Trade finance secures the deal for the UAE and Middle East

As risk increases, demand for letters of credit and guarantees – the core instruments of trade finance – grow. That is one reason why it is gaining ground in the downturns. But banking regulations threaten trade finance’s progress.

Banks must maintain higher capital reserve against trade finance deals in accordance with new Basel rules, said Haytham El Maayergi, global head of transaction banking at Abu Dhabi Islamic Bank. Irene Garcia Leon / The National
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Trade finance in the UAE and Middle East is growing, but it faces challenges relating to the economic slowdown, high cost of compliance, tightening of liq­uidity and new banking rules, accord­ing to bankers.

Financing of trade has long been essential to this country, with UAE non-oil trade growing by 0.65 per cent to Dh1.07 trillion in 2014 from a year earlier, according to the Federal Competitiveness and Statistics Authority.

In the first six months of last year, trade reached Dh534 billion. Non-oil trade in the UAE in the first nine months of last year remained stable at Dh792bn compared with the year-earlier period, according to the Federal Customs Authority.

Globally, trade was forecast to grow 2.8 per cent last year, up from 2.5 per cent in 2014, the World Trade Organization forecast last September. World trade growth is estimated at 3.9 per cent for this year.

Slower trade has not stopped the growth of trade finance, according to a September survey conducted by the International Chamber of Commerce (ICC) Banking Commission. The body sets rules and guidelines for international banking practices. The survey covered 482 respondents from 112 countries, including the Mena region.

About 72 per cent of the survey respondents said they had witnessed an increase in trade finance net income in 2014, and 63 per cent reported an increase in overall trade finance activity.

“Trade is slowing down but trade finance is increasing,” said Vincent O’Brien, chairman of the ICC Banking Commission Education and Market Intelligence Group. “That is driven by risk, the perception of risk is going up. When there is an increase in the perception of risk, there is an increase in demand for the core trade finance products – letters of credits, standby letters of credit and guarantees.” he said.

The global trade finance gap is about US$1.4 trillion, $693bn of which is in developing Asia, according to the Asian Development Bank.

That leaves the UAE and the wider Middle East region in good standing to take advantage of this gap and increase trade fin­ance transactions.

The Middle East, particularly the UAE, is also gaining ground as a trade hub for Africa and Asia, boosting cross-border trade.

The Middle East was the only region where trade finance messaging traffic grew by 1.59 per cent in 2014, while globally messaging traffic decreased by 1.79 per cent that year, according to the financial messaging network Swift. It provides a system that enables financial institutions worldwide to send and receive information about financial transactions in a secure, standardised and reliable environment. Swift also sells software and services to financial institutions. The majority of international interbank messages use the Swift network.

Efforts in the UAE and the Middle East to diversify the economy will also help to boost trade fin­ance, bankers said.

“Over the last two decades or so, UAE has evolved from being one where traders bought goods and commodities in bulk from Asia and then re-exported in smaller shipments across the world to now being a major fin­ancial and operational hub for many large global corporates,” said Motasim Iqbal, head of transaction banking, UAE and Middle East at Standard Chartered Bank. “This has resulted in many multinational companies setting up shop in the UAE to cover the broader Middle East region and also Africa. Cross-border versus pure domestic trade is hence a key aspect of overall trade financing requirements in the UAE.”

Dubai-based Mashreq is one lender that has grown its trade fin­ance business, with open accounts growing more than documentary credit. Trade finance is the biggest contributor to the bank’s corporate trade business.

“Trade finance is one of the most secure ways to lend to the corporate sector, and this is why banks have redoubled their efforts to develop this aspect of their business in the UAE,” said Rahul Jayakar, head of global transaction services, products and trade at Mashreq. “Another important advantage of trade structures is that they are generally self-liquidating, which is a great comfort to risk managers.”

But various challenges are creeping up and threatening to halt the growth in trade finance in the UAE and the region.

The Basel III banking standards, which were introduced in 2010 and are being phased out, will pose new hurdles to trade finance.

The pricing for trade finance products could rise by 18 to 40 per cent under the Basel III rules, according to study by BAFT-IFSA, an association for organisations actively engaged in international transaction banking.

“According to the new [Basel III] rules, banks must maintain higher capital reserve against trade finance deals, which is their biggest concern,” said Haytham El Maayergi, global head of transaction banking at the Sharia-compliant lender Abu Dhabi Islamic Bank. “The proposed leverage ratio would require banks to set aside 100 per cent of capital for any off-balance sheet trade finance instruments, such as letters of credit, which is five times more than the 20 per cent credit conversion ratio used for trade finance in Basel II.”

The drop in oil prices is affecting the Arabian Gulf and has led to a liquidity squeeze in the energy exporting region, which will deter banks from boosting trade finance transactions.

“The significant drop in commodity prices, both for energy and soft commodities, has led to a tightening in overall liquidity situation in the market,” said Mr Iqbal. “Across markets including the UAE bank lending, conditions are expected to tighten going forward, which would have a downstream impact on availability of trade finance for cross- border and domestic trade.”

Bank compliance with banking standards and anti-money laundering regulations are hampering trade finance, particularly to small and medium-sized businesses (SMEs), thereby increasing trade finance costs for banks.

Globally, SMEs make up nearly 53 per cent of all rejected trade finance transactions, while 79 per cent of proposals for larger corporates are accepted, according to the ICC survey. Seventy per cent of respondents said declined transactions were because they did not comply with anti-money laundering regulations. Forty-six per cent of respondents said termination of correspondent relationships were because of related costs and complexities.

Trade finance also offers lower revenue compared to other products, making them less attractive to some banks.

“The trade finance business was out of favour with banks due to its relatively low margins, and better revenues in other complex and risky derivative products that boosted bank profitability,” said Mr Al Maayergi.

“Various factors led to lower profit margins in trade finance, including the shift of global trade from traditional trade fin­ance products, such as letters of credit and guarantees, to an open account basis that requires less banking intervention. ”

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