* Basel supervisors urged to create trade finance group
* 60 percent of banks say trade finance decreased in 2009
* 84 percent expect increase in demand this year
BEIJING, April 22 (Reuters) - Banking regulators should rethink the rules for trade finance to prevent the market being suffocated as it recovers from the financial crisis, the International Chamber of Commerce (ICC) said on Thursday.
The report said planned regulation changes could raise the cost of trade finance or cut it off for some exporters.
"It is our contention that this approach is unjustified," said the report, which is based on a survey of banks active in trade finance, the traditional instruments and relatively secure instruments that keep global commerce flowing.
"Moreover it is liable to lead to an overall reduction in the supply of trade finance, contrary to the G20 London Summit agenda to promote international trade as a key vector of economic recovery."
The ICC urged the Basel Committee on Banking Supervision to set up a specialist working group on trade finance, and called for better data on the sector, including on how risky it is. The ICC is already working with the Asian Development Bank to build a database on trade finance default rates.
Banks argue that the current rules do not reflect the short-term self-liquidating nature of most trade finance, while proposed tougher regulations would require banks to set aside 100 percent of their value as off-balance-sheet assets, compared to about 20 percent now.
"It appears that low-risk trade finance instruments are being lumped together with higher risk off-balance sheet items, without an appreciation of unintended consequences," the ICC report said.
REDUCED SUPPLY
The report and survey, commissioned by the World Trade Organization, are aimed at the G20 summit in Toronto in June.
A similar survey ahead of the G20 summit in London in April last year drew attention to strains in the sector and led to the group approving a $250 billion two-year trade finance package.
Some 90 percent of the $12 trillion trade in merchandise is supported by trade finance -- simple instruments sometimes centuries old, secured on the goods being sold, liquidating when the short-term transaction completes and based on the knowledge that exporter, importer and their banks have of each other.
But the financial crisis made banks unwilling to lend to each other and trade finance was caught up in the panic.
As trade finance dried up, and the price of what was available spiralled, policymakers feared the drought could choke off economic recovery by intensifying the contraction in trade.
Economists now believe that trade finance accounted for only a small part of the contraction in world trade last year, put at 12.2 percent by the WTO, but the fear remains.
"The economic crisis has significantly reduced the supply of trade finance, both in volume and value terms, raising fears that the lack of such finance may prolong the recession," the ICC said.
The survey of 161 banks in 75 countries, one third more than last year, showed trade finance contracted together with trade.
In value terms, 60 percent of respondents said trade finance activity had decreased in 2009, mainly due to lower commodity prices, the weak dollar and debt restructuring.
In volume terms, 43 percent of respondents reported a decrease in export letters of credit, one of the main instruments, while 26 percent saw a decrease in import letters of credit and 51 percent saw no change from 2008.
Although 96 percent said losses in traditional trade finance products were the same or lower than losses for banking generally, 40 percent said they had cut trade credit lines for companies and 42 percent had cut them to financial institutions.
With trade rebounding this year -- the WTO forecasts a 9.5 percent rise -- 84 percent of respondents in the survey expect an increase in demand for traditional trade finance products and 93 percent are confident they can meet any increase in demand. (For FACTBOX on trade finance regulation go to) (For full ICC report go to www.icctradefinancereport.org ) (Reporting by Jonathan Lynn, editing by Lin Noueihed)