Aside from global economic woes, perhaps the biggest challenge facing the transaction banking sector at present is a regulatory onslaught of unprecedented proportions. The Banker examines some of the major legislative headaches facing the sector.

Regulation is nothing new for the banking world. Current levels, however, are. After the financial crisis so brutally exposed the shortcomings of the global financial system, an inevitable barrage of legislation followed, as law-makers attempted to close loopholes, patch up vulnerabilities and ensure that the events of 2008 would not be repeated.

Much of this, even bankers will admit, was sorely needed. After all, there is no doubt that mistakes were made and unsafe practices indulged in during the boom years. But now, regulatory demand is being heaped upon demand, requiring even the most innocuous of business segments to comply with a mass of legislation that is unprecedented in scope, complexity and sheer scale.

Transaction banking is a case in point. It has never been a controversial business line; in fact, its core components – trade finance, cash management, payments and securities custody – are essentially a logical continuation of the services and operations that the entire banking industry was founded upon. A world away from Warren Buffett’s “financial weapons of mass destruction”.

As investment banking suffered a major dent in reputation and decline in profits, transaction banking became the unlikely darling of the financial world, growing in importance and favour thanks to its role in supporting the broader economy and the slow and steady returns that once condemned it to relative obscurity.

Nevertheless, specific requirements and broader legislation aimed at the industry as a whole has had a major impact on transaction banking operations. Indeed, the sheer volume of regulation facing the industry is in danger of swamping it completely, bankers say, to the point that just keeping pace with the latest developments is no easy task. A plethora of legislative consultations and proposals in different development stages all need to be scrutinised for potential to impact upon clients, overall operations or even entire markets.

The SEPA saga

Of course, legislation is not necessarily anything new, even pre-crisis there was hardly a dearth of regulatory initiatives. For transaction bankers, much of this took place in Europe, and was focused around industry-led initiatives working towards standardised processes, and in many cases increased competition. Chief among these is the Single Euro Payments Area (SEPA).

The initiative’s goals of opening up cross-border competition and simplifying transfers met with apparent approval from banks, businesses and regulators. However, post-2008 it was no one’s top priority and was mired in a series of delays, frustrations and painfully slow progress. For some time, one of the most pressing complaints was the lack of a solid end date, without which there was little motivation for any affected parties to make the investment required to comply.

Now, things may be looking up, with the announcement of a February 1, 2014, deadline for banks to migrate to SEPA credit transfers and direct debits. Significant progress has already been made in credit transfers, where 20% of transactions had moved to the new standard as early as the third quarter of 2011. Progress has been less spectacular on the direct debit front, although thousands of banks are already able to deliver the service.

The announcement of a solid end date has been welcomed almost universally by the banking world, but SEPA may not be good news all round. According to a recent survey conducted by payments technology provider Clear2Pay and Finextra, 75% of bankers agree that SEPA will have a negative impact on the number of banks their corporate customers choose to do business with, while 74% of respondents have concerns about increased competition as corporates choose to connect directly to clearing systems.

Meanwhile, there is of course a shadow hanging over any move towards an integrated Europe – the eurozone crisis. Consequently, there have been questions over the future of SEPA should the eurozone fragment. However, somewhat counter intuitively, SEPA could in fact be strengthened by the prospect; should multiple currencies return to the region, its role in making seamless cross-border payments would be even more valuable.

Unintended consequences

Today SEPA is but one of many pieces of legislation in the post-crisis landscape. Transaction bankers, like the rest of the industry, also have to deal with a veritable deluge of proposed legislation. While the sector has not been singled out for special regulatory attention, perhaps the main worry is the possibility of collateral damage as a result of attempts to safeguard the global financial system.

Perhaps the most obvious example is the third iteration of the Basel Committee on Banking Supervision's Basel Accords. For some time now, bankers and economists have warned that the accord’s stringent capital requirements and planned global standards for leverage and liquidity might result in trade financing becoming prohibitively expensive. Under the new rules, a leverage conversion factor of 100% is assumed, meaning banks would be required to hold capital against the entire value of a trade finance lending commitment, up from the current pre-requisite of 20% under Basel II – itself an increase of 10% from Basel I.

The rules are predicated on the principle that off-balance-sheet instruments could be a significant source of leverage for banks, and, therefore, should be considered along with an institution's overall obligations and limited as such. However, planned leverage ratios do not take account of a loan’s risk profile. As a result, lower-risk trade obligations – such as letters of credit – face being caught up with other, riskier instruments such as a long-tenor syndicated loan or derivatives.

The potential repercussions, according to some estimates, could lead to a 6% reduction in global trade finance capacity, as well as an increase in pricing of as much as 40%. At the same time, an increase in the amount of capital that banks have to set aside for trade finance would make it a far less attractive business proposition. If trade finance instruments, which are not massively lucrative, are treated in the same manner as far more profitable products, their provision will appear to be a far less attractive proposition.

In response the banking industry does appear to have pulled together on the issue. The International Chamber of Commerce (ICC) together with the Asian Development Bank, for example, has created a register of 5.22 million trade finance transactions conducted around the world by nine international banks over a five-year period. For the first time, the industry has empirical data to present to regulators on the average duration (115 days) of a trade finance deal and on total default rates (which amounted to just 1140).

It seems some are paying attention. The EU parliament recently voted through lower capital requirements on trade finance than proposed under Basel III. But that does not mean all is well. Asian banks have voiced major concerns about difficulties that banks in the region will have in meeting Basel III’s leverage ratios. Worries have also been raised that the accord’s onerous requirements in dealing with banks with poor credit ratings (requiring more risk-weighted capital to be held against their assets) might ease many such institutions – which are often active trade finance providers – out of the market.

Basel III will inevitably have wider repercussions, too. Any regulation that will impact on how banks operate and result in increased collateral or balance sheet costs will ultimately be passed on to the customer via increased costs or reduction in services.

Impending regulation

In the US, all encompassing regulation is an added problem. In particular, the Dodd-Frank Wall Street Reform and Consumer Protection Act, which, instead of being divided into separate chunks European-style, sees a variety of resolutions crammed together in a 2000-page whole.

Its sheer magnitude could cause some serious problems. Much of the act is focused on addressing potential weaknesses in the US financial system, via increased balance sheet liquidity, for example, making it by nature the kind of legislation that has the potential to impact across a bank’s operations.

Moreover, additional clauses have been added that could have a direct effect on transaction services providers. These include attempts to regulate overseas remittances and better protect consumers when moving money internationally.

These provisions are an attempt to create, for example, predictability in foreign exchange deductions right up to the beneficiary, but that is no easy task in an international transaction, and a lack of clarity over requirements may see providers withdraw from the market.

For the world of transaction banking then, regulatory requirements – both specific and broad – will likely remain major issues for some time. But as an easing of Basel III’s trade financing implications show, cohesive attempts to engage with governing bodies appears to be paying dividends as awareness grows of the industry’s importance to the broader economy.

PLEASE ENTER YOUR DETAILS TO WATCH THIS VIDEO

All fields are mandatory

The Banker is a service from the Financial Times. The Financial Times Ltd takes your privacy seriously.

Choose how you want us to contact you.

Invites and Offers from The Banker

Receive exclusive personalised event invitations, carefully curated offers and promotions from The Banker



For more information about how we use your data, please refer to our privacy and cookie policies.

Terms and conditions

Join our community

The Banker on Twitter