European Banks Lose Appetite for Commodity Trade Financing
Reprinted from the FT – 14/08/2020
ABN Amro and BNP Paribas are retreating amid a series of scandals, large losses, and rising regulation. The retreat of ABN and BNP risks making the financing of raw materials more difficult at a time when the world is already reeling from COVID 19.
Some of Europe’s biggest banks are turning their backs on the business of financing the global market in raw materials, amid a series of scandals, large losses, and increasing regulation.
This week ABN Amro announced it was exiting commodity trade financing, a business whose roots with the Dutch bank stretch back to 1824 when King William I of the Netherlands founded its predecessor to finance the East Indies colonies.
It followed last week’s news of a decision by BNP Paribas to pull back from financing the sector amid questions over the future of its Geneva-based branch, which had played a key role in establishing the modern oil trading industry.
Banks lend to traders of energy, agricultural, and metal commodities through facilities encompassing borrowing bases, revolving credit lines, and simple letters of credit.
With a single supertanker capable of hauling a cargo of crude oil valued at more than $80m — or far more when oil prices are higher — the sums involved can be substantial.
Commodity traders, which operate on razor-thin margins, said they expected that less competition would naturally cause costs to rise. The largest of them believe they may be beneficiaries if smaller competitors are squeezed out. “If more banks withdraw from the sector then everyone could face higher financing costs, especially the smaller players,” said an executive at a major commodity trading house.
“It’s likely to be part of a cycle and we wouldn’t be surprised to see more exit before stronger banks fill this space. But in the short-term less competition will be a factor.”
The most immediate issue has been a series of alleged frauds revealed as commodity prices slumped in March and April in the face of government measures to try and halt the spread of the pandemic. The highest-profile was Singapore-based Hin Leong Trading, one of Asia’s biggest fuel traders. A police investigation is underway after its owner admitted to $800m of undisclosed losses.
ABN has previously been criticised by analysts for taking excessive risks to make up for a lack of scale across its corporate banking division, which includes trade and commodity finance. This led to several large one-off losses, including more than €200m linked to Hin Leong.
Meanwhile, BNP decided to pause lending to commodity trade houses after being hit by losses at Coex Coffee in the US, as well as GP Global Group and Phoenix Commodities in the Middle East. Clifford Abrahams, a chief financial officer at ABN, said the bank did not take on riskier customers than peers but added that its relatively small size meant any exposure to high-profile frauds had a bigger impact. “If you’ve got a big, diverse portfolio you can afford to absorb the occasional big loss — we are a smaller bank in that area so those losses may be more visible,” he said.
However, while larger banks may be more insulated from the risks of fraud, the entire sector is exposed to rising regulatory costs. Under Basel IV reforms, which come into force over the next few years, banks have less leeway to determine the risk weightings attached to their corporate loan books, requiring them to have more capital to protect against losses.
ABN’s corporate and investment banking division, for example, would need to have a third more capital than under previous arrangements. “It makes the risk/return calculations that much tougher,” Mr. Abrahams said. “That’s another reason behind our decision to focus on Europe where we have clear links with our other businesses, so there’s a better chance of earning a good return.”
Commodity traders are now asking whether the exit of two high-profile European banks will spark a wider trend.
Jean-François Lambert, a former commodity banker and founding partner of consultant Lambert Commodities, said he feared a “herd mentality” could develop. “Banks are thinking very hard these days about their strategy,” he said.
“It may not lead to complete withdrawal, but some scaling back will definitely happen, so if I was a midsized trader I would be worried.” Mr. Lambert said negotiations over the renewal of existing credit facilities could become more difficult with banks demanding additional due diligence or higher fees.