* Banks, regulators, to discuss trade finance regulation
* Meet again in June
* Banks setting up trade finance default database
By Jonathan Lynn
GENEVA, May 18 (Reuters) - Banking regulators and commercial banks have started to discuss ways of ensuring that regulation does not hamper trade finance -- the lifeblood of global commerce -- as the sector shows an uneven recovery.
A meeting hosted by the World Trade Organization on Tuesday to review the recovery of the $10 trillion market in trade finance since the crisis brought an official from the Basel Committee on Banking Supervision around the table with industry practitioners who fear regulation could undermine the market.
"(This was) a first contact between the regulators... and the bankers on this particular issue of trade finance," one trade finance source who attended the meeting told Reuters.
Regulatory issues affect huge sums for banks active in the market that underpins the $12 trillion in world trade through traditional, short-term loans.
For instance the current Basel II regulations treat all short-term loans as if they run for at least one year, requiring banks to set aside capital accordingly.
At their London summit in April last year, G20 leaders urged regulators to be flexible in this for trade finance, but only Britain's Financial Services Authority (FSA) has waived the one-year rule for the industry.
TIED CAPITAL
The representative of one major bank in the industry told the meeting that if all other regulators followed the FSA, his bank would save $10-15 billion in capital on trade finance.
That could finance 10-12 times as much again in trade.
The meeting heard that 95 percent or more of trade finance deals -- collateralised on the cargo and self-liquidating -- for manufactured goods run for 60-90 days. For commodities it is less, with an oil cargo typically turned around in 38 days.
Because trade finance is a low-returns business, it cannot compete with more glamorous areas such as investment banking or forex trading at the best of times.
Regulations already make it unprofitable for many of the big international players, who are only sticking with it because they need to provide a full range of transaction banking services to their global clients, sources at the meeting said.
Banks fear further pressure on margins will come from proposed regulations known as Basel III that will impose a liquidity ratio to tax off-balance sheet items, where many banks hid toxic assets in the run-up to the crisis.
Because basic trade finance instruments such as documentary letters of credit are held off balance sheet until they are verified and become irrevocable commitments, this will hit trade finance banks hard, especially as 75 percent of such letters are never confirmed.
To back their contention that trade finance is twice as safe as other forms of lending, banks have agreed to pool data on default rates in a project managed by the International Chamber of Commerce (ICC), which sets letters of credit standards and arbitrates disputes, and funded by the Asian Development Bank.
The meeting heard that 8-10 leading banks in the sector will provide five years of proprietary data in a pilot project for the defaults database -- enough to test the highs and lows of the business cycle.
The Basel regulator was receptive but, like WTO Director-General Pascal Lamy, stressed the need for hard data, sources at the meeting said.
"Very encouraging -- the dialogue will continue," said one banker.
Bankers and regulators will meet again on trade finance in June, once in Frankfurt and once in Seoul, the sources said.
Banks attending the meeting include Royal Bank of Scotland