Trade Finance Strategy For Commercial Banks In China Under Capital Constraint

While commercial banks in China are looking to explore new business model for trade finance in the face of fierce competition, the tightened capital-based supervision over banking industry presents new challenges to them. The announcement of Basel II Capital Accord and the promulgation of Regulation Governing Capital Adequacy of Commercial Banks in 2004 signify the establishment of risk capital-based business philosophy and supervision approach in China. Banks are not only subject to regulation from external supervisory authority but also bound by internal capital constraint on assets expansion, and supposed to achieve satisfactory return on capital. Therefore, it's essential for commercial banks to change their business focus to such business as trade finance that requires less capital, thus forming a new strategy of trade finance under capital constraint turns to be of great importance.At present, many domestic researches have been made on the impact of capital constraint to commercial banks on strategic level, but few is said about the impact to certain business line on operational level. This paper serves to fill the gap in this field by analyzing the influence of capital constraint on trade finance from operational perspective. Under Basel II's Internal Rating Based Approach, the facility rating process factors in the self-liquidation and low default characteristic of trade finance and risk mitigation, thus the decreased Loss Given Default of trade finance can improve facility rating and in turn economize capital allot and lead to higher risk adjusted return on capital (RAROC). In order to achieve higher RAROC of trade finance, a bank needs to improve revenue, decrease cost and accurately compute economic capital, which depend on the bank's business growth, cost control and risk management respectively. As such, based on international banking practice, the author suggests that commercial banks should adapt to the changing regulatory and business environment and remold trade finance business model. Commercial banks can leverage the low default characteristics of trade finance and risk mitigation technology to provide diversified and unique trade finance products, and adopt three positive strategies including Supply Chain Finance, Restructured Finance and building electronic trade platform to increase RAROC and achieve sustainable development under capital constraint. The research offers valuable and practical reference to trade finance practitioners of banking industry in China.This paper comprises the following four parts:Part I is on the general condition of trade finance business of commercial banks in China, and the change of regulatory and competition environments; Part II offers brief account of BASEL II and analysis on the capital constraint confronted commercial banks in China; Part III provides introduction of the IRB approach and capital allot, and analyses of capital constraint impact on trade finance in terms of risk measurement, risk mitigation, capital allot and RAROC; the last part contains the strategies for trade finance presented by the author.