By Jamuna Ravi, President and Geo-head, Banking and Capital Markets, Europe, Infosys Technologies Ltd
Basel III’s main objective is to re-establish the rules and ensure the global economy doesn’t become a victim of a financial fall out of the kind that was experienced in 2008. Regulators have been quick to exert their authority to make sure banks have sufficient capital to return deposits in the event of a crisis, are able to survive a protracted liquidity freeze, and are less dependent on the vagaries of short-term credit markets. These rules had to be implemented, especially in retail banking, where it was necessary to curb high risk mortgage and credit card lending. However, when taking a three hundred and sixty degree view of the financial market place, the new ‘rules’ appear restrictive and could even be accused of squeezing life out of a recovering economy.
Whilst the mature markets are expecting flat GDP rates in the near term and are battling with deflation, currency crisis’s and resorting to quantitative easing, the emerging markets are experiencing exponential growth. It is predicted that emerging markets’ GDP will grow at a rapid pace of 6.3 per cent in 2011 and 6.2 percent in 2012[1]. Yet, this economic growth could be seriously threatened by the Basel III regulation, thanks to the impact the rules will have on the trade finance business.
The emerging markets dependency on trade is significant and Basel III is likely to result in an increase in trade finance pricing and consequently a reduction in the volume of trade finance, due to the new capital and liquidity ratio requirements. Standard Chartered Bank estimates that trade finance pricing will increase by between 15 and 37 per cent and the impact of this could see the volume in activity reduce by six per cent, which would result in a reduction in global trade by $270 billion per annum. This equates to a 0.5 per cent reduction in the global GDP[2].
Also, a study conducted by the Chamber of Commerce found that based on the trade finance activity of nine global banks from 2005 to 2009, out of the 5.2 million transactions which took place, only 1,140 defaulted and only 445 of those defaults were during the banking crisis from 2008 to 2009[3]. Basically, the statistics prove that the existing trade finance system works, but it will become ten times more expensive to do a low-risk trade guarantee than it previously was, due to new regulations that are based on a set of rules for the mass finance industry, that don’t accommodate for the niche markets within it.
Emerging markets are breathing life into the existing economy and are an integral part of the global market moving forwards. They are recognised for their innovation, talent and creativity in enabling mature markets to establish new, more profitable business models through collaboration. Basel III regulations on leverage, liquidity ratio and treatment of off-balance-sheet items fail to distinguish between new ‘hot money’ financial instruments (like CDOs and SPVs) and the more stable and time-tested instruments (like LCs and trade-finance guarantees). Any adverse impact to International Trade Finance may lead to slow down of growth in emerging economies through a second and third level impact to infrastructure and capital goods financing.
As the governmental authorities thrash out the final detail of the Basel III regulations they need to take into consideration the potential hindrances that the new rules could have on existing financial structures that already work and aid economic growth.
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