UNSUNG HEROES When the global financial crisis struck, it was the world s DFIs that helped contain the contagion in emerging markets. TFR talks to four of the biggest to find out more. THE PANEL: RUDOLF PUTZ, Head, Trade Facilitation Programme, European Bank for Reconstruction and Development (EBRD) STEVE BECK, Head of Trade Finance, Asian Development Bank (ADB) DANIELA CARRERA MARQUIS, Chief, Financial Markets Division, Structured and Corporate Financing Department, Inter-American Development Bank (IDB) KARIN OSZUSZKY Advisor, The OPEC Fund for International Development (OPIC) 24 TFR MAY 2011 TFR [May 2011] cs4.indd 24 18/05/2011 16:41:23
Q1. How did the global financial crisis change the environment for DFIs? Rudolf Putz, EBRD: As a result of the global financial crisis, several leading DFIs increased the capacity of their trade finance facilities to financial institutions in less advanced countries. This enabled these institutions to meet the financing requirements of local importers and exporters. Steve Beck, ADB: Prior to the financial crisis, some quarters were questioning the requirement for development financial institutions (DFIs) or multilateral development banks (MDBs). The private sector was thriving, creating innovative new financial products and increasingly moving into many emerging markets. When the fundamental risk (the assets) underlying some of the financial innovations turned out to be of a low credit quality, many of which started to go into default, markets, financial institutions, rating agencies, the whole system started to lose faith in itself; suddenly, not knowing what to believe was reliable. With the loss of arguably the most important element in financial markets confidence some of the world s greatest (and highly leveraged) financial institutions were unable to meet their obligations without government bailouts. Needless to say, this put a significant dent in the availability of liquidity and the ability of banks to provide guarantees to cover each other s obligations in trade. In the face of this massive uncertainty and financial institution failures, government institutions, including MDBs, clearly had an indisputable role filling the huge gaps left behind by a hobbled financial sector. Daniela Carrera Marquis, IDB: The global financial crisis underscored the significance of trade for DFIs. When trade flows cease or become unreliable, the domino effect is devastating. In contrast, trade finance that is reliable and inclusive has a counter-cyclical effect in times of economic downturn, especially in developing countries such as Latin America and the Caribbean (LAC) region, which suffers from uneven access to trade finance, not only on a regional basis but also across countries and banks. Ensuring access to trade finance ensures the diversification of goods and services, specialisation of products, transfer of technology, business expansion and job creation all pillars of DFIs mandate. During the financial crisis in LAC, trade finance had a role in cushioning falling stock and bond prices, currency depreciations and the declining asset values in the region s principal economies. Karin Oszuszky, OFID: DFIs have traditionally considered their role as that of providing support to developing and emerging market governments. This support is invariably for investment programmes of long-term duration and rarely self-financing. Being government loans, no major credit risk is involved, while political risk is somewhat attenuated by the special relationship the DFIs enjoy with their clients, which are at the same time their shareholders. Repayment of loans is the responsibility of the borrowing party, whether the programme succeeds financially or not. The creditor-debtor relationship is somewhat skewed and governments could hardly fail to honour their obligations as the lender can recover its dues, however indirectly, through future lending programmes. Lending to the private sector, whether for investment or trade, is evidently not as secure. Not unlike the commercial equivalent, it involves counterparty as well as country risk. DFIs, though, are expected to offer their clients products of a higher risk profile than can be afforded by the typical commercial bank. DFIs nonetheless see their role, once again, as that of support. Q2. What do you feel were the most effective schemes devised in the wake of the global financial crisis? Rudolf Putz, EBRD: The EBRD s Trade Facilitation Programme (TFP) had been created as a crisis response tool of the EBRD to ease the negative effects of the Russian banking crisis in 1998. When the global financial crisis hit EBRD s countries of operation, once again, in 2009, the EBRD did not have to create a new trade programme, but just had to re-establish or increase its TFP facilities for its partner banks in Eastern Europe and the CIS. Through the programme, the EBRD provides guarantees to international confirming banks, taking the political and commercial payment risk of international trade transactions undertaken by banks in the countries of operation (the issuing banks). More than 118 issuing banks in the region participate in the programme with limits exceeding 1bn. In addition to providing trade finance guarantees, the EBRD also extends short-term loans to selected banks in its countries of operations. Steve Beck, ADB: Trade plummeted at an alarming rate during the crisis. Because we lacked statistics it was difficult for policy makers to understand how much of the fall in global trade was due to a lack of trade finance and how much was due to a huge drop in demand. Clearly, the latter can take most of the blame, but a lack of trade finance did not help. Bob Zoellick, President of the World Bank, estimated that between 10% and 15% of the drop in international trade could be attributed to a lack of trade finance. The G20 group of industrial nations asked export credit agencies (ECAs) and MDBs to ramp up their trade finance programmes and this is exactly what happened. Looking back on the ECA and MDB response, the general view among the private sector seems to be that the response was swift and effective. Likewise, ADB s Trade Finance Program (TFP) responded. In 2009, the TFP supported nearly $2bn in trade and, in 2010, nearly $3bn. This may seem like a drop in the ocean and it is but when one considers that the TFP does not assume risk in China, India, Thailand, Malaysia, South Korea and other relatively developed markets, the figures become more interesting. www.tfreview.com 25 TFR [May 2011] cs4.indd 25 18/05/2011 15:57:02
Given the TFP s limited resources, and our mandate, we decided to focus efforts on the more challenging Asian markets. The TFP s five biggest user countries last year where TFP did most of its business were Bangladesh, Pakistan, Vietnam, Sri Lanka and Nepal. We focus on where the private sector market gaps are the greatest. Mongolia, Azerbaijan and Indonesia have also been active markets for us. Our focus for 2011 is to create a broader distribution network and to complete TFP s expansion throughout Central Asia, including Kazakhstan. There will be some announcements on this soon. The TFP continues to see strong growth and we anticipate supporting well over $3bn in trade in 2011. Daniela Carrera Marquis, IDB: The IDB, the largest of the regional DFIs, took big steps in the wake of the financial crisis to support trade flows in a way that complemented the efforts of national governments, which were quick to respond by injecting liquidity in local markets. First, the IDB s 2008 Liquidity Program for Growth Sustainability was implemented to compensate for shortfalls in US dollardenominated financial flows to LAC s productive sector. Operating through public sector financial institutions (FIs), the programme offered a $6bn line to borrowing member countries, with a $500m limit per country, in order to provide FIs with liquidity to make short-term loans for trade financing. The goal was to smooth the shock of the potential dislocation of access to credit lines by local FIs. Second, the IDB expanded its existing Trade Finance Facilitation Program (TFFP) from $400m in maximum exposure to $1bn. Such a programme, common among other DFIs, enabled the IDB to react swiftly, leverage its existing network of issuing and confirming banks, and to approve new participants. To date, the TFFP has built a network of 72 issuing banks in 19 LAC countries with lines amounting to $1.2bn. Through the network of international confirming banks, the programme is now present in 51 countries worldwide with 250 confirming banks belonging to 92 banking groups. Third, the TFFP broadened its scope from providing guarantees to offering direct trade loans as well. Direct A/B loans responded to issuing banks demand for liquidity and increased FI clients traderelated activities. While many banks cut credit lines during the global financial crisis, the IDB s trade finance funds, supported by equity and long-term funding, continued to provide stable, reliable financing for medium-sized exporters through special-purpose trade vehicles many of whom were small and medium-sized enterprises (SMEs). These innovative instruments provide access to finance for SME clients who would otherwise face unaffordable or limited financing from conventional outlets. The IDB s trade funds financed more than $1bn in trade activity in 2009 alone. Engagement was counter-cyclical, leading to a multiplier effect that stimulated production, movement and consumption of more goods and services across a range of countries and industries. Karin Oszuszky, OFID: The financial crisis certainly upset the landscape. Risks became systemic and global, and projected DFIs of global reach into the role of substituting retrenching commercial banks and as operators of countercyclical strategies. Helping governments run the right strategies was, for DFIs, as essential as providing credit in support of a market in deep distress. Indeed, governments and markets needed to regain the confidence that drives the economy. DFIs brought to bear their analytical capacity as much as their funding. Remarkably, private and public sectors acted together; the short- and long-term demarcations got blurred. An all-out campaign at global level, as well as at a specialised level, helped reduce the risks of contagion and uncoordinated action. Importantly, DFIs soon realised that the situation called for dynamic partnerships with commercial banks to better handle the risk bearing capacity of the DFIs. Q3. What do you foresee as the biggest challenges that you and your organisation will face over the next year or two? Rudolf Putz, EBRD: A major objective of the EBRD s Trade Facilitation Programme will be to support smaller and medium-sized banks in Russia and banks in countries which have been strongly affected by the financial crisis, for example in Ukraine, Kazakhstan and Belarus. In addition, we will continue to provide risk cover and technical assistance to Southeastern Europe, the Caucasus and Central Asia. Steve Beck, ADB: The demand for ADB support in infrastructure, clean energy, trade and a multiplicity of other areas, including various social sectors such as education, is huge and yet ADB s resources are finite. Our greatest challenges, at least from my personal perspective, are two-fold. First, where in the context of finite resources does ADB focus its resources to achieve maximum development impact? There needs to be a targeted focus in specific niches that have the greatest private sector gaps that are important for development. Making decisions on where to focus to the exclusion of worthwhile initiatives is not easy, given the dearth of demand that can take ADB in many directions. Second, how can ADB leverage its activities to the maximum with the private sector to mobilise more resources for priority niches that ADB targets. Surely part of the answer lies in greater efforts to involve funds, insurance companies, capital markets. Daniela Carrera Marquis, IDB: Key challenges in the future would stem from a burst in commodity prices. If European and American appetites for end-products continue to be suppressed by a stagnating economic recovery, Asia could see a dip in its demand for inputs, forcing Latin American and Caribbean commodity exporter nations to adjust. Karin Oszuszky, OFID: Sudden and unpredicted it may have been, but the crisis nevertheless had known factors, which were also found in the Asian crisis of the 1990s or the Latin American debt of the 1980s. Over-leveraging and toxic assets 26 TFR MAY 2011 TFR [May 2011] cs4.indd 26 18/05/2011 15:57:03
are characteristic of such crises. Indeed, they are timeless natural outcomes of excessive deregulation and over-dependence on industry self-policing. DFIs have also learned from the past. Their most effective contribution to solving such crises is in helping governments of developing and emerging countries, as well developed economies, to interact and take a global view of a crisis that had transcended geographic borders. Q4. How do you foresee Basel III affecting banks willingness to finance trade in your region? Rudolf Putz, EBRD: Basel III will probably increase the cost of trade finance provided by foreign banks. In addition, there is a risk that some foreign banks might also decide to reduce their number of correspondent banking relationships with smaller banks in EBRD countries of operation, and concentrate on lending only to larger financial institutions and corporates with good credit standing. "When the global financial crisis hit EBRD s countries of operation, once again, in 2009, the EBRD did not have to create a new trade programme but just had to re-establish or increase its TFP facilities for its partner banks in Eastern Europe and the CIS." Rudolf Putz, EBRD Steve Beck, ADB: We completely support the Basel committee s efforts to create a more robust financial system. They have an important and very tough job. Our concern is with unintended consequences with respect to trade finance. If trade finance is treated the same as other transactions, if the cost of capital to do trade finance is the same as the cost of capital to do a more risky higher-margin transaction, we are concerned about two unintended consequences. First, it will encourage financial institutions to employ capital in transactions other than trade finance, where margins are higher. This would make the private-sector gap in trade finance in developing countries even greater than it already is. Second, it would result in financial institutions assuming higher risk; the antithesis of what Basel III sets out to achieve. But it is difficult to have this conversation with Basel and other regulators without hard evidence that trade finance really is a uniquely low-risk activity compared with other types of finance. It was out of concern for the unintended consequences that ADB s TFP took the initiative to team up with the International Chambers of Commerce (ICC) to create the ICC-ADB Trade Finance Default Register. What the ICC-ADB Register succeeded in doing was to create the only available statistics compiled with data from nine major trade finance banks to demonstrate what we all know intuitively; that trade finance carries a relatively low probability of default and loss. The Register s statistics indicate a 0.02% probability of default on more than 5.2 million transactions going back five years, including during the global financial crisis. This is powerful stuff. We presented these findings, along with the ICC, to the Basel Secretariate and believe it is helping them to have a think about how to treat trade in Basel III. As it turns out, the ICC-ADB Register statistics may also be having a positive effect on financial institutions willingness to assume trade finance risk in tough markets. The Register statistics have been shown to credit-risk management departments in many financial institutions, backing requests for higher limits. Going forward, ADB s catalytic role in creating the Register is complete and it is withdrawing from the Register to let ICC take full control, along with an array of 16 banks. The ICC aims to broaden and deepen the scope of the Register s future reports by having even more data and, hopefully, having the default and loss data broken down on a country-by-country basis, which would be enormously helpful for risk management departments around the world. We are confident that these statistics will be instrumental in working with regulators and risk managers around the world to bring more support to trade, especially in developing countries. Trade is the lifeblood of any emerging market and is critical to creating the jobs and prosperity that can lift people out of poverty. This is why ADB puts so much focus on these important issues. Daniela Carrera Marquis, IDB: The arrival of Basel III may affect banks willingness to finance trade in LAC. The IDB recognises that Basel III proposes new capital, leverage www.tfreview.com 27 TFR [May 2011] cs4.indd 27 18/05/2011 15:57:03
and liquidity standards that may enhance supervision and risk management of the financial sector, but the downside is that it is especially stringent with trade finance. Basel III requirements will increase the level of provisions required for trade instruments and therefore raise costs. Trade volumes may shrink as margins are squeezed, hurting smaller exporters and financial institutions significantly more than the larger players with economies of scale and global market access. Ensuring that smaller clients continue to access international markets at competitive prices and that economic growth happens inclusively and sustainably will continue to challenge the region moving forward. Karin Oszuszky, OFID: The crisis shed a light on the role of the DFIs at a time when their resources had no common measure with the volumes transacted in the market and when their mandate appeared to have become localised and somewhat outdated. Indeed, their own policy of graduation distanced them from old partners that had become major actors in a globalised economy. DFIs need to reposition themselves and re-engineer their instruments to form better partnerships with regulators and supervisors in the market. In this crisis, the commercial banks appeared to be driven by the market rather than driving it. Their mandates need to expand beyond adding value to their shareholders; they need to include responsibility for preserving the sustainability of their actions. The crisis also demonstrated the need for DFIs and commercial banks to better interface, not simply to avoid so-called unfair competition, but to forge a new relationship that combines their respective synergies and aims to be complementary, especially in the undeveloped markets of frontier countries. Basel III and its presumed constraints is an additional reason for joint efforts to develop markets and to reduce risks. Q5. How do you see the role of DFIs evolving as the developing world joins the developed world? Rudolf Putz, EBRD: We hope that foreign commercial banks, private insurance underwriters and export credit agencies will soon gradually re-open trade finance facilities for Ukraine and Kazakhstan, and also look at smaller banks in Russia and deals in early transition countries in the Balkans, the Caucasus and Central Asia. Risk cover by DFIs will then be required only for trade finance transactions with longer tenors and larger amounts than foreign commercial banks and insurance underwriters can provide. However, I expect that for some time the trade programmes of DFIs will still play an important role in facilitating trade between less advanced countries and exports from our countries of operation. Daniela Carrera Marquis, IDB: As the paths between developed and developing economies begin to merge, SMEs especially importers and exporters may be left behind. This would reinforce the mandate of DFIs, which would need to ensure that SMEs are not excluded from growth. Leaving behind SMEs would be ruinous for the region. No matter how big companies grow, SMEs will always find a void to fill and will be a relevant source of goods, services and job creation. It is important that FIs continue to downscale and develop new products and services to address the evolving needs of this critical market segment. To adapt, DFIs will have to offer instruments and incentives that not only reduce FI risk, but also portfolio risk, fostering inclusiveness and competitiveness. It is up to the DFIs to level the playing field by developing new partnerships, risk sharing mechanisms and lines of financing. DFIs participation in trade finance is pivotal to long-term sustainability and commercial viability in LAC moving forward. Through its many trade finance programs and initiatives, the IDB seeks to ensure stable and reliable sources of trade finance for the region s many trade clients. Karin Oszuszky, OFID: OFID experienced a significant increase in requests for support from partner countries, including governments, para-statals and private-sector entities. Due to the urgency of the situation, OFID responded flexibly and rapidly. The governing board of OFID realised the importance of directing support to the most vulnerable countries, particularly in Sub- Saharan Africa where the liquidity crunch aggravated an already shallow market and caused a major slowdown in production and economic growth. OFID provided funding through its private-sector facility directly or in partnership with other DFIs. Programmes were launched to support microfinance institutions and to help recapitalise commercial banks, mainly in Africa. OFID accelerated the deployment of its trade finance facility and enhanced its resources by allocating an additional $500m. This facility faced high demand the moment it was established, particularly for pre- and post-export and import finance, and working capital for small and mediumsized enterprises. New products were introduced, particularly unfunded risksharing guarantees, with OFID sharing the risk in the portfolios of commercial banks and other DFIs. Thus, through the leveraging of the trade finance facility and collaboration with other institutions, OFID was part of a coordinated response for ensuring a continued access to finance for its partners. 28 TFR MAY 2011 TFR [May 2011] cs4.indd 28 18/05/2011 15:57:03