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Basel III Could Cause Bank Exodus from International Trade

Exporting companies know that banks are an essential part of the process. They provide security and information for sellers of all sizes looking to take advantage of the, in some places, booming international market and weak dollar. But as the Basel Committee on Banking Supervision implements the third iteration of their capital requirement regime, dubbed Basel III, the result could be a mass international exodus on the part of banks from the business of financing trade transactions.

Many in the exporting and banking industry are already familiar with Basel II, the committee's previous international regulatory framework for banks. "Basel II really went in relatively painless," said John Ahearn, global head of trade at Citigroup, Inc. "Most European banks embraced Basel II pretty well. Now we get to Basel III and the world starts to change."

The major shift that could lead many banks to exit the trade financing market is in what's considered capital. The Basel regimes establish what a bank has to keep in reserve in relation to its lending and, as the definition of capital expands under Basel III, banks are required to hold more money in reserve in order to be in compliance, and their costs go up.

Basel III also includes a leverage ratio as a backstop to its other risk-weighted capital requirements. In essence, banks will have to maintain a certain amount of reserve capital to maintain the proper leverage ratio, regardless of how risky the assets are and regardless of whether or not the asset is on- or off-balance sheet. While some sellers might consider trade finance a high-risk endeavor, to banks it's a famously low-risk affair, so having to calculate a leverage ratio, without accounting for how surefire a trade financing transaction might be, increases the bank's costs.

"I think you are going to see a pretty large exodus of banks out of the trade business," said Ahearn, noting that this is already taking place, as banks rid themselves of these types of assets. "They're not just selling transactions; they're selling entire portfolios. What's going to happen is that there's going to be a conversation about 'what is a core business for my bank, and what is not?'"

While this threatens the availability of export financing, a larger problem could arise in the form of a secondary market for these sorts of transactions. "From a regulator's point of view, you're taking all this business in a highly regulated market, and moving it out of that market and into an unregulated market," said Ahearn, drawing a parallel between this and the negative role that non-traditional lenders played in the subprime lending crisis. "It's not that hard to figure out the equation, and people can see how well this asset class performs. This is a very good asset class and they don't necessarily need to be provided by a bank."

Jacob Barron, CICP, NACM staff writer