provide more direct funding in the short-run (working capital lending, other forms of short-term direct support), via increased capacity on the insurance side.
Finally, several institutions, such as international financial institutions, export credit agencies and other government agencies, will try to revive the secondary market by intervening directly in that market. Since the package is expected to be implemented over two years, early commentary by some press and academics about the lack of new funding should be put in a longer-time perspective bearing in mind that the package has been designed with the objective of raising new money only.
However, since the G20 meeting, the market has not gone back to normal. There is lack of visibility on the banks’ side and surveys, including the International Chamber of Commerce’s global survey and subsequent regional efforts such as the joint ICC–Inter-American Development Bank survey, indicate a strong increase of payment defaults, as confirmed by May 2009 statistics from the Berne Union on insured credit. The rise in “casualties” into what would normally be a relatively safe market is creating an abnormally high aversion to risk. This can be measured by the maintenance of high prices on the opening of new letters of credit for customers in developing countries – 150 basis points for some of the best counterparty risks at the present moment in India, for example. The perception of risk varies from country to country, depending on counterparty risk, the assessment of the sovereign risk, and the capitalisation required to finance such operations (whether the bank financing the credit applies Basel I or II international rules).
The most recent information indicates that the situation seems to have eased a bit in Asia, particularly in China, although some countries see their access to finance still very restricted (Philippines, Vietnam). In Africa, the situation remains tense, and active banks are seeking support from international financial institutions. In Latin America, credit rates have somewhat eased up since the fall of 2008, but are still higher than usual both in small Latin American states, and increasingly in larger countries such as Mexico and Argentina.
1 See ICC Banking Commission (2009a, 2009b).
2 Germany and Japan have made a strong commitment on the amounts. Very large lines of credit have been granted to secure supplies with key trading partners in the USA with Korea and China.
3 Since October 2008, Brazil’s central bank has provided $90 billion to the local market. The Korean central bank has pledged $10 billion of its foreign exchange reserves to do likewise. The central banks of South Africa, India, Indonesia, and Argentina are also engaged in similar operations.
4 Standard Chartered Bank and Standard Bank have already signed off on credit lines with several hundreds of millions of dollars for financing Africa’s trade.
ICC Banking Commission (2009a), An ICC Global Survey for the WTO Group of Experts Meeting on March 18, 2009, ICC Document 470-1118 WJ 1/ March 09.
ICC Banking Commission (2009b), Rethinking Trade Finance 2009, ICC Global Survey sponsored by the Asian Development Bank, the EBRD, the Inter-American Development Bank, the IFC, the International Financial Services Association.