Risks Involved in International Trade Finance: A Banker's Perspective
By Peter J. Boland
Traditionally, international trade has always been considered "low risk", and this is attributed to the four "S's". Compared with other forms of bank lending, financing trade transactions is popular because these deals are:
- Short term
- Self liquidating (e.g., banks finance the import of goods which are then resold to repay the bank)
- Secured (by the underlying goods)
- Speedily completed (e.g., within
- the short life of a documentary credit, there may be several transactions which are completed quickly, at "high velocity")
Nevertheless, there are three main areas of risk. This article will focus on these risk factors and suggest ways to counteract them.
The three main areas are micro risks, macro risks, and product risks.
Micro risks are encountered at the individual customer level and are confined to the financial (credit) and operational risks associated with their business.
Macro risks can be defined as those external factors which have a tendency to impact adversely on a customer's international trade business. Some of the more frequent problems in trade financing are caused by a lack of appreciation of country risk, foreign exchange risk, industry risk, bank risk and fraud.
Let's examine some of these macro risk areas in more detail.
Country Risk
The factors usually associated with this type of risk are the political and economic stability of a country, exchange controls, if any, and the country's penchant for protectionism of domestic industry at short notice. All these factors will determine whether the country can and will honor their payment commitments-in time. For example, from many a first world country point of view, Sri Lanka is seen as a reasonable short term risk, (i.e., an export exposure up to two years is considered in order, provided the Sri Lankan importer can produce a documentary credit, preferably confirmed by a "first class" bank.) This is because Sri Lanka has liberalized exchange control, has no history of default on foreign debt commitments and has a reasonably robust economy. What holds the country back from being seen as a "more comfortable" level of risk is the political problems caused by the separatist issue.
Most banks have specialized units dealing with country risk and they control the level of exposure that bank will assume for each country. This system of policing is vital where balancing the stability of the institution against the greater profitability of transactions with higher risk areas. However, there is often a lot of friction between commercial bankers and these units where the former feels that the latter is too strict at times and business considerations are overlooked.
Foreign Exchange Risk
Payments and receipts in foreign currency are an everyday occurrence in international trade and the trader is always at the mercy of exchange rate...
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