Managing Credit Risk in International Trade
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- Godfrey Hart
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1 Risk in Overview Chapter 15 Managing Credit Risk in
2 Overview Risk in Overview Simple solutions and their risks bills Payments: Credit: The Letter of Credit Advising/Confirming a L/C Factoring Credit insurance
3 Overview Risk in Overview Simple solutions and their risks bills Payments: Credit: The Letter of Credit Advising/Confirming a L/C Factoring Credit insurance
4 Overview Risk in Overview Simple solutions and their risks bills Payments: Credit: The Letter of Credit Advising/Confirming a L/C Factoring Credit insurance
5 Overview Risk in Overview Simple solutions and their risks bills Payments: Credit: The Letter of Credit Advising/Confirming a L/C Factoring Credit insurance
6 Overview Risk in Overview Simple solutions and their risks bills Payments: Credit: The Letter of Credit Advising/Confirming a L/C Factoring Credit insurance
7 Issues in this chapter Risk in Payments: Credit: Physical risks can be insured contract stipulates who has to insure e.g. cif v fob price Credit risks of all kinds non-delivery of goods or money substandard or late delivery; late payment bureaucratic hick-ups; transfer risk etc... all complicated by distance and travel time (persons, goods) different jurisdictions Financing extra long delays: travel, clear thru customs
8 Issues in this chapter Risk in Payments: Credit: Physical risks can be insured contract stipulates who has to insure e.g. cif v fob price Credit risks of all kinds non-delivery of goods or money substandard or late delivery; late payment bureaucratic hick-ups; transfer risk etc... all complicated by distance and travel time (persons, goods) different jurisdictions Financing extra long delays: travel, clear thru customs
9 Issues in this chapter Risk in Payments: Credit: Physical risks can be insured contract stipulates who has to insure e.g. cif v fob price Credit risks of all kinds non-delivery of goods or money substandard or late delivery; late payment bureaucratic hick-ups; transfer risk etc... all complicated by distance and travel time (persons, goods) different jurisdictions Financing extra long delays: travel, clear thru customs
10 Outline Risk in Simple solutions and their risks bills Simple solutions and their risks bills Payments: Credit: Payments: Credit: The Letter of Credit Advising/Confirming a L/C Factoring Credit insurance
11 Simple solutions and their risks Risk in Simple solutions and their risks bills Payments: Credit: Payment after delivery like in domestic trade. X s risks: Payment before shipment. M s risks: Legal redress? one party faces unfamiliar language, legal system court ruling comes too late ruling cannot be enforced in at least one country Gvmt acting as Gvmt ( prince ) is beyond the courts
12 Simple solutions and their risks Risk in Simple solutions and their risks bills Payments: Credit: Payment after delivery like in domestic trade. X s risks: Payment before shipment. M s risks: Legal redress? one party faces unfamiliar language, legal system court ruling comes too late ruling cannot be enforced in at least one country Gvmt acting as Gvmt ( prince ) is beyond the courts
13 Simple solutions and their risks Risk in Simple solutions and their risks bills Payments: Credit: Payment after delivery like in domestic trade. X s risks: Payment before shipment. M s risks: Legal redress? one party faces unfamiliar language, legal system court ruling comes too late ruling cannot be enforced in at least one country Gvmt acting as Gvmt ( prince ) is beyond the courts
14 Keeping scores Risk in Simple solutions and their risks bills Payments: Credit: Scorecard pay after delivery pay before shipment D/P D/A L/C a. Exporter s risks confirmed L/C a.1. Importer refuses goods Importer refuses documents a.2. Importer defaults + L/C s issuing bank defaults a.3. No license to import goods + a.4. No license to remit payment + b.1. Exporter doesn t send goods + b.2. Goods sent do not conform + b.3. No license to ship the goods + b. Importer s risks
15 bills Risk in Simple solutions and their risks bills Payments: Credit: What s a trade bill? like an invoice: drawn by seller (drawer) upon buyer (drawee) refers to trade transaction accepted bills; acceptance Why do banks like them? negotiable (discounting, rediscounting; discount house, CB) CB or specialized Gt discount house used to discount export bills at subsidized rates protesting: ruins your creditworthiness country-wide secured loan: recourse on drawer, who endorses Payment via acceptance upon delivery? Importer s risk: time to inspect goods? Exporter s risk: default
16 bills Risk in Simple solutions and their risks bills Payments: Credit: What s a trade bill? like an invoice: drawn by seller (drawer) upon buyer (drawee) refers to trade transaction accepted bills; acceptance Why do banks like them? negotiable (discounting, rediscounting; discount house, CB) CB or specialized Gt discount house used to discount export bills at subsidized rates protesting: ruins your creditworthiness country-wide secured loan: recourse on drawer, who endorses Payment via acceptance upon delivery? Importer s risk: time to inspect goods? Exporter s risk: default
17 bills Risk in Simple solutions and their risks bills Payments: Credit: What s a trade bill? like an invoice: drawn by seller (drawer) upon buyer (drawee) refers to trade transaction accepted bills; acceptance Why do banks like them? negotiable (discounting, rediscounting; discount house, CB) CB or specialized Gt discount house used to discount export bills at subsidized rates protesting: ruins your creditworthiness country-wide secured loan: recourse on drawer, who endorses Payment via acceptance upon delivery? Importer s risk: time to inspect goods? Exporter s risk: default
18 Outline Risk in Simple solutions and their risks bills Payments: Credit: Payments: Credit: The Letter of Credit Advising/Confirming a L/C Factoring Credit insurance
19 Payments: Risk in Payments: Credit: credits (of many forms) try to overcome the delay/distance problem lower the importer s incentive to default redistribute risks towards parties better placed to assess the risk bear the risk The bank is your friend 8 < describe the goods sent X sends docs that provide title to a trusted : are needed for customs intermediary, j verifies whether all required docs are there.. who transmits them to M.. against j either payment (D/P) or acceptance of a bill (D/A) (+ signing trust receipt, sometimes)
20 Payments: Risk in Payments: Credit: credits (of many forms) try to overcome the delay/distance problem lower the importer s incentive to default redistribute risks towards parties better placed to assess the risk bear the risk The bank is your friend 8 < describe the goods sent X sends docs that provide title to a trusted : are needed for customs intermediary, j verifies whether all required docs are there.. who transmits them to M.. against j either payment (D/P) or acceptance of a bill (D/A) (+ signing trust receipt, sometimes)
21 Payments: Risk in Payments: Credit: credits (of many forms) try to overcome the delay/distance problem lower the importer s incentive to default redistribute risks towards parties better placed to assess the risk bear the risk The bank is your friend 8 < describe the goods sent X sends docs that provide title to a trusted : are needed for customs intermediary, j verifies whether all required docs are there.. who transmits them to M.. against j either payment (D/P) or acceptance of a bill (D/A) (+ signing trust receipt, sometimes)
22 Payments: Risk in Payments: Credit: credits (of many forms) try to overcome the delay/distance problem lower the importer s incentive to default redistribute risks towards parties better placed to assess the risk bear the risk The bank is your friend 8 < describe the goods sent X sends docs that provide title to a trusted : are needed for customs intermediary, j verifies whether all required docs are there.. who transmits them to M.. against j either payment (D/P) or acceptance of a bill (D/A) (+ signing trust receipt, sometimes)
23 Frequently asked documents (fads) Risk in Payments: Credit: Documents Needed for the Customs Administration(s): A regular commercial invoice (an original and duplicates). A customs invoice a form for M s Customs Dpt A consular invoice certifying there is an import license A certificate of origin by exporter s government or the local chamber of commerce Phytosanitary certificates for verification of compliance with regulations. Documents Needed by the Importer: The commercial invoice. An inspection certificate item (cif etc:) An insurance policy for the individual transaction or an insurance certificate. (cif, fob etc:) A mate s receipt: goods have been loaded on board a vessel contract, and useful whenever evidence of shipping is needed). A shipping list, describing the parcels, crates, or containers. bill of l(o)ading: (i) title to the goods and (ii) contract between the exporter and the shipping company. Clean/dirty bill.
24 Frequently asked documents (fads) Risk in Payments: Credit: Documents Needed for the Customs Administration(s): A regular commercial invoice (an original and duplicates). A customs invoice a form for M s Customs Dpt A consular invoice certifying there is an import license A certificate of origin by exporter s government or the local chamber of commerce Phytosanitary certificates for verification of compliance with regulations. Documents Needed by the Importer: The commercial invoice. An inspection certificate item (cif etc:) An insurance policy for the individual transaction or an insurance certificate. (cif, fob etc:) A mate s receipt: goods have been loaded on board a vessel contract, and useful whenever evidence of shipping is needed). A shipping list, describing the parcels, crates, or containers. bill of l(o)ading: (i) title to the goods and (ii) contract between the exporter and the shipping company. Clean/dirty bill.
25 Outline Risk in Simple solutions and their risks bills Payments: Credit: The L/C Advised/Confirmed L/C Payments: Credit: The Letter of Credit Advising/Confirming a L/C Factoring Credit insurance
26 Letters of Credit: Risk in j pay immediately (D/P) L/C = promise to accept a bill drawn on bank (D/A) conformable docs arrive. international usance & practice (CC Paris), not codified law if warehouse Payments: Credit: The L/C Advised/Confirmed L/C exporter 3a: goods shipped 3b: docs sent to issuing bank 2. L/C sent to X 0. negotiations about goods and payment 4a. money or acceptance sent to X, and... 4b. docs sent to M issuing bank 5. M collects the goods importer 1. M requests a L/C from her bank
27 Advising/Confirming Risk in Payments: Credit: The L/C Advised/Confirmed L/C Risks not covered by regular L/C L/C may be counterfeited, or signed by unauthorized person, or issued by banks that are not trustworthy or hardly exist transfer risk, and default risk by issuing bank Additional information or : Advised L/C: the advisory bank checks whether that bank really exists, looks sound; whether signatures seem to be OK Confirmed L/C: confirming bank actually the payment: (D/P:) pays immediately upon receiving conformable documents (D/P:) accepts a bill upon receiving conformable documents Forfeiting. The forfeiting company discounts, without recourse, the issuing bank s acceptance or even the customer s invoice.
28 Advising/Confirming Risk in Payments: Credit: The L/C Advised/Confirmed L/C Risks not covered by regular L/C L/C may be counterfeited, or signed by unauthorized person, or issued by banks that are not trustworthy or hardly exist transfer risk, and default risk by issuing bank Additional information or : Advised L/C: the advisory bank checks whether that bank really exists, looks sound; whether signatures seem to be OK Confirmed L/C: confirming bank actually the payment: (D/P:) pays immediately upon receiving conformable documents (D/P:) accepts a bill upon receiving conformable documents Forfeiting. The forfeiting company discounts, without recourse, the issuing bank s acceptance or even the customer s invoice.
29 Advising/Confirming Risk in Payments: Credit: The L/C Advised/Confirmed L/C Risks not covered by regular L/C L/C may be counterfeited, or signed by unauthorized person, or issued by banks that are not trustworthy or hardly exist transfer risk, and default risk by issuing bank Additional information or : Advised L/C: the advisory bank checks whether that bank really exists, looks sound; whether signatures seem to be OK Confirmed L/C: confirming bank actually the payment: (D/P:) pays immediately upon receiving conformable documents (D/P:) accepts a bill upon receiving conformable documents Forfeiting. The forfeiting company discounts, without recourse, the issuing bank s acceptance or even the customer s invoice.
30 ? Risk in Payments: Credit: The L/C Advised/Confirmed L/C Final scores pay after delivery pay before shipment D/P D/A L/C a. Exporter s risks confirmed L/C a.1. Importer refuses goods Importer refuses documents a.2. Importer defaults L/C s issuing bank defaults a.3. No license to import goods + + a.4. No license to remit payment + + b. Importer s risks b.1. Exporter doesn t send goods b.2. Goods sent do not conform + +? +? +? +? b.3. No license to ship the goods
31 Benefits and costs Risk in Payments: Credit: The L/C Advised/Confirmed L/C Benefits. DocCredits achieve more than just risk-shifting: Lower costs if default actually happens: issuing bank... is (often) wealthier & better diversified (insurance principle), and operates in the same legal environment as importer (lower costs). More reliable assessment of risk: banks are specialized in evaluating credit/transfer risks; issuing bank has inside info about importer. confirming bank has more info about issuing bank. Reduction of moral hazard: Costs importer will not lightly default towards its house bank, idem for issuing bank towards confirming colleague Advisory fees: ca 0.10%, often capped Confirmation fees: as of 0.10% for good risks and short maturities Commissions for the actual payment or discounting: as of 0.10%
32 Benefits and costs Risk in Payments: Credit: The L/C Advised/Confirmed L/C Benefits. DocCredits achieve more than just risk-shifting: Lower costs if default actually happens: issuing bank... is (often) wealthier & better diversified (insurance principle), and operates in the same legal environment as importer (lower costs). More reliable assessment of risk: banks are specialized in evaluating credit/transfer risks; issuing bank has inside info about importer. confirming bank has more info about issuing bank. Reduction of moral hazard: Costs importer will not lightly default towards its house bank, idem for issuing bank towards confirming colleague Advisory fees: ca 0.10%, often capped Confirmation fees: as of 0.10% for good risks and short maturities Commissions for the actual payment or discounting: as of 0.10%
33 Outline Risk in Simple solutions and their risks bills Payments: Credit: Factoring Credit insurance Payments: Credit: The Letter of Credit Advising/Confirming a L/C Factoring Credit insurance
34 Factoring Risk in Payments: Credit: Factoring Credit insurance Services offered by a factor company may include: pure debt collection (with recourse; fee of e.g. 1/8-1/2%. Export factor & import factor cooperate. credit insurance, sometimes up to 100%, for a fee of e.g. 0.5 to 2%. accounts receivable financing, e.g., up to 85% for uninsured A/R, 100% for insured Comparing with L/C s: cannot be used on a case-by-case basis: a factor company wants to handle all sales, or at least all sales for a given market. factor also first evaluates the customer and imposes credit limits per customer and/or per country.
35 Factoring Risk in Payments: Credit: Factoring Credit insurance Services offered by a factor company may include: pure debt collection (with recourse; fee of e.g. 1/8-1/2%. Export factor & import factor cooperate. credit insurance, sometimes up to 100%, for a fee of e.g. 0.5 to 2%. accounts receivable financing, e.g., up to 85% for uninsured A/R, 100% for insured Comparing with L/C s: cannot be used on a case-by-case basis: a factor company wants to handle all sales, or at least all sales for a given market. factor also first evaluates the customer and imposes credit limits per customer and/or per country.
36 Credit insurance Risk in Payments: Credit: Factoring Credit insurance Who? private: Hermes, Euler: near exports, developed countries government: Eximbank, ECGD,...: far exports, developing countries Coverage credit risk and/or transfer risk. [If the export contract is with a government body, credit risk and transfer risks are often not separated.] risk of contract cancellation can often be insured with government agencies. can be used either on a case-by-case basis, or for all contracts for a given market (better rates). coverage is never 100%, and depends on the type of policy.
37 Credit insurance Risk in Payments: Credit: Factoring Credit insurance Who? private: Hermes, Euler: near exports, developed countries government: Eximbank, ECGD,...: far exports, developing countries Coverage credit risk and/or transfer risk. [If the export contract is with a government body, credit risk and transfer risks are often not separated.] risk of contract cancellation can often be insured with government agencies. can be used either on a case-by-case basis, or for all contracts for a given market (better rates). coverage is never 100%, and depends on the type of policy.
38 Outline Risk in Simple solutions and their risks bills Payments: Credit: Payments: Credit: The Letter of Credit Advising/Confirming a L/C Factoring Credit insurance
39 Risk in Payments: Credit: The issues goods travel slowly and far working-capital financing issue. bills provide low-risk and cheap financing. Direct B2B payments offer extreme distributions of risk to one party. Legal redress is difficult, costly, late. DocCredits reduce both probability of default and cost of bearing default, and shift risks to better-informed parties. How financial institutions can help: D/P and D/A provide more balanced distributions, but there is still no insurance effect. Letters of credit shift risks to a bank that is better placed to assess them and to bear the costs of default. Id for confirmation. Advising may suffice. Factoring may combine debt collection with credit insurance and financing. Factoring does not work case by case. Insurance is available as a separate product, and possibly case by case (at a price). Cover is never 100%.
40 Risk in Payments: Credit: The issues goods travel slowly and far working-capital financing issue. bills provide low-risk and cheap financing. Direct B2B payments offer extreme distributions of risk to one party. Legal redress is difficult, costly, late. DocCredits reduce both probability of default and cost of bearing default, and shift risks to better-informed parties. How financial institutions can help: D/P and D/A provide more balanced distributions, but there is still no insurance effect. Letters of credit shift risks to a bank that is better placed to assess them and to bear the costs of default. Id for confirmation. Advising may suffice. Factoring may combine debt collection with credit insurance and financing. Factoring does not work case by case. Insurance is available as a separate product, and possibly case by case (at a price). Cover is never 100%.
41 Risk in Payments: Credit: The issues goods travel slowly and far working-capital financing issue. bills provide low-risk and cheap financing. Direct B2B payments offer extreme distributions of risk to one party. Legal redress is difficult, costly, late. DocCredits reduce both probability of default and cost of bearing default, and shift risks to better-informed parties. How financial institutions can help: D/P and D/A provide more balanced distributions, but there is still no insurance effect. Letters of credit shift risks to a bank that is better placed to assess them and to bear the costs of default. Id for confirmation. Advising may suffice. Factoring may combine debt collection with credit insurance and financing. Factoring does not work case by case. Insurance is available as a separate product, and possibly case by case (at a price). Cover is never 100%.
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