Transaction Banking

Regulators need to ensure that new rules passed in the wake of the U.S. banking crisis do not increase financial exclusion, writes Tod Burwell, President & CEO of BAFT.

Via The Banker

Reactions to recent bank failures in the U.S. have unfolded along predictable lines. Banks are re-examining their client diversity, liquidity, risk management approach, lending practices and counter-party risk. Regulators are re-examining the appropriateness of existing regulations and the need for new guardrails. Investors are re-examining their risk profiles and due diligence on portfolios. There is a flight to quality.

These are all very reasonable measures to reinforce the resilience of individual institutions and the overall banking system. Yet what has not often been mentioned are the implications of recent banking failures on the underbanked and those most at risk of financial exclusion.

For several years, BAFT (Bankers Association for Finance and Trade) has highlighted the impact of correspondent bank de-risking, with the current trade finance gap standing at around $1.8bn globally, and discussed potential solutions.

The trade finance industry has endeavored to close this gap; multilateral development banks and alternative finance providers have increased lending to fill funding gaps in emerging markets; fintechs have introduced solutions to reach the underbanked; and governments have introduced policies that widen participation in national financial systems.

Then, in one day, we witnessed $42bn of deposits withdrawn from a single institution in what has been described as “the first Twitter-fuelled bank run”, causing a wave of disruption throughout the system. U.S. bank deposits fell by about $175bn in the week following the collapse of Silicon Valley Bank (SVB), hitting their lowest level in two years by the end of April.

Lower deposits limit the amount of lending that banks can extend, with small and medium-sized enterprises (SMEs) the most vulnerable to the resulting squeeze in credit. Biz2Credit’s Small Business Lending Index shows that large bank lending approval rates fell to 13.5% in April 2023, a drop of more than 50% in the past three years. Small bank approvals meanwhile fell to 18.7%, nearly a 60% decline over the same period.

Strong Systems Needed

Increased financial inclusion is a contributing factor to two-thirds of the UN’s Sustainable Development Goals, promoting growth, addressing poverty and enhancing financial stability of society. While large banks remain systemically important to the global economy, these institutions rely on strong local and regional banking systems to reach parts of the market they are less equipped to serve.

In the weeks following the recent U.S. bank failures, the country’s regional banks have been adversely affected, with their letters of credit requiring additional confirmation and additional restrictions being placed on their ability to obtain insurance on certain transactions. Relationship reviews are underway, putting additional institutions in jeopardy of being de-risked.

Fintechs routinely partner with banks to extend capabilities to the SME and micro-SME market with cost- and technology-efficient solutions. Non-traditional financial service providers are engaging in more traditional banking activity.

However, fintech, crypto and digital wallet companies that accept and hold client funds are also susceptible to interest rate risk, uninsured assets and liquidity crises. What will be the consequences of SVB for fintech banking? Fortunately, the recent U.S. bank failures have not spread to other regions of the world, but the effect on the broader ecosystem’s behaviors will be seen in the coming months.

The overall health of the international banking system remains strong, and greater inclusion inside the transparent and regulated system is better than outside it. Correspondent banks should absolutely look at their individual portfolios to make sound risk and liquidity decisions, but also consider the broader economic impact of fewer companies able to trade, transact and make payments if de-risking is expanded.

While it is certainly appropriate to re-examine regulations to determine if any modifications are required, regulators should also take care to avoid unintended consequences of more financial exclusion resulting from new regulation.

Next Steps

BAFT has participated in the World Trade Board’s efforts to produce a roadmap for financial inclusion in trade, outlining steps various parties can take to help eliminate the $1.8tn trade finance gap. It calls for digital, data and legal infrastructure reform, new funding sources and technical assistance to organizations that need to build their capabilities.

This last point was identified particularly with local and regional banks in mind. Regional banks would do well to increase not only their technical capabilities, but also would benefit from increasing their direct relationships with each other across the global community.

The World Bank estimates around 1.4 billion adults remain unbanked, and SME and micro-SMEs around the world remain particularly vulnerable to disruption in the financial system. If our collective response leads to more financial exclusion, one could argue that we will have weakened, rather than strengthened, the overall financial system.

During a recent conversation with a friend who is a small business owner, I talked about what the banking industry and policy-makers were doing in response to recent bank failures. His response still resonates: “Don’t forget about us.”