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WTO Working Papers

WTO working papers usually represent research in progress. Such research may be conducted in the preparation of WTO Secretariat reports, studies or other material for WTO members. The papers are circulated for comment because the WTO considers critical review of professional research to be extremely important.

English

The Impact of Basel III on Trade Finance

The Potential Unintended Consequences of the Leverage Ratio

Trade finance, particularly in the form of short-term, self-liquidating letters of credit and the like, has received relatively favourable treatment regarding capital adequacy and liquidity under Basel III, the new international prudential framework. However, concerns have been expressed over the potential” unintended consequences” of applying the newly created leverage ratio to these instruments, notably for developing countries’ trade. This paper offers a relatively simple model approach showing the conditions under which the initially proposed 100% leverage tax on non-leveraged activities such as letters of credit would reduce their natural attractiveness relative to higher-risk, less collateralized assets, which may stand in the balance sheet of banks. Under these conditions, the model shows that leverage ratio may nullify in part the effect of the low capital ratio that is commensurate to the low risk of such instruments. The decision by the Basel committee on 12 January 2014 to reduce the leverage ratio seems to be justified by the analytical framework developed in this paper.

English

Keywords: trade financing, prudential supervision and trade, cooperation with international financial institutions
JEL: G32: Financial Economics / Corporate Finance and Governance / Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill; G21: Financial Economics / Financial Institutions and Services / Banks; Depository Institutions; Micro Finance Institutions; Mortgages; F13: International Economics / Trade / Trade Policy; International Trade Organizations; F34: International Economics / International Finance / International Lending and Debt Problems; O19: Economic Development, Innovation, Technological Change, and Growth / Economic Development / International Linkages to Development; Role of International Organizations; F36: International Economics / International Finance / Financial Aspects of Economic Integration; E44: Macroeconomics and Monetary Economics / Money and Interest Rates / Financial Markets and the Macroeconomy
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