Trade credit risks discussed at Zimnat conference

The majority of trade transactions across the world are conducted on open account terms, supported by a purchase order and invoice with mutually agreed payment terms as the basis for trust, according to Continental Reinsurance Kenya managing director Souvik Banerjea.

He told the Zimnat Trade Credit Insurance Conference in Harare on Friday (June 8) that 80 to 85 percent of trade transactions were on these terms. However, this percentage was much less in Africa.

The remaining 15 percent of trade transactions used trade finance instruments, such as export letters of credit and export collections that provided more security against the risk of non-payment.

He said most trade was conducted on credit terms because a buyer could not readily afford to pay for goods purchased until they had been sold. Offering credit also gave a company a competitive advantage over those that insisted on advance payment and made for better relationships with customers. It provided access to finance and supported sales expansion.

However, extending such credit carried with it the risk of non-payment due to bankruptcy, delayed payment or simple refusal to pay due to some reason that might or might not be valid.

Credit risk could be mitigated by risk-based pricing, diversification of the pool of borrowers, reducing the amount of credit permitted, reducing the payment period or taking out credit insurance.

“Credit insurance protects your business from non-payment of commercial debt. It makes sure that your invoices will be paid and allows you to reliably manage the commercial and political risks of trade,” he said.

He said any company that sold regularly on credit terms, had ever experienced bad debt losses, ever had a customer who became insolvent, had commercial debts it could not collect, regularly sold to new customers, sold in international markets, needed help in assessing the financial status of customers or needed to improve its cash flow should consider trade credit insurance.

He said the insurer monitored the financial performance of the client’s various customers, allocating a grade which reflects the health of their activity and the way they conduct business. Based on this assessment, each buyer was given a credit limit up to which the client could trade. This limit could be revised upwards or downwards as more information became available.

Insurance could be provided for a transaction between just one seller and one buyer or for transactions between one seller and many buyers (whole turnover policy). The premium for insurance covering just one buyer was normally high.

A lenders’ all risk policy could be provided for lenders and to cover receivables discounted by a bank.

A whole turnover policy could be taken out by banks to cover a portfolio of their clients, exporters who sell across the globe, manufacturers with a large book of customers to protect, suppliers and traders.

“A typical scenario can involve a customer who uses its receivables as collateral to obtain advance payment or bank financing.

“Blanket protection against payment default risks provides clients with the freedom to continue expanding their business without worry,” he said.

He said a company could obtain a bank loan using receipted invoices as collateral. However the bank had to take higher levels of collateral than the value of the loan. Where there was a credit insurance policy in place this could be used as additional collateral, as the bank was able to transfer the risk of non-payment of the invoices to the insurance company.

Across the world, he said, export credit and guarantee insurance was one of the major tools for growing a country’s exports.

Rahul Aggarwal, from Genesis Risk in Mauritius, explained the rationale for bonds and guarantees that were often required of companies in the construction and other sectors by the organisation hiring or considering hiring them.

He said they were a means of providing a surety that what the contracted company had undertaken to provide was in fact provided, that deeds matched words.

Bid bonds ensured that those bidding for a tender were serious contenders. Advance payment bonds ensured that work for which an advance payment had been made was carried out. Performance bonds covered all contractual obligations of the contractor.

Bonds could be provided by insurers, such as Zimnat, as well as by banks. However, a bond was not an insurance policy. If the company for which a bond or guarantee was provided failed to meet the requirements for which the bond was offered, the insurance company would pay the amount of the bond or guarantee on behalf of the company but would require the amount to be repaid to it.

Zimnat offers a wide range of bonds or guarantees, including construction contract bonds, customs bonds and guarantees, and estate administration bonds.

Zimnat Trade Credit Insurance, Bonds and Guarantees Division general manager Shepherd Tembosaid it was necessary to respond to market needs. He said Zimnat was offering credit insurance in a transitioning environment which demands the adoption of the structured credit insurance model.

He said Zimnat had formed a partnership with BankABC and is intending to do the same with all other financial institutions that have an objective of developing the trade finance market in Zimbabwe, while capitalising on the security offered by trade credit insurance facilities.