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Trade Finance in Africa:
Understanding Political & Commercial Risk
    and the Role of Credit Insurance

                 ...
2

Outline
1. Trade Finance & Risk
          Risks associated with TF
          Political Risk
          Bank Risk
       ...
3




Trade Finance and Risk
4

Trade-Related Risk
                                          Commercial Risk



  Political/Country
         Risk


   ...
5

Political/Country Risk


  Risk associated with the countries involved in the
  transaction, most commonly the importer...
6

Bank Risk

           Issuing Bank              Advising Bank
                                   (Confirming Bank)


 B...
7

Commercial Risk

            Importer                       Exporter
        (Buyer/Applicant)            (Seller/Benef...
8

A Philosophy of Risk

 Risk can be avoided, minimized, mitigated, optimized, or
 accepted fatalistically
 Avoiding risk...
9

A Working Definition of Risk
 Optimization – informed, expert assessment of
 risk/reward, including risk profile
 Seeks...
10

Understanding Risk
  Mitigation
  Cost
                                                          O/R: Optimized Risk
 ...
11

Risk Mitigation/Optimization
 Political Risk                    Bank Risk                    Commercial Risk

    1.  ...
12




Role of an Export Credit Agency
13

The Role of an ECA
Export Credit Agencies (ECAs) play an important
role in international trade and investment flows.
•...
14

ECA Business Models
 While the mandates and roles of all ECAs are
 broadly similar, there is no such thing as a
 “typi...
15

ECA Business Models
 There is no single, perfect model for an ECA
 Variety of forms, structures, products, delivery
 m...
16

Main ECA Business Models
Model            Description                                            Countries
Private    ...
17

What is Export Credit?
 Risk is inevitably associated with international trade
 transactions, arising regardless of wh...
18

What is Credit Insurance?
 Credit insurance protects the insured party (normally the
 seller/exporter), in exchange fo...
19
Financial Requirements of Exporters
throughout the Export Chain

  Exporters have different financial requirements
  th...
20

Export Credit Facilities
ECAs can play a significant and important role throughout the
export chain providing faciliti...
21

Facilities for Exporters
 There are two basic mechanisms that are useful
 for both SME and larger companies:
  1. Cred...
22

Facilities for Banks
  2. Working Capital Guarantees
       ECAs normally are not directly involved in providing
     ...
23
How Export Credit Facilities can
Work
 The range of export credit facilities offered by a typical ECA
 provide many adv...
24

International Trade Transactions
               A Simple International Trade Transaction

                            ...
25

International Trade Transactions
  A Trade Transaction with Payment Through Banks
                                    ...
26

 International Trade Transactions
                               A Letter of Credit Transaction
                      ...
27

International Trade Transactions
                          Export Credit Insurance
                                   ...
28

 International Trade Transactions
                               Domestic Credit Insurance

                      2   ...
29

International Trade Transactions
      Export Credit Insurance with Assignment to a Bank
                             ...
30

 International Trade Transactions
        Direct Bank Purchase of Export Credit Insurance
                            ...
31

International Trade Transactions
                        Working Capital Guarantee
                                   ...
32

Short-Term Credit Insurance
   In practice, most ST business is less than 180 days
   Traditional mainstay of export c...
33

Working Capital
 Working capital loans are normally not provided directly by
 the ECA, but the exporter can obtain wor...
34

Bonding and Letters of Guarantee
 Normally, the ECA provides cover to a bank that issues a
 bond or letter of guarante...
35

Parties to a Trade Transaction

                                Exporter
          Importer
                          ...
36

Use of Insurance/Risk Mitigants

                         ECA insurance:
         Importer         Open account       ...
37

Parties to a Transaction: Underwriters
  Risk Mitigation/Optimization is a critical value-
  add of Trade Finance
  Pr...
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Transcript of "Trade Finance in Africa"

  1. 1. Trade Finance in Africa: Understanding Political & Commercial Risk and the Role of Credit Insurance Diana Smallridge, President International Financial Consulting Ltd. March 15th, 2006 Nairobi, Kenya 100 Queen Street, Suite 1350. Ottawa. Ontario. K1P 1J9. Canada tel: 1.613.742.7829 fax: 1.613.742.7099 www.i-financialconsulting.com info@i-financialconsulting.com
  2. 2. 2 Outline 1. Trade Finance & Risk Risks associated with TF Political Risk Bank Risk Commercial Risk 2. Export Credit Agencies The role The business models 3. Trade Credit Insurance Export credit Trade credit insurance 4. Financial Requirements throughout the Export Chain Export Credit Facilities Facilities for Exporters Facilities for Banks How the facilities can work
  3. 3. 3 Trade Finance and Risk
  4. 4. 4 Trade-Related Risk Commercial Risk Political/Country Risk Importer Exporter (Buyer/Applicant) (Seller/Beneficiary) Issuing Bank Advising Bank (Confirming Bank) Bank Risk
  5. 5. 5 Political/Country Risk Risk associated with the countries involved in the transaction, most commonly the importers’ & exporters’ countries of residence the inability of the buyer to transfer foreign currency; or actions by the government of the buying country to prevent import or payment or to the destruction of the goods etc. the imposition of export licensing or import licensing in either the buying or importing country.
  6. 6. 6 Bank Risk Issuing Bank Advising Bank (Confirming Bank) Banks may assess their interest in a transaction based upon the stature of their counterpart institution in the other market Confirmations under L/C’s are provided based on assessment of Bank Risk (and Country Risk) by the Confirming institution Financial standing, trade expertise, nature of Correspondent relationship are all factors. Probability of default on payment obligation also considered
  7. 7. 7 Commercial Risk Importer Exporter (Buyer/Applicant) (Seller/Beneficiary) Risk associated with non-payment or non-performance by buyer or seller the cancellation of an order; the deterioration of the financial position of the buyer or his country so as to make it imprudent for the exporter to ship
  8. 8. 8 A Philosophy of Risk Risk can be avoided, minimized, mitigated, optimized, or accepted fatalistically Avoiding risk equates to foregoing business Minimizing risk generates modest returns Mitigating risk suggests measured, conservative approach Full acceptance of risk is not a viable option in trade We advocate a view based upon Risk Optimization…
  9. 9. 9 A Working Definition of Risk Optimization – informed, expert assessment of risk/reward, including risk profile Seeks to achieve a commensurate return Risk as a reality and a cost of doing business, perceptions are critical Trade Finance tools & techniques exist to help strike the desired risk/cost/reward balance
  10. 10. 10 Understanding Risk Mitigation Cost O/R: Optimized Risk $ Optimized with reference to: O/R Risk Tolerance Expected/Target Return Acceptable Mitigation Costs Risk Low Medium High Level Understanding risk means the ability to act effectively in the face of risk
  11. 11. 11 Risk Mitigation/Optimization Political Risk Bank Risk Commercial Risk 1. Education & Information Information about a market, institution or company can mitigate perceived risk. 2. Transaction-Level Mitigation Political Risk L/C Confirmation Credit Insurance Insurance (ECA or Standby Credit or private sector) Guarantee L/C Confirmation IFI/DFI Guarantee 3. Payment Timing Payment at “Sight”, discounting of term items without recourse can assist in risk mitigation
  12. 12. 12 Role of an Export Credit Agency
  13. 13. 13 The Role of an ECA Export Credit Agencies (ECAs) play an important role in international trade and investment flows. • All OECD and most developing countries have ECAs. • There is no single model for an ECAs; they come in different shapes and sizes. • ECAs support and encourage exports and outward investment • ECAs provide credit and political risk insurance, guarantees, and sometimes, direct finance. • Most ECAs do not lend directly to exporters • The basic common function of an ECA is to take (or provide cover for) political and commercial risks of foreign buyers/borrowers.
  14. 14. 14 ECA Business Models While the mandates and roles of all ECAs are broadly similar, there is no such thing as a “typical” ECA. ECA business models, status, objectives, institutional arrangements, and government involvement vary widely from country to country. These differences reflect unique national circumstances and histories.
  15. 15. 15 ECA Business Models There is no single, perfect model for an ECA Variety of forms, structures, products, delivery mechanisms exist Each must be tailored to individual national or regional circumstances Some ECAs underwrite business on their own account as well as the government’s. Some do only short-term (ST) business; some only medium/long- term (MLT), and some do both. Some only insure or issue guarantees. Some only lend, and some do both. Some are called insurers and some export/import banks. Some only insure exports, while another institution insures investments.
  16. 16. 16 Main ECA Business Models Model Description Countries Private • Government has an exclusive arrangement with a France Company acting private company that issues policies as agent for Netherlands as an Agent the Government. Germany Government • Separate department of the government operating UK department/ under the authority of a government minister, Switzerland facility secretary etc. State-owned • Autonomous institution owned by the government Canada, US, Agency (or governments if regional) Turkey, Africa Virtual ECA • Government is only involved in the risk taking and New Zealand decision-making. No underwriting expertise or “bricks and mortar” institution exists Government • Government will not underwrite ST business UK Provider of directly, but will provide reinsurance to insurers Australia* Reinsurance
  17. 17. 17 What is Export Credit? Risk is inevitably associated with international trade transactions, arising regardless of whether or not goods are sold on credit. As soon as an exporter or seller begins to produce goods or services to sell to someone else, there is the risk that: they may be unable to ship the goods or deliver the services or if they can do so, they may not be paid. These issues are particularly acute for Small and Medium Enterprises (SMEs), for whom access to finance is crucial.
  18. 18. 18 What is Credit Insurance? Credit insurance protects the insured party (normally the seller/exporter), in exchange for a premium, against a range of risks that result in nonpayment by the buyer. It is also called accounts receivable insurance. In export credit cover, both commercial and political risks are normally involved. Normally, pre-credit and post-credit periods are covered. The traditional product is an umbrella policy (or whole turnover policy) covering an agreed part of exports of insured party. Single transaction cover is less often offered by insurers due to adverse selection.
  19. 19. 19 Financial Requirements of Exporters throughout the Export Chain Exporters have different financial requirements throughout the export chain. Pre- Pre-Production Production Credit Period Payment Phase 1 Phase 2A Phase 2B Phase 3 Phase 4 Phase 5 Export Exporter Exporter Exporter Exporter Buyer Buyer purchases purchases produces packages receives makes Chain imported raw materials goods for and ships goods payment equipment/m from domestic export product achinery suppliers Exporter’s Financial Foreign Local Working Receivables -- Currency Currency Capital Loan Finance Requirements: Term Loan: Loan: 6 months to 5 Short term – years under 6 months
  20. 20. 20 Export Credit Facilities ECAs can play a significant and important role throughout the export chain providing facilities to both exporters and banks. Pre- Pre-Production Production Credit Period Payment Phase 1 Phase 2A Phase 2B Phase 3 Phase 4 Phase 5 Export Exporter Exporter Exporter Exporter Buyer Buyer purchases purchases produces packages receives makes Chain imported raw materials goods for and ships goods payment equipment/m from domestic export product achinery suppliers ECA Facilities: For Exporters / Domestic Export Credit Insurance: Suppliers: Credit pre- and post-credit risks Insurance Export Pre-Shipment Export For Banks: Performance Working Finance Post- Guarantee Capital Shipment (Import Duty) Guarantee Guarantee
  21. 21. 21 Facilities for Exporters There are two basic mechanisms that are useful for both SME and larger companies: 1. Credit Insurance Insurance against a range of risks that result in non- payment by the buyer Protecting the insured party in exchange for a premium Typically a framework or umbrella policy which will embrace all or an agreed part of the exports of the insured party over an agreed period (normally one year)
  22. 22. 22 Facilities for Banks 2. Working Capital Guarantees ECAs normally are not directly involved in providing working capital ECA credit insurance policies can sometimes be used as security by exporters to obtain working capital from their banks Working capital facilities can also be issued direct to banks and other financial institutions that are providing working capital loans Normally, the provision of working capital to exporters or working capital facilities to financing banks would be done in respect of a specific export transaction 3
  23. 23. 23 How Export Credit Facilities can Work The range of export credit facilities offered by a typical ECA provide many advantages to SMEs and other exporters: Risk mitigation; Increased sales through more competitive payment terms; Management of foreign receivables; Access to buyer information and buyer country information of all kinds. Different buyers/sellers, and different market conditions call for a range of international trade transactions with associated facilities. 3
  24. 24. 24 International Trade Transactions A Simple International Trade Transaction 2 1 Goods & Exporter Services Importer Money Exporting Country Importing Country 3 1. Receive export order 2. Goods & services shipped 3. Payment received from importer 3
  25. 25. 25 International Trade Transactions A Trade Transaction with Payment Through Banks 2 1 Exporter Goods & Importer Services 3 Money Money Bank Money Bank Exporting Country Importing Country 4 1. Receive Export Order 2. Goods & services shipped 3. Payment received by foreign bank 4. Payment received by domestic bank / exporter 3
  26. 26. 26 International Trade Transactions A Letter of Credit Transaction 3 4 1 Goods & Exporter Services Importer Letter of Credit Fulfillment Title and other 7 of 5 Money Conditions Documents documents Money Bank A Money Bank B 2 Exporting Country 6 Importing Country 1. Receive Export Order 5. Exporter submits documentation to Bank A, who in turn sends documentation to Bank B 2. Bank B opens Letter of Credit 6. Bank B remits funds to Bank A, who in turn pays 3. L/C is passed to Bank A the exporter 4. Exporter produces / ships goods and services 7. Importer remits – and otherwise fulfills L/C conditions. funds to Bank B 3
  27. 27. 27 International Trade Transactions Export Credit Insurance 5 1 Exporter Goods & Importer Services 4 Money Insurance 2 Premium Export Credit 6 Agency 3 Exporting Country Importing Country 1. Receive Export Order 4. ECA provides insurance to exporter in exchange for premium 2. Exporter submits application to ECA 5. Exporter produces / ships goods & 3. ECA calls for / receives status report services on buyer / importer from ECA alliance 6. Exporter receives payment from importer 3
  28. 28. 28 International Trade Transactions Domestic Credit Insurance 2 Sub- Goods & 1 Services Exporter Supplier Money 5 Insurance 3 Premium 6 7 4 Export Credit Agency Exporting Country 1. Receive Export Order 5. Exporter produces/ships goods to importer 2. Domestic sub-supplier receives order from 6. Exporter receives payment from importer exporter 7. Sub-supplier receives payment from exporter 3. ECA provides insurance to sub-supplier in exchange for premium 4. Sub-supplier produces/ delivers goods to exporter 3
  29. 29. 29 International Trade Transactions Export Credit Insurance with Assignment to a Bank 5 6 1 Exporter Goods & Importer Services Money 2 Premium Repay Money - ments Insurance Export 7 3 Credit Bank Agency Exporting Country 4 Importing Country 1. Receive Export Order 5. Bank provides credit to exporter with insurance policy as collateral 2. Exporter submits application to ECA 6. Exporter produces / ships goods & services 3. ECA calls for / receives status report on buyer / importer from ECA alliance 7. Exporter receives payment from importer and repays bank 4. ECA assigns policy to bank 3
  30. 30. 30 International Trade Transactions Direct Bank Purchase of Export Credit Insurance 5 4 1 Exporter Goods & Importer Services Export Money Letter of Credit Credit Title and other 7 Agency documents Money Documents Insurance 3 Premium Money Bank B Bank A Exporting Country Importing Country 6 2 1. Receive Export Order 5. Exporter submits documentation to Bank A, who in turn sends documentation to 2. Bank B opens Letter of Credit, L/C passed to Bank A Bank B 3. ECA provides insurance to Bank A in exchange for 6. Bank B remits funds to Bank A, who in premium turn pays the exporter 4. Exporter produces / ships goods and services – and 7. Importer remits funds to Bank B otherwise fulfills L/C conditions. 3
  31. 31. 31 International Trade Transactions Working Capital Guarantee 4 1 Exporter Goods & Importer Services Export Money Money Credit Agency Guarantee 5 3 Premium Bank 2 6 Exporting Country Importing Country 1. Receive Export Order 4. Exporter produces / ships goods to importer 2. Exporter applies for working capital loan from Bank 5. Exporter receives payment from importer 3. As condition for providing working capital, bank requires (and arranges) 6. Exporter repays bank guarantee from ECA 3
  32. 32. 32 Short-Term Credit Insurance In practice, most ST business is less than 180 days Traditional mainstay of export credit insurance Normally, both political and commercial risks are covered In this area, private sector activity has been very significant Private-sector activities have grown substantially and there is significant private reinsurance capacity Privatization and consolidation have given rise to three large global insurers with extensive alliances (e.g., Euler-Hermes, Coface, Atradius) Large global players have massive databases of buyer information The product has expanded beyond the traditional credit insurance (i.e. risk transfer) to include risk assessment, underwriting decision and credit information 3
  33. 33. 33 Working Capital Working capital loans are normally not provided directly by the ECA, but the exporter can obtain working capital from its bank by using the credit insurance policy as security Where the bank sector has difficulty assessing or taking the direct risk of the exporter, the ECA can provide a working capital guarantee In some cases. ECAs will provide loans directly to the exporters for working capital with or without bank guarantees In OECD countries, traditionally ECAs have not been actively involved in this segment. The support is generally directed at SMEs which often have limited access to financing 3
  34. 34. 34 Bonding and Letters of Guarantee Normally, the ECA provides cover to a bank that issues a bond or letter of guarantee to a buyer on behalf of an exporter. A wrongful call on the bond results in a claim against the ECA. Bonds can be advance, bid/tender, performance, warranty ECAs do not normally issue bonds direct.
  35. 35. 35 Parties to a Trade Transaction Exporter Importer (Seller/Beneficiary) (Buyer/Applicant) Domestic Bank Overseas Bank(s) 1
  36. 36. 36 Use of Insurance/Risk Mitigants ECA insurance: Importer Open account Exporter (Seller/Beneficiary) (Buyer/Applicant) ECA insurance: Letter of Credit Domestic Bank Overseas Bank(s)
  37. 37. 37 Parties to a Transaction: Underwriters Risk Mitigation/Optimization is a critical value- add of Trade Finance Provided by banks to a limited degree, especially in Developing/Emerging Markets Export Credit Agencies & Risk Insurers frequently work with Banks on trade transactions Private insurers (COFACE, Atradius, Euler, AIG & others) are increasingly active in underwriting trade risk
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