Trade credit for trade receivables

An Expert's View about Credit Insurance/Non-Payment Risk in Lebanon

Posted on: 7 May 2012

For a peace of mind in good times and bad, trade credit insurance prevails as one of the most important tools to facilitate and secure domestic and export commercial transactions, says Mr Karim A Nasrallah of The Lebanese Credit Insurer.

SPECIAL FEATURE – TRADE CREDIT INSURANCE Trade credit for trade receivables For a peace of mind in good times and bad, trade credit insurance prevails as one of the most important tools to facilitate and secure domestic and export commercial transactions, says Mr Karim A Nasrallah of The Lebanese Credit Insurer. rade credit is a key function of general sales. In Yemen and Jordan. They were established with a specific order to sell more, companies have to be prepared mission of supporting their national exporters but, in Tto grant deferred payment terms that offer many cases, this mission has also been extended to include attractive payment options to their customers. Trade elements of domestic trade as well. credit insurance is thereby the tool that greatly reduces During the surge of the Gulf economies in the 1990s the risk of a company not being paid and the disastrous and early 2000s, three dominating European/international consequences this might have. private credit insurers (Euler-Hermes, Atradius and Coface) Trade credit insurance covers manufacturers, traders established offices in Dubai. The Lebanese Credit Insurer and providers of services against the non-payment of their was also established in Lebanon in 2001 as the only local receivables by local or foreign customers. It protects against and regional specialised private trade credit insurance commercial risks (insolvency of a buyer or non-payment company. of an invoice for a period exceeding a defined protracted Within the Middle East and the Levant region, it was only default period) and also political risks (only in export on the back of the international financial crisis in 2008 that transaction in case of war, transfer risks, cancellation of a strong awareness was created for trade credit insurance licence, embargo, etc). as a protection against companies’ failure to pay. Adding In the absence of trade credit insurance, many trade to the financial instability and the lack of liquidity in the transactions are undertaken on either a pre-paid / cash markets, the “Arab Spring” has also brought another surge in basis, or by the use of secure terms such as letters of credit, demand for credit risk protection, including political risks. that actually increase the financial pressure on the buyers. Taking extended risk Credit risks are not accidental Bear ing in mind that most of the t rade flows remain within Unlike risks covered by other types of insurances, credit the region, it is in this type of environment that exporters risks are not fortuitous. They can be foreseen, managed and importers have to maneuver with little medium to and prevented. Trade credit insurance is an essential credit long term visibility. management tool that helps control those risks, improve Depending on the country of exposure, such covers payment behavior, obtain vital buyer information and may not be easily accessible or available as more monitor exposures. international credit insurers and their reinsurers have Historically, trade credit insurance penetration has become more selective, mainly by significantly reducing been good in Europe and Asia (between 20% and 25% of their participations / acceptances and have imposed tighter the insurable market), but it is still under-developed in the underwriting conditions. Middle East and the Levant regions (less than 5% of the Against this sort of background, local / regional insurers insurable market). ECAs and multilaterals have become closer to the risks with Within the Middle East, two multilateral agencies were a better understanding of the “local” culture and language. set up by governments to promote inter-regional trade and They have shown strong growth commitment to supporting investment. Dhaman (1974) and The Islamic Corporation for inter-regional trade. However, instability is not the only the Insurance of Investment and Export Credit (ICIEC, 1994) obstacle to the growth of inter-regional trade. were originally established to cover exports respectively The lack of transparency and corporate governance between Arab country members and between Islamic together with the quasi inexistence of reliable financial country members. Today however, their scope has widened information on companies make it very difficult for traders to cover not only exports to non-member countries, but also to sell on open account (unprotected) which would greatly some types of domestic transactions. contribute to increasing their trading volumes. Having to impose secure payment terms (mainly through banks) Presence in MENA greatly limits their growth potential as their clients would Governmental export credit agencies, known as ECAs, are also be limited by their access to financing and incur also active in Oman, Dubai, Saudi Arabia, Qatar, Egypt, substantial costs. 62 May 2012 SPECIAL FEATURE: –T RTRADADE EC RCREDEDITI TI NINSUSURRANANCECE Letter of credit – Calculation of cost to buyer Typical company asset distribution Cash Letter of credit $100,000 for 120 days 3% Buyer’s bank requires collateral via existing $100,000 lines of credit Accounts Net fixed receivables assets Interest cost, assuming 45% 39% $3,000 9% pa, for 120 days Additional cost to buyer $100,000 + $3,000 Stock = $103,000 (+ loss of use of 13% working capital / line of credit for 120 days) In some countries, the interest rate may be higher and therefore the cost to the buyer increases making a letter Cost effective assurance of credit exporter even less attractive. If we estimate Trade credit insurance remains a straightforward and cost that the cost of trade credit insurance would be at an effective way to ensure companies get paid. It remains the average of 0.5%, and this is an amount that is included preferred tool to enable smooth trade transactions, protect within the contra price, the seller’s price becomes very companies balance sheets and give access to new forms competitive in the eyes of the buyer. of financing. Unprotected risk comparison Why credit insurance? Because the largest asset of a company often remains Contract price $100,000 uninsured! Assume profit % 10% Domestic and export trade receivables are very often Bad debt $100,000 the largest asset of a company. Why do companies usually protect their fixed assets (buildings, equipment, vehicles, Number of new additional contracts 10 x $100,000 stock, cash, etc) against fire, theft, earthquake, etc, but ignore required to recover bad debt within the = $1,000,000 the risks affecting their trade receivables? remaining financial year If profit percentage is lower than 10% the number of new Mr Karim A Nasrallah is Managing Director of The Lebanese Credit additional contracts required is even larger. Insurer. 64 May 2012
Posted: 07 May 2012
Presenting the contributor

Gabrielle Saade, Consultant