Risks Associated With International Trade Finance
When discussing risks associated with international trade finance it can be difficult to separate risks in terms of international trade finance and international trade. Risks associated with international trade are those risks such as production, labor and transport. These can have financial implications but the primary risk is associated with the act of doing international trade as opposed to the financing of international trade.
In this article we discuss specifically risks associated with international trade finance. These risks can be categorized into the following three types:
Micro risks – Macro risks – Product risks
Micro risks are those risks specific to the customer and the credit risk associated with the trading status of the company. Credit risk analysis of the company is undertaken to assess the credit worthiness of the company. Factors impacting this are not indifferent to usually business lending. These factors include length of time in business, trading statements, years in business, sales, orders & credit history.
A robust credit analysis of the company will serve to mitigate risk.
Macro risks are by far one of the most interesting categories of risks and as the name suggests deals with large external factors which are beyond one’s control. Macro risks can be further categorized as;
Country risk – Every country is different politically and economically. Banks and financial institutions engaging in international trade finance carry out risk analysis on each country so that they can assess risk and institutional exposure to that country. Political stability, strong institutions of government and good governance with a stable economic history will rank your country in the low risk category. Countries with unstable government, political unrest and a history of defaulting on foreign debt and an unpredictable policy on international trade tariffs will rank as high risk.
Nobody likes volatility.
Foreign exchange risk- Exchange rates, especially volatile exchange rates and a tendency for cliff edge patterns enhance risk in international trade finance. A fall of 15% in a 90 day cycle of trade can businesses exposed.
On July 25, 2018 the South African Rand was trading at ZAR 13.11 to $1.
On September 5, 2018 it was ZAR 15.45 to $1
A significant shift in under 40 days.
Mitigating currency risk is essential for any business. Buying forward can protect the deal from adverse currency fluctuations but conversely a currency move in your favor will not benefit you.
Bank risk – Banks pose a risk in transactions. Banks carry out analysis of other banks to examine their exposure and consequent risk when dealing with them. A good relationship built on trust over years of trading is of course the ideal scenario.
Being domiciled in a country with a high credit risk.
A history of delaying or even non-payment.
Product risk manifests itself in the form of fraud. International trade finance is paid against sighting of documents which is naturally open to fraud ranging from defective goods to fake documents.