Vanya Dragomanovich in London -

In these spectacularly turbulent times, trade finance, one of the oldest forms of financing, is going through its very own mini boom and bust. Except it's moving at a slightly different pace to the rest of the market.

When emerging markets were booming, and certainly until the summer of 2007, trade finance was in decline because banks were happy taking on risk involved in selling to emerging markets. But as the markets started turning down and risk aversion became once more a key issue, trade finance started coming back into its own. Margins were rising sharply for the best part of this year, making trade finance a sort of financial Promised Land. However, September put paid to all of that and now, although there are good deals to be done, an acute lack of liquidity means that there are fewer and fewer deals happening.

"The real downtrend for us started in September, which means we are only two months into the crisis and that we don't know how long it will last," says Tomaz Lavric, deputy managing director at NLB InterFinanz. NLB InterFinanz is a Zurich-based subsidiary of Nova Ljubljanska Banka, the biggest Slovenian bank.

Indeed, on November 12, the WTO chief Pascal Lamy warned that the trade finance market's severe deterioration is likely to deteriorate further in the coming months. He identified two key problems: one is a shortage of liquidity to finance trade credits, the second is a general re-assessment of risks caused as much by the financial crisis as by the slowing down of the world economy. "The world economy is slowing and we are seeing trade decrease. If trade finance is not tackled, we run the risk of further exacerbating this downward spiral," Lamy was quoted by newswires as saying.

Promissory notes

How does trade finance work? If, for example, a German exporter sells machines to a Bulgarian company, that company will ask a local bank to issue a promissory note or a letter of credit guaranteeing that the payment will eventually be made. If the exporter is still not happy with the risk involved, it can sell the promissory note on the market. A company like NLB InterFinanz would buy it and pay the exporter, eliminating the exporter's risk. NLB could then either hold on to it until it is paid or sell it to a trade house known as a forfeiter.

Looking back, Lavric says that until the summer of 2007, "everybody was throwing cash at emerging markets and assuming there was no risk involved. Pricing was getting ridiculous." Margins collapsed as competition from banks increased and banks started taking on risk themselves. Forfeiters ended up closing shop or being acquired by banks. But as the financial crisis in the West intensified, trade finance started picking up and the secondary market for promissory notes started booming. "Once again, as a financial institution you could be picky about which papers you wanted to pick up," adds Lavric.

The heyday didn't last long though. The risk has rapidly increased since this summer and countries that provided interesting deals earlier in the year, such as Ukraine, Kazakhstan and Russia, are now considered too high a risk. There are still companies that provide trade finance for Ukraine and Russia, but at much steeper prices. While one year ago deals were done at the London Interbank Offered Rate (Libor), by this summer the going rate was 300 basis points over Libor and now it can be anything up to 600 basis points over.

For NLB InterFinanz, Belarus remains an interesting market, as do Bulgaria and Romania, although their risk profile has changed since they joined the EU. Lavric notes that one of his company's advantages when dealing with Central and Eastern Europe is that it's a Slovenian company. "They like us (in the region) because we are Slavs, we are like a bridge to the West but not the West."

Its background gives the company a particular advantage on its old turf - former Yugoslav countries. "If you fully understand your market, you can do a lot. We have local knowledge in Serbia, Croatia, Montenegro and Macedonia, and we can do things that other banks can't do," says Lavric.

Regards the financial risks involved, Lavric says the way to handle it is to look at the local bank. "If the bank in the country of the importer is a good bank, a respectable bank, then as a trade finance firm you can take the risk and you should be OK."

Given what is currently happening in other parts of the financial sector, trade finance and forfeiting carry less risk than, say, trading bonds. Countries will try and avoid at all cost a situation in which their banks default on import payments because of the implications this would have on securing trade finance in the future. "Every country knows it will still have to trade once the crisis is over, they will still have to build things, buy tractors etc, and they know that if they default on trade finance there is no future. We have seen this in past crisis situations and local banks have always come good on their payments," says Lavric.

Despite the shortage of liquidity, which is currently stifling the market, Lavric is still optimistic. He says that there are good deals still to be done and that those trade houses that have the finance are still making "very nice" margins. "I don't feel too pessimistic. The markets went down really fast and I expect that when they turn, they will also turn around fast," he says. In a shifting market "forfeiters are the first two go, but they will be also the first to come back."

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