The purpose of Basel II, the second of the Basel Accords (which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision), was to create an international standard that banking regulators can use when creating regulations about how much capital needs to be reserved to guard against financial and operational risks. In essence, the goal was to reduce risk and insure trade even in the event that a series of major banks collapsed.
But did it, in fact, accomplish the exact opposite? In two recent articles in the financial times which addressed the current trade credit shortages that are threatening to throttle the global flow of goods, we see that Basel II has become (an) obstacle to trade flows. It seems that the Basel II charter imposes a significant increase in the risk weighting for this activity, relative to its predecessor. (This is scary. Physical goods HAVE a value and invoices to solvent companies result in receivables and trade credit loans make a lot more sense than business development loans to risky start-ups or bail-outs to big corporations that ARE NOT too big to fail in this economy).
More specifically, the focus of Basel II on the “probability of default” of banks’ counterparts — which naturally increases during downturns — substantially exacerbates the negative effect of recessions on banks’ lending. In this context, Basel II has inadvertently become an obstruction to the very lifeblood of international trade. As a result, even though the World Bank (is) urged to lift trade credit finance by the primary global players in trade finance, until a review of the impact of Basel II implementation on lending activities is carried out and new recommendations are made, those companies that don’t take a different path to trade finance and start trading against accounts receivable on The Receivables Exchange (in the US) or Venture Finance (in the UK) are going to have a very rough road ahead.