European banks are losing their appetite for commodity trade finance
Amid a series of scandals, high losses and increasing regulation, some of Europe’s largest banks are turning away from financing the world commodity market.
This week, ABN Amro announced that it was Exit from commodity trade financing, a company whose roots at the Dutch bank go back to 1824, when King William I of the Netherlands founded his predecessor to finance the East Indian colonies.
This was followed by the message from last week from a Decision by BNP Paribas to withdraw from financing the sector given the future of the Geneva office, which had played a key role in building the modern oil trading industry.
Banks lend to traders of energy, agricultural and metal commodities through facilities that include credit bases, revolving lines of credit, and simple letters of credit. With a single supertanker capable of carrying a cargo of more than $ 80 million worth of crude oil – or far more at higher oil prices – the sums involved can be substantial. The withdrawal of ABN and BNP harbors the risk that the financing of raw materials will be made more difficult at a time when the global economy is already suffering from the coronavirus.
Commodity traders who operate with wafer-thin margins expected that less competition would of course lead to rising costs. The biggest of them believe that they could benefit from crowding out smaller competitors.
“If more banks pull out of the sector, everyone could face higher financing costs, especially the smaller players,” said a manager of a large commodities trading house. “It’s likely part of a cycle and we wouldn’t be surprised to see more exits before stronger banks fill this space. But in the short term, less competition will be a factor. “
The most immediate problem was a series of alleged scams that were exposed when commodity prices plummeted in March and April amid government measures to contain the spread of the pandemic.
The most famous company was in Singapore Hin Leong Trading, one of the largest fuel traders in Asia. A police investigation is ongoing after the owner admitted undisclosed losses of $ 800 million.
ABN was previously criticized by analysts for taking undue risk to offset the lack of size across their corporate banking business, which includes trade and commodity finance. This resulted in several large one-time losses, including more than € 200 million related to Hin Leong.
Meanwhile, BNP decided to suspend lending to commodity trading houses after suffering losses at Coex Coffee in the US and GP Global Group and Phoenix Commodities in the Middle East.
Clifford Abrahams, chief financial officer at ABN, said the bank is not accepting riskier clients than its peers, but added that its relatively small size means any exposure to high profile scams will have a greater impact.
“When you have a large, diverse portfolio, you can afford to absorb large losses on occasion – we are a smaller bank in this space so those losses may be more visible,” he said.
However, while larger banks may be more insulated from the risk of fraud, the entire sector is exposed to rising regulatory costs.
As part of the Basel IV reform, which will come into effect over the next few years, banks will have less leeway in setting the risk weights of their corporate loan books, so they will have to have more equity to hedge against losses.
For example, ABN’s corporate and investment banking division would have to have a third more capital than under previous agreements.
“It makes the risk-reward calculations a lot more difficult,” Abrahams said. “That is another reason for our decision to focus on Europe, where we have clear connections to our other business areas and thus have better chances of a good return.”
Commodity traders are now wondering whether the exit of two high-profile European banks will trigger a broader trend.
Jean-François Lambert, former commodity banker and founding partner of the consulting firm Lambert Commodities, fears that a “herd mentality” could develop.
“Banks these days think very hard about their strategy,” he said. “It may not lead to a complete withdrawal, but there will definitely be a reduction. So if I were a medium-sized trader I would be worried. “
Mr Lambert said negotiations on extending existing credit facilities could become more difficult as banks demand additional due diligence or higher fees.
The response to ABN’s announcement, which was part of a broader review of its corporate and investment bank, clarified why competitors might be tempted to follow suit. The bank’s shares rose 7 percent despite posting a second straight quarterly loss.
ABN told analysts that withdrawing from trade finance would be easier than restructuring projects at other investment banks. Its balance sheet is made up of relatively simple loans, and its mainly Asian-based clients have had little overlap with the rest of its businesses.
“If it will be so easy to close without affecting the rest of the bank, as management says, why did it take so long?” said Kian Abouhossein, an analyst at JPMorgan. “The question is not why now, but why wasn’t it done five years ago?”
He suggested that the gaps left by banks like ABN and BNP are likely to be filled by more local lenders in Asia or Japanese banks. “I don’t see the other Europeans stepping in,” he said.
Baldev Bhinder, managing director of Blackstone & Gold, a Singapore-based law firm specializing in commodities, said there was a “big problem” with transparency and visibility with smaller commodity houses. Increasingly, banks want more information about their customers than just a nice looking set of accounts.
“They used to lend to SMEs with good balance sheets,” said Bhinder. “But I think we’ve got to a point where we have to accept that the balance sheets may not be the full picture.”
The biggest commodity traders won’t run out of lenders anytime soon. Trafigura, one of the top three independent oil traders, has loan agreements with 135 banks.
But ABN was seen as one of the most prominent. She was one of the bookrunners of a revolving credit facility of $ 8 billion in 2019.
Mr. Lambert said: “It sends a signal when a bench of this size leaves the room.”