An inflection point for trade banks

“Low growth has become the new normal.” This, from Chinese Finance Minister Lou Jiwei at the third G20 Finance Ministers and Central Bank Governors Meeting in Chengdu on July 23-24, 2016, sets the pessimistic tone for trade. With low growth comes low demand: latest available data shows the volume of global trade slipping 0.4% in May versus estimates for a 0.6% gain, and on top of a 0.3% fall in April .

“There are a lot of indicators pointing to a continued weakness in the markets,” says Michael Quinn, Global Product Management Executive for Financial Institutions for Global Trade & Loan Products at J.P. Morgan.

Commodity prices are one such indicator, with the World Bank’s latest markets outlook forecasting crude oil for 2016 at $43 per barrel, a 15% drop from 2015; metals down 11% and a “marginal” year-on-year

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. Another is the global political landscape. Given the lag in economic data, it is still too soon to discern the impact of the ‘Brexit’ vote on trade growth in the European Union (EU) – which, taken as a whole, represents the world’s second-largest economy. In the U.S., to the extent that policy uncertainty surrounding the election could be causing businesses and households to delay big-ticket purchases or investments, “there is a possibility the election may impact the economy before it even happens .”

Political upheavals of varying severity in Brazil, Venezuela, Turkey and the MENA region, and a global political sentiment also present potential complications to open trade.

Added to all of these are continued regulatory developments which could lead to a shaking out of the trade finance market, such as a group of proposed rules by the Bank for International Settlements (BIS) that will increase the capital requirements of Basel III, resulting, in effect, in Basel IV; and the inclusion by EU authorities of trade finance instruments in the list of bank liabilities that could be written down in case of a bank collapse.

“We are seeing banks starting to respond to Basel III and liquidity requirements with increased pricing and in some cases, abstaining from some bids. As a result, it is likely that some banks with lesser activity in the trade finance space will curtail their activities there,” says Quinn.

Is Opportunity Knocking? Despite the overarching narrative of news, it is vital to remember that current downward pressure on trade comes from episodic events as opposed to true underlying business. “With demand down and an influx of market conditions with an impact on trade growth, the time is now for banks to refocus on what they want to do,” points out Pravin Advani, Global Head of Trade & Loan Products at J.P. Morgan. Rather than a challenge, today’s challenging market represents an opportunity for banks to take stock.

Transforming Trade Finance If banks can play to their strengths, they can take advantage of an opportunity to retool to ensure that they are perfectly positioned in their growth areas as market conditions improve. Along the way, they can transform trade finance into a much more agile, nimble and specialized business.

“Trade finance has long been viewed as tradition-bound and in some cases, slow-moving. Now is the perfect time for banks to shed some weight and improve their footwork,” says Quinn. It is time for trade banks to ask themselves some candid questions about where their strengths and weaknesses lie and where their resources and expertise can be best deployed.

Some may need to shift their geographical focus. Is a bank going to play in all markets or narrow its focus to where it has a physical presence? Are there markets that are underbanked today but might soon become more attractive?

Some may need to take tough decisions on customer segments and product offering. Are a bank’s products sufficiently profitable to retain while still addressing the needs of target clients? This cost-benefit analysis could also further impact decisions about geography.

Investment decisions in technology will be crucial. They should be driven not only by customer growth plans but also with an eye to addressing productivity and compliance demands. Should a bank buy new software, enhance existing capabilities or seek a third party provider? Each option comes with implications which may facilitate some of the other decisions in the business plan.

“Another consideration in revising the business plan is the mix of assets a bank may choose to retain,” says Conor O’Dowd, Global Portfolio Management Executive for Global Trade & Loan Products at J.P. Morgan. “Many banks have appetite for country risk as well as credit risk appetite for other banks or corporate customers. The question is, do they have the ability, the market presence and the right customer mix to leverage that capacity? There may be opportunities for banks to reduce their origination costs while still maintaining profitable risk premiums.”

Inset – Checklist: Key Considerations for Growth

Geographical focus Customer segments Product mix Investment in technology Rebalancing portfolio of assets People “There is one key question for banks,” says Advani. “When demand picks up, am I in the right place at the right time and do I have the right people to respond to it?”

That pick-up is on the horizon, with a modest recovery projected for most commodities in 2017 as demand strengthens and supply tightens. Bright spots exist in trade blocs such as the Pacific Alliance, which eliminated tariffs on 92% of goods this year; and in the newly-minted free trade routes among the TPP countries.

“In this environment, a product sales mode is not going to be effective; a more consultative approach is required. J.P. Morgan can share its advice and expertise to enable banks to leverage market conditions to their advantage,” says Advani.

The current economic situation should be viewed by trade finance practitioners as an inflection point to refocus their business plan and become better at what they do, and those who are capable of doing so will be the drivers of change for the better for the trade finance industry.