What is the impact of the new Basel IV regulation for banks and corporates? TFG heard from Swiss Re’s Global Head of Trade and Infrastructure Finance on the current state of Basel regulation as well as the latest updates following on from the EBA’s Consultation Paper. The interview was held at ExCred Commodities London.

Featuring: Davide Guidicelli, Global Head of Trade & Infrastructure Finance, Swiss Re

Host: Deepesh Patel, Editor, Trade Finance Global

DP: Thank you for joining us Davide! What do you do Davide at Swiss Re?

My name is Davide Guidicelli. I’m heading up Bank Trade & Infrastructure Finance (BTI) at Swiss Re Corporate Solutions. BTI is our credit insurance offering for banking clients in the space of trade, structured trade, commodity finance and project finance. I’m based in Zurich, already 19 years with Swiss Re Group in various roles, and I’m originally from the Italian part of Switzerland.

Basel IV and Insuring Commodity Finance

What are the key considerations for credit insurance on Basel IV?

I think there are 2 main considerations for the credit insurance community in general:

1.) To what extent will Basel IV impact the demand for distribution in general, and the demand for credit insurance in particular;

2.) To what extent will credit insurance as a risk transfer tool to free up capital remain effective under Basel IV.

Basel IV Impact for Distribution and Demand for Credit Insurance

On the first one, on the demand side, the impact of Basel IV will very much depend bank by bank. This is mainly because many banks operate under the advanced internal ratings-based approach (A-IRB) when setting capital charges: the farther away they are to the more standardised capital charges of Basel IV, the bigger the impact of Basel IV.

Generally, I sense active capital management and the need for distribution will become even more important with Basel IV which is promising for credit insurers. My sense out of client discussions is that the more credit insurers can give credit to structures, to security, particularly on longer-term assets, the more beneficial it is for a bank to work with credit insurers.

Basel IV and Credit Insurance – Risk Transfer Tool

Now, let’s turn to the second point on how effective credit insurance will remain as a risk transfer tool under Basel IV. Credit insurance essentially leads to substitution of relevant parameters, namely probability of default (PD) and loss given default (LGD), of the underlying position with that of the credit insurer. On the probability of default we should still be good, if insurers have a strong rating (e.g. substituting the PD of the underlying position with Swiss Re Corporate Solutions AA- rating).

Basel IV and Loss Given Defaults (LDG)

The trickier point is the LDG side, the loss given default, where obviously the Basel IV framework as it stands today foresees a generic 45% LGD floor for financial institutions. This might be an acceptable LGD level if a bank lends to an insurer but with credit insurance, the bank is a policyholder of an insurance cover, and this is a much more preferential and senior position than senior unsecured lending. If this LGD floor is not lowered, the risk I see is anti-selection, namely that only the riskiest positions of bank portfolios will remain economically viable to insure. This might lead to a shrinking of credit insurance supply because obviously also insurers strive for a balanced and diversified book of credits. With that, I think it’s fair to say that we, I mean the full value chain of banks, insurers, broker partners, are all in the same boat: we strive to ensure that credit insurance remains effective and viable under Basel IV.

This is also the background of active lobbying around this topic to really make the case that LGD for credit insurance gets differentiated. On one side, there is the technical part of the 45% LGD floor as explained above, but in my view there’s also a broader macro-economic perspective: essentially credit insurance and brokers together with banks form part of a value chain which is important to finance the real economy. Obviously, if this value chain gets disrupted with the Basel IV framework this has an impact on the real economy (e.g. less lending for smaller corporates/SMEs leading to less economic activity and development).