We have been writing for a few weeks that the credit crisis had engulfed letters of credit, a crucial instrument in international trade, particularly of commodities (ex oil) and other raw materials. With banks hesitating to extend credit to each other much beyond overnight (finally changing only by virtue of massive liquidity measures and recapitalizations), they are leery of taking each other’s letters of credit (when used to facilitate a sale, an L/C from a buyer must be accepted by the seller’s bank of title to the goods to pass hands).
However, despite its importance, letters of credit are a low-margin, operationally intensive banking business that seldom gets the attention of senior management. With so many trouble areas competing for attention, this one has been largely neglected.
However, the mainstream media is finally starting to take note, just as it appears (finally) to be getting on the radar screen of regulators and international trade organizations . From the Times Online:
The credit drought is undermining international trade in goods and raw materials with savage increases in the cost of funding for exporters. At the same time, buyers of goods are being denied access to letters of credit – the banking instruments that are the nuts and bolts of global trade.HSBC, a leading trade finance bank, has said that the cost of guaranteeing a letter of credit, a routine instrument used for payment of goods, has doubled. Concern is growing in the shipping industry that business is foundering because of failures in trade finance, and Pascal Lamy, director-general of the World Trade Organisation, has given warning that the credit crunch is affecting global trade, particularly in the emerging markets of Brazil, India and China. He said: “Trade finance is being offered at 300 basis points above the London Interbank Offered Rate and even at this high price, it has been difficult for developing countries to obtain.”
Mr Lamy has called a group of trade finance banks, including HSBC, Royal Bank of Scotland, JPMorgan and Commerzbank, to a meeting on November 12 with the IMF and World Bank to consider the trade finance problem.
Lack of trade finance is having a disastrous effect on shipping. In a report issued on Friday, Maersk Broker, a subsidiary of the Danish shipping group, blamed logjams in the banking system for the slump in the dry bulk cargo market: “Banks’ refusal to offer letters of credit has resulted in very few fresh cargoes reaching the market, which is adding to the owners’ woes.”
A collapse in the trade of raw materials such as grain and iron ore, after years of frantic activity, is causing havoc. The Baltic Exchange Dry Index, which measures the price of voyages and the cost of chartering vessels, has plummeted. Rates for the largest transporters, known as Capesize, peaked in May at $230,000 a day. It is estimated that the daily cost of running the ships, including depreciation, is about $15,000 but at the end of last week, rates had fallen to $5,982 a day.
According to HSBC, there has been a surge in customer requests for trade tools that can guarantee payment.
Stuart Nivison, an executive in the bank’s trade finance division, said companies that two years ago might have been happy to deal on the basis of simple orders from customers are now insisting on documentary credit.
This addresses a point a reader raised earlier, that a good deal of trade, but I believe mainly finished or intermediate goods (there the trade relationships are longer-standing) are on an open account basis. The comment above indicates that buyers are increasingly insisting on documentary letters of credit, which are used when buyers perceive the transactions to be high risk or do not have confidence in the seller. (ie, either the goods may not be what they were purported to be, or the buyer perceives there to be risk that the seller may not have satisfied certain obligations such as the payment of customs duties or port charges). Back to the article:
Anxiety about payment was pushing companies to ask for greater security, Mr Nivison said, and in such transactions, fees were soaring. He pointed to a recent case of a shipment of industrial equipment from Britain to India, where the confirmation and discounting of a letter of credit, which would normally cost 0.5 per cent of the value of the goods, had risen to more than 1 per cent. “These are big moves and reflect the nervousness in the market. People want to be sure they are paid,” Mr Nivison said.Distrust of banks is compounding the problem. “We have received requests to guarantee the credit of top-tier banks and we have also seen cases of exporters in China saying to their UK buyers which banks they will or will not accept,” Mr Nivison said. He added: “Trade finance is the oil that keeps the wheels of commerce going. Without it, everything grinds to a halt.”
Tom Lindmark 
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Curious detail here…
“We have received requests to guarantee the credit of top-tier banks and we have also seen cases of exporters in China saying to their UK buyers which banks they will or will not accept,” Mr Nivison said.
What are the exporters of China basing their list of acceptable banks on? Are they privy to information that no one else is?