Regulatory reform aimed at preventing banks from building up toxic assets could make it more expensive and harder for banks to fund exports, a trade finance expert said.

Reigniting world trade, which suffered its biggest collapse last year since World War Two, is seen as vital to revive the global economy.

But Marc Auboin, the World Trade Organisation's trade finance expert, said draft regulatory reforms known as Basel III, making it more expensive for banks to hide assets off their balance sheets, would also push up the cost of funding trade.

Banks, encouraged by the WTO, had already started gathering evidence to show that the existing treatment of trade finance under the current Basel II rules is unfair.

'The professionals argue that the safe, short-term and self-liquidating nature of trade finance has not been properly recognised in the Basel II framework,' Auboin told Reuters.

'When we discovered what was to be put back on balance sheets (under Basel III) we had a bit of a shock and wondered whether trade finance would face another obstacle,' he said.

What is at stake is hundreds of billions of dollars of trade, especially among developing countries.

It is unclear how hard the 2008 credit crunch has hit the roughly $15 trillion of world trade, not least because there are no firm statistics on trade finance.

One indication is that a $250 billion two-year package from the World Bank and regional development banks agreed by the G20 summit in April last year has been more than fully mobilised, taking advantage of the revolving nature of such funds.

Academics believe that the bulk of the contraction in world trade last year - put at about 12 per cent by WTO director-general Pascal Lamy last week - was due to the collapse of demand in the recession.

But researchers believe that world trade fell about 10-30 per cent more than the fall in global demand would have suggested, with part of that decline due to a lack of financing.

Trade volumes are already reviving, especially in Asia.

What is clear is that the proposed Basel III rules would drive up the cost of traditional forms of trade finance, such as letters of credit, whose origins go back to mediaeval Europe and which are among the least risky forms of credit, Auboin said.

Under the existing regulations, banks must set aside capital to cover roughly 20 per cent of the value of letters of credit, because they have long been seen as so safe.

But the Basel III proposals, which require banks to cover liquidity as well as capital risks, state that banks must cover 100 per cent of off-balance-sheet assets - a five-fold increase.

Banks hold letters of credit off balance sheet while they are going through the painstaking process of verifying them - checking on the names and identities of the parties, shipping details, and local commercial law.

They only move on to a bank's balance sheet once confirmed, but typically some 75 per cent are rejected before that.

Auboin said it was reasonable for regulators to seek to cover off-balance sheet assets but letters of credit were the wrong target.

'Letters of credit have never been used for leveraging. People don't play with them in the industry.'   

Trade finance can be handled on banks' balance sheets through a form of funding known as open account, similar to an overdraft facility.

But that requires highly sophisticated software to monitor creditworthiness and is beyond the capacity of most banks in developing countries, who will be handling the growth area of South-South trade and who prefer traditional letters of credit.

'In my view this is something that is the product of a lack of understanding by regulators of what the trade community does, and what the trade community does is not properly explained to regulators,' Auboin said.-Reuters