The COVID-19 pandemic has impacted several industries while global trade has suffered the most given the restrictions on the movement of goods across countries.
While uncertainty continues to loom over how and when things will ease and borders will open again for trade, the biggest challenge will be at what terms and conditions businesses will reopen. Will you still have the same level of confidence in your buyer? Would you be able to extend the same credit terms to your customers? Most of us will be unsure, and rightly so because the risk contours of every business have changed significantly.
So, what are the solutions to mitigate these concerns? One of the closest I could think of is ‘insurance’. For all the global businesses that had covered their receivables through trade credit insurance, were able to mitigate the losses due to defaults by their buyers. This can also be understood from the recent study by Morgan Stanley which estimates that coronavirus-related trade credit insurance claims could run up to $46 billion globally.
Majority of the industries are struggling on both demand- and supply-side issues. Even though buyers are facing reduction in demand due to reduced trade activities, it is expected to be temporary. With most of the countries reopening, India already being in Unlock 2.0, the demand graph will start reversing soon and is expected to see a gradual recovery.
The biggest challenge will continue to be on the supply side. Suppliers are facing multi-fold challenges starting from skilled labour availability to financing their operations. They are already burdened with existing outstanding receivables and unless there is a realization of their receivables, the working capital cycle would not be restored and their ability to take additional exposures will be limited to that extent. One step further, suppliers are wary of their credit terms with the buyers going forward due to the evolving business environment. With government announcing no fresh IBC processes to be initiated against a debtor for another six months, it has added to the concerns of suppliers whether they are MSMEs or large corporates as they cannot approach the insolvency courts either.
Moreover, the Indian government is looking to reclassify several offences under financial sector laws, including the bouncing of cheques as civil offence rather than criminal. Traditionally, sellers dealing on open/credit terms were comfortable in getting a post-dated cheque from their customers as there was a strong legal recourse available on criminal side vis-a-vis the civil suit if the rules change.
However, there are various platforms and options available to suppliers specially to support them for their working capital requirements—TReDS platform, channel financing, bill discounting—to name a few. There are many fintech companies providing suppliers, especially to MSMEs and SMEs, an ecosystem where they can also participate in various receivable auctions. All these avenues are good options to address the working capital financing needs. However, with the shift in today’s business landscape, risk mitigation plays a critical role which can only be covered through trade credit insurance.
Although one cannot insure the existing outstanding receivables, protecting the future receivables is essential. Credit Insurance underwriters analyze the credit profile of the buyer, track the performance of the buyers in their portfolio on a regular basis, review the compliance related information such as GST, CIBIL, ROC, credit ratings before granting limits on the buyer. On a regular basis, these approved credit limits are reviewed and portfolio of the sellers is tracked. In case of a non-payment and default of the buyer, the insurers also manage the legal process wherein up to 85 per cent of the legal cost (share of the loss by the seller) is borne by the Insurer.
In case of international trade, it is generally the export credit agencies of the country, i.e. ECGC for India, that insures the non-payment risk of the buyers once the goods are exported out of India and thus in turn limit the risk of non-payment for the suppliers. Today, Indian insurers (ECGC and private insurers) support trades around $15 billion on domestic and international receivables while Indian exports stood at $330 billion for FY 2019, grossly underpenetrated space of trade credit insurance
Globally, trade credit insurance is a mature product. Recently the UK government rolled out a scheme by giving reinsurance support to leading credit insurance companies in the UK to the tune of $12.67 billion, whereby the businesses would be able to buy credit insurance policies from insurers who are supported by the government in case of claims. Similar arrangements have been made by other governments in France, Germany and Canada. Such support from governments would ensure that the supply chain is not affected as the sellers can continue offering credit to their customers and can get support from the banks and factoring companies.
With COVID-19 situation, the loss ratio of most of the underwriters has crossed almost 100 per cent and the appetite of the insurers has been reduced. Hence, they have become very selective and critical in underwriting the policies, scrutinizing the trade credit history extensively. While insurers need a morale booster through government measures supporting the suppliers and mitigate their risk as they look to reopen their businesses, suppliers should start viewing insurance as a risk management tool instead of just another added expense.