OREANDA-NEWS. Traditional trade finance, a short-term form of lending, is generally low risk but the standalone ratings we assign to specialist trade finance banks indicate speculative fundamental credit quality, says Fitch Ratings.

Viability Ratings (VRs) are almost all in the 'bb' range, reflecting the higher-risk emerging markets in which the banks operate, their small size, monoline business models and niche franchises, which often rely on strong client relationships, particular industries, commodities or countries.

The banks have an inherently higher risk appetite and are vulnerable to external shocks. Transaction structures are designed to mitigate credit risk, but concentrations can be high and asset quality can come under pressure when operating conditions deteriorate.

Where counterparties are other banks, impairments are low, but defaults are more common where banks have diversified away from traditional business, such as letters of credit, into broader trade-related activities. These may include the provision of unsecured working capital finance for importers and exporters. In our view, a significant shift away from a bank's area of expertise often results in losses.

Operational risks are significant because transaction structures can be complex, documentation checking is labour intensive and trade deals can extend across countries with different legal systems. Risk of compliance failure, fraud and human error is high.

More positively, senior management at rated trade finance banks tend to have had long careers at their banks and levels of expertise are high. This can help offset some of these the business risks faced by the banks.

Funding and liquidity profiles are generally stable despite a reliance on market funding. Some banks attract customer deposits, but concentration levels are high, which reduces the benefit of funding diversification. Liquidity is supported by the short-term and self-liquidating nature of a large proportion of trade finance operations.

Regulatory capital ratios are adequate, but in our opinion, the banks are sensitive to shocks because absolute levels of capital are low. Trade finance banks have high off-balance-sheet exposures and credit conversion factors assigned to these are favourable, reflecting their generally low-risk nature. Basel III leverage ratios are leading to an increase in minimum capital requirements for the trade finance banks, which is a positive rating factor.

An in-depth review of rated specialist trade finance banks, Arap Turk Bankasi A. S, Banque de Commerce et de Placements SA, Fimbank Plc, Banca UBAE and Union de Banques Arabes et Francaises, is contained in a peer review report, released today, and available by clicking on the link with this release.