Trade Finance sneaking back into the limelight

... as a saviour or a culprit?

For years, trade finance has quietly gone about its own business providing the essential oil that keeps the cogs of commerce turning. It was never a dinner party topic and few people outside the industry had even considered it, until excessive lending and the ensuing credit crunch has thrust trade finance into the limelight.

There are two side effects of this, on the one hand industry better understands the importance of trade finance, but the credit crunch has also increased the cost of trade finance creating in many industries the semblance of a house of cards, where the smallest break in the supply chain could have a huge effect on many.

Whilst the world was trying to understand what was happening to the financial services industry and what impact it would have on the global economy, few were quick to shine the light on trade finance. However, quickly and quietly (initially), companies started encountering problems with rising costs of trade finance and credit volumes drying up. The area of trade finance has taken national and international interest to the point that Pascal Lamy, head of the World Trade Organisation (WTO), called a meeting to discuss the global crisis. The message from the meeting was that things are unlikely to get better over the coming months.

Even if the sharp fall of the Baltic Dry Index measuring the price of moving the major raw materials by sea, or the reports from Rotterdam to Malaysia indicating the growing number of cargo ships stranded at ports, or the recent year-on-year decrease in SWIFT trade finance messages volumes all point to a decline in trade finance transactions, their relationship with tangible goods, their short term arrangements and the good visibility over their lifecycle present a relatively low risk profile interesting for banks pulling back from other traditionally higher levels of risk.

It is still early to confirm if the downfall in Letters of Credit has started to falter despite early reports from several major trade banks that it has, but the more traditional trade tools are expected to win back favour as opposed to those on the back of open account based transactions. A complementary effect will be the rise of transaction banking, where banks focus more on multiple fee-based revenue streams that are not directly related to debt.

So, after all, is the current turmoil a bad news (with global trade volumes likely to contract and short term credit fairly easy to cut for any bank executive) or a good news (thanks to its low risk and well known profile) for trade finance?