Metals trading companies face increasing funding costs and counterparty risk as the banks' funding crisis threatens to spread to the industrial sector, an executive at UK-based trading house Stemcor told Reuters.

In terms of counterparty risk from customers such as producers, we anticipate a deterioration of credit conditions of counterparties, said Colin Heritage, managing director at Stemcor Trade Finance, a wholly-owned subsidiary of the Stemcor Group. But we hedge this risk as much as we can, particularly with insurance.

The worry that we have is that the bank crisis will feed into a much larger industrial crisis as confidence falls. There is no sign of that happening yet - but the more bank credit restrictions go on the more worrying it will be.

The deteriorating credit climate is putting pressure on the finances of smaller, less liquid trading companies and is constraining business expansion for larger companies, which have become much more cautious when it comes to invest in new, long-term, bigger projects, Heritage said in an interview.

Soaring financial costs have pushed metals trading companies to look further afield as their usual lenders cut exposure to commodity trade finance.

We are thinking more carefully of banks we'd like to work with, Heritage said.

For new or non-vanilla transactions some banks who we traditionally work with in commodity trade financing are now happy for us to move business elsewhere... It's not a problem for our business, we may just simply go to a different selection of banks.

Non-vanilla, or customized rather than plain transactions, represent a growing part of the services that trading companies offer to their customers.

THE BIG SQUEEZE

Analysts say French and other European banks, which have been very active in commodity trade finance, are cutting down on this activity due to the euro funding stress in money markets.

This has left room for other banks, U.S. banks in particular, to expand their exposure to commodity trade finance.

Some American banks are interested in getting more involved into commodity trade financing but the track record of American banks, like British banks, has been patchy, Heritage said.

They are more conservative. We'll have to wait and see how long they are going to be committed to this.

Independent banks and funds are also trying to cash in on the French banks withdrawal from commodity trade finance, said Ramon Muga, global head of trading, coal & fuels, at London-based trading house Metalloyd.

While most large trading houses are not suffering too much from the credit squeeze yet in terms of day-to-day activity, the pressure on medium and smaller traders is mounting as banks are less prone to finance less established businesses, Heritage said.

Big traders tend to have a larger availability of committed credit lines while smaller businesses depend more on uncommitted lines, which are a less reliable funding mean.

While in a committed credit facility terms and conditions are clearly defined by the lender and the borrower and cannot be altered, under an uncommitted facility, banks are not under any obligation to provide the amount of money promised to the borrower.

Raising any kind of credit however, will become more expensive in the next few months.

The issue of funding these syndicated committed facilities will come at the moment when these facilities will have to be renewed. Banks are giving notice of likely price increases for bilateral facilities, Heritage said, adding that about 33 percent of Stemcor's financing facilities today are committed.

Raising dollars has become one of the difficulties European banks face and is restricting their role in commodities, which are mostly dollar-denominated.

Borrowing dollars is much more expensive that it was, Heritage said. Some European banks have offered to lend euros rather than dollars and is 1 or 2 cases, when our customer was available to bear to currency risk we have accepted it.

But in many cases it is not really appropriate because our business is still dollar-denominated and that is what we need.

(Editing by William Hardy)