There are few topics these last few weeks, which have polarised opinion so strongly, but also where everyone has an opinion. In this blog we highlight the impacts of the tariffs on corporate banking but have striven hard to keep it neutral and factual. It also assumes that everything continues the way they are, but the situation is evolving. The thoughts then that follow are based on the information we have today, April 9th.

Ripple effect

An obvious statement perhaps, worth mentioning first. International trade impacts everybody, in whatever country you reside in, not least because it’s a two-sided equation – there is an importer and exporter. While there is clear impact on the exporter, and on cross-border trade, there is an impact on the buyer. They either have to: cover the additional costs themselves; hope that their buyers (and their buyers’ buyers) will bear some of the increase; or find an alternative source of the goods, which of course takes time. This will place the whole value-chain under increasing financial pressure. Businesses with low margins and/or subject to goods from countries with higher tariffs may become financially distressed quickly. For example, one potential (and probably immediate) consequence will be a rise in non-performing assets (NPAs) within banking, as many export oriented businesses rely on bank credit for working capital. With revenue impacted, some will struggle to meet repay their loans.

Expect Increased Risk, Higher Costs, Lower Revenue for Banks

This then creates risk in transaction banking, such as defaults by importers and exporters. Banks will need to review their client base, understand the risks and prepare accordingly. For example, placing higher premiums on Letters of Credit and Letters of Guarantee. This may well have impacts on liquidity availability and pricing. If trade falls, payment volumes fall. Many banks have enjoyed healthy FX rates on these trade payments. With fewer payments, and greater FX volatility, revenue are likely to fall. It’s worth noting that payment volumes domestically crudely track GDP growth. With a likely decrease in GDP, payment volumes may fall or stagnate in line, creating a higher cost per payment for the bank as a result.

What should banks do?

If we compare today to prior economic shocks, based on our IT spending forecasts going back over 20 years, the default for banks will be to pause spending on anything non-essential. Yet that isn’t necessarily the best course of action. Banks should be:

• ensuring their risk models are refined. For example, what products does the bank use that may be impacted? And they may not always be obvious – chips in processors in a data centre run by a supplier for example. And while services and software have yet to be mentioned, the impact that some form of tariff might have would have significant impact. And that’s before anything covered under the free trade agreements (i.e. financial services and insurance) is considered.

• Re-visiting their pricing engines and analytics to ensure the right prices are being charged, rather than a one-size fits all.

• Looking to reduce costs, probably by looking to the cloud or SaaS. While the threat of service tariffs and retaliation hang in the air, longer term the banks were already moving in this direction – these events accelerate this.

• Re-visiting correspondent banking. With trade seeking new import and export options, banks will need to revisit who they have relationships with. This is the subject of a forthcoming report but underlines the need for better risk management. Indeed, it may mean that some banks will tun to players such as Wise for some, or all, of their correspondent banking needs. Rather than the threat of old, banks can mitigate some of the risks they face by partnering with fintech’s.

Think long term, not short term

It’s worth noting though that previously these turbulent periods have shown those banks who lean into the challenging times, often emerge stronger on the other side.