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How Covid-19 will increase trade finance regulation

02 August, 2020Ouida Taaffe

Global institutions would like banks to close the trade finance gap that has widened during the Covid-19 crisis. But there could be a push for greater oversight and compliance – particularly during the transition to digital services.

Cranes in a dockTrade banks are struggling under the rising cost of compliance.

This was revealed in the recent International Chamber of Commerce (ICC) Banking Commission’s Global Survey – based on the responses of 346 trade banks in 85 countries.

Asked about potential obstacles to growth prospects, 63% of the banks said they were “extremely concerned” about anti-money-laundering (AML) and ‘know your customer’ (KYC) requirements.

Compliance was their biggest worry with a 13-percentage point lead over “high transaction costs or low-fee income”.

But, despite the high costs of compliance, other issues could increase the load on banks – at least in the near term.

Companies may become more demanding

One answer is business practice.

Companies are keen to ensure their supply chains are stable and remain open, despite pressures from the US-China trade war and the Covid-19 crisis. 

But at the same time, this could raise opportunities for criminals – particularly as they onboard new suppliers. The increased reliance on electronic forms of communication in the current crisis also presents threats as it can be prone to misuse. 

Companies might push banks to either help them more by monitoring what’s going on, or lose business to fintechs who can provide the monitoring services they need. So the burden on banks increases.

Regulators could increase the compliance burden

Crises often trigger changes in regulation as jurisdictions start to grapple with new problems and the unintended consequences of existing rules.

After the financial crisis of 2008, for example, tougher compliance standards led to a fall in correspondent banking relationships. Increased costs simply made some of them uneconomical.

Finance consultant, Dominic Broom says, “During the financial crisis of 2008 – when there was a crisis of confidence around ability to pay – there was a spike in the use of letters of credit and of documentary credits. But that shift, from open account to documentary credits as perceived risks increase, has not happened this time.”

This might be because the current crisis wasn’t caused by a credit or liquidity crisis. And because letters of credit rely on manual processes, which have been challenging to manage during lockdown.

But according to Broom, it does not indicate any complacency around risk or an easing-up on compliance.

In particular, there’s concern about how to close the widening trade finance gap, which will likely lead to some regulatory changes.

To make funding small firms more economically viable, banks want regulators to ease the rules on the capital risk-weighting of trade finance – the so-called “risk-aligned treatment”.

But that may lead regulators to put more pressure on banks in relation to KYC, AML and countering the financing of terrorism.

“Compliance is an increasingly hot topic,” says Broom. He points to the nearly £38m fine imposed on Commerzbank in June for failing to have adequate AML systems and controls.

Regulators globally have sought to ensure that compliance requirements do not stop financial services firms from funding clients during lockdown.

For example, the FCA has recognised that “continuing to operate within the legislative framework for anti-money laundering and counter terrorist financing, firms may need to reprioritise or reasonably delay some activities”.

However, there is no free pass.

“Firms must not weaken their controls” and money laundering reporting officers can only be furloughed “as a last resort”.

Can technology ease the compliance burden on banks?

Technology promises to offer greater transparency on what is really going on in supply chains, but it’s still early days. Banks may have to brace themselves for yet more regulation. 

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