Step into liquidity

Trade Finance, Covid-19

Step into liquidity

June 2020

As Covid-19 disrupts societies and economies, demand for trade finance remains strong. Banks can support their corporate and financial institution clients throughout this turbulent time through the with the use of low-credit risk products and strong client relationships, explains Deutsche Bank’s Russell Brown

Global trade flows – the driving force of the real economy – have seen impressive growth since 2000, almost trebling to reach US$18.1trn in 2019.1 Since the beginning of the year, however, the industry has been heavily impacted by the global response to Covid-19, with national lockdowns significantly hindering the pace of activities. As a result, the World Trade Organisation expects global trade to fall anywhere between 13% and 32% in 2020.2

While the crisis resulting from the pandemic inevitably affects trade volumes, corporates and financial institutions still require access to trade finance to ensure adequate risk mitigation and liquidity – perhaps even more so in the face of higher macroeconomic and geopolitical uncertainty. Banks must be prepared to support them with such requests. The low-credit risk profile of trade finance products ensures that this remains an attractive proposition for all parties involved, as confirmed by the International Chamber of Commerce’s (ICC) Trade Register.

Russell Brown

Russell Brown

Global Head of Trade Finance Financial Institutions, Deutsche Bank

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Proven profile

The ICC Trade Register – produced with the help of Global Credit Data and Boston Consulting Group (BCG) – is now in its 11th year and represents a unique source of information regarding the credit risk profile of trade and export finance products. Drawing on data from 25 trade and export finance banks, the latest edition is based on a representative data set comprising 32 million transactions across trade and export finance, representing nearly US$15trn in exposures. In total, these amount to 28% of global traditional trade finance flows.3

With a decade of data now available for analysis, results are consistent year-on-year, confirming the low-credit-risk profile of trade and export finance instruments compared to other banking products. Compared to other asset classes, trade finance debt is less likely to be defaulted on, while defaulted contracts show high recovery rates and shorter times to recovery.

Weighted at obligor level, default rates for trade finance products from 2008−2018 are 0.36% for import letters of credit (LCs), 0.04% for export LCs, 0.73% for loans for import/export and 0.45% for performance guarantees.

In addition, loss given default (LGD) rates (the percentage of an investment that can’t be recovered by a bank in the case of a default) are 29.9% for import LCs, 36.3% for export LCs and 37.7% for loans for import/export. Performance guarantees, meanwhile, have an LGD of 52.3%, which may seem high at first glance, but in practice this amounts to 2.2%, when factoring in the low call rate and negligible losses.

Time to recovery is also markedly improved compared to other asset classes, averaging six months for import LCs or even two months for performance guarantees, in contrast to a whole year for certain asset classes.

111 days import LCs contractual maturity
129 days export LCs contractual maturity

Average contractual maturity according to ICC Trade Register 2019

So what is it that drives this low risk? One key factor is the short maturity of trade finance debt – an attractive trait for banks as the time frames involved make it unlikely something significant will go wrong with the debtor before the debt is due. According to the Trade Register, the average contractual maturity for trade finance products is 111 days for import LCs, 129 days for export LCs, 133 days for loans for import/export, and 625 days for performance guarantees.

This, along with the self-liquidating nature of trade finance, where the financing paves the way for the company to earn the money that will repay it, cements trade finance’s position as a highly secure and reliable asset class. See Figure 1.


Figure 1: Comparison of trade finance to other asset classes, 2008−2018

Source ICC Trade Register 2019

Prioritising support

The ultimate impact of Covid-19 on the trade finance industry and wider economy is yet to be fully realised and will depend on the scale and duration of the pandemic itself. Initial estimates from BCG, as noted in this year’s Trade Register, which come close to the WTO’s previsions summarised at the start of this article – indicating that global trade could fall by anywhere between 11% and 30% in 2020.

While trade and export finance products retain a low-credit-risk profile, it is inevitable that the economic crisis will cause a spike in defaults, as companies face cash flow struggles and challenges in repaying their trade finance facilities. This will particularly affect micro, small and medium-sized enterprises (MSMEs) which lie at the heart of the real economy. However, this should not dissuade banks from supporting their corporate and financial institution client base.

Quick and decisive governmental, central bank and regulatory action has injected mass liquidity into the financial markets, provided support for businesses from micro and small medium enterprises (MSMEs and SMEs) to large corporates, and banks with the capacity to ensure the stability of the financial system and resilience of the global economy.

Trade finance products will play a critical role in this respect, helping fund global trade flows, providing risk mitigation and liquidity to exporters and importers – in turn allowing them to conduct cross-border business with confidence.

As such, banks must continue to support their clients with these low-risk trade finance products. For instance, traditional trade finance products such as LCs will likely see a surge in interest, as they provide the necessary risk mitigation that importers and exporters are seeking as a result of Covid-19.

Fostering existing client relationships will be essential for banks as they navigate the current environment. If we are to weather the crisis, we must ensure our clients can as well – and providing them with sufficient credit is a central part of that. Supporting clients through the use of trade finance products – as proven low-credit-risk instruments – remains a priority for Deutsche Bank, not only to help promote the continued flow of goods worldwide today, and as markets reopen, but also to help drive the post-Covid-19 economy.


Russell Brown is Deutsche Bank’s Global Head of Trade Finance for Financial Institutions.

 

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Sources

1 See https://bit.ly/2YyJpbZ at iccwbo.org
2 See https://bit.ly/3eAubc5 at wto.org
3 See https://bit.ly/3dCx1fm at iccwbo.org

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