Mitigating Techniques for Commercial Risk
Unit 3.5- Mitigating Techniques for Commercial Risk
This lesson discusses what an international credit manager might do to mitigate the risk of nonpayment and when to do it. An international credit manager, to be successful in global business, needs to be able to identify and describe techniques for managing nonpayment risk.
There are four types of reactions to risk situations that a seller or exporter can take regarding nonpayment by the buyer:
- Avoidance: Don’t sell on credit.
- Transference: Ask a third party to assume the risk, such as a buyer’s bank.
- Mitigation: Take precautions that reduce the probability that nonpayment will occur, such as performing a complete credit check.
- Acceptance: Establish a contingency allowance for nonpayment accounts.
Sellers will use all of the above depending on the buyer and the specific circumstances associated with the sale. This section provides a brief summary of the following techniques used for responding to and managing the risk of nonpayment.
|Technique||Type of Risk Response Summary|
|Commercial Banks||Mitigation - By involving the bank and asking them to provide the payment, a seller is mitigating risk. It may also seem like a risk transfer, but there is a country risk that the buyer’s bank may default. For example, if a bank is located in a country that becomes insolvent or suffers some other economic or political change, the bank of the buyer could be unable to meet its obligations.|
|Accounts Receivable Financing||Transference or Mitigation - Risk is transferred if the loan is set up to allow the financing company to go after a buyer in the event of nonpayment. Risk is mitigated when only a percent of the accounts receivable is covered.|
|Governments||Transference - An Export Credit Agency (ECA) provides insurance or loan guarantees through that country’s financial institution and will share any losses with the bank which actually provides the financing since the government guarantees the bank financing in the event of a nonpayment, depending on the agreement between the ECA and their country’s banks.|
|Factoring||Transference - Similar to accounts receivable financing. Here a seller gets money, and the factor company assumes the responsibility to collect from a buyer.|
|Forfaiting||Transference - The purchasing of an exporter's (seller’s) receivables (the amount a buyer or importer owes the exporter or seller) at a discount by paying cash. The forfaiter, the purchaser of the receivables, becomes the entity to whom the importer or buyer is obliged to pay its debt.|
|Countertrade||Acceptance - Countertrade acknowledges that payment by money is probably not going to take place. Using countertrade as payment provides other benefits to a seller, which in the long run, may yield future payments and advantages in the market.|
|Bankers' Acceptances||Transference – A seller gets money from the buyer’s bank.|
|Credit Insurance||Mitigation - Credit insurance covers a buyer’s failure to meet the debt obligation on time due to protracted default (slow pay) or insolvency. In the event of a claim, the insured provides the insurer with all documentation of the transaction and, once validated by the insurer, receives payment less any agreed retention, such as coinsurance and/or deductible and negotiated fees.|
The goal of this material is to introduce you to mitigating techniques for commercial risk associated with international transactions. By the end of this unit you will be able to
- identify techniques for mitigating commercial risk.
- identify when to use each technique.
- Commercial Banks-Mitigation
- Letter of Credit
- Documentary Draft Collection
- Accounts Receivable Financing-Transference or Mitigation
- Banker's Acceptances-Transference
- Credit Insurance-Mitigation
Correlation: Materials from this unit correlate with NASBITE CGCP's Knowledge Statement 04/03/05: Knowldege of mitigating techniques (e.g., credit risk insurance from Overseas Private Investment Corporation (OPIC) and U.S. Export-Import (Ex-Im) Bank)