Impact of the Financial Crisis on Corporate Trade Finance
The most significant source of short-term financing for corporates are trade receivables (and liabilities). Trade finance is the most important instrument for companies looking to optimise short-term bank loans and is a strong determinant of corporates financing costs. In addition, trade finance has an impact on the balance sheet structure.
The financial crisis of 2008 showed that corporate trade finance volume depends not only on the market structure of physical products, but also on the general health of the financial markets. The conclusion is that although the physical markets’ product volume had not changed, the banks and credit insurers could not support corporate trade credit in the same way as before the crisis.
Corporates have felt the impact on trade credit and also bank loans in general, experiencing a shortage of liquidity. Notably corporates felt the pinch in the reduced ability to gain access to liquidity. This is critical as sufficient liquidity is a fundamental condition when buying and selling contracts and entering into a trade relation. Without adequate liquidity support from banks, some corporates could become insolvent because they would not have sufficient liquidity to pay their obligation.
The impact of the financial crisis on corporate trade finance can best be described as a result of the end of a highly speculative market bubble in the derivative markets. However, from a corporate trade finance perspective, the basic situation for trade finance was, and remains, unchanged. Trade credit has some fundamental advantages to other credit forms, including:
Due to the adverse market developments and positive trade finance factors, there is much research being done on what can be done to make corporate trade finance as strong as it was before the financial crisis, plus uncover best practice.
gtnews conducted a global survey in January 2012, inviting its corporate treasury readers to participate. In total 149 corporate treasurers responded, which shows the interest in and awareness of the topic.
The majority of respondents are based in western Europe, and together with North America, made up 75% of all respondents. As most multinational groups are located in these two regions, the percentage does reflect the real world. Asia-Pacific respondents made up 11%, and central and eastern Europe (CEE), Middle East and Africa (ME&A) and Latin America each made up about 5% of the total.
One further detail is the impact of the financial crisis in relation to the revenue (in US dollars) of the company. Therefore, the feedback also reflects the typical export industry diversification. Respondents from companies with a turnover below US$50m made up about 5% of the total number of respondents. Slightly more than a quarter (26%) of respondents came from corporate with an annual turnover of US$50m-US$250m; this is the second largest respondent group. Slightly less significant is the group with turnover from US$250m to US$1bn with 20% of the total number of respondents. Corporates with revenues between US$1bn and US$10bn are most often operating globally. Therefore, it is not surprising that they made up the largest proportion of respondents: 32%. Finally, corporates with revenue of more than US$10bn represented 17% of respondents.
On average, about two-thirds of the participating corporates now have stricter trade credit management guidelines as a result of the financial crisis in 2008. Outside western Europe/North America, more than 80% of participants report stricter guidelines. Latin America answers are similar to the global average of about 66%.
Around 60% of experienced private companies in western Europe/North America reported stricter guidelines due to the crisis, which is lower than the global average. The lower rate could be explained by the fact that these corporates may have started developing credit management guidelines earlier than other regions; or the opposite reason, which is that they did not take action on different credit risk. The result could also reflect a different risk situation in the regions.
The reason is unknown, but the rate for Latin America might give us a hint. This region was not strongly affected by the financial crisis and their credit management frameworks were built many years ago due to the difficult financial situation in the 1980s.
Interestingly the size of the company/group does not seem to have an impact on reassessing credit guidelines. All revenue categories exhibit fluctuations within 5% from the overall average. This shows that the financial crisis had a global impact.
This question examined stricter guidelines in credit management, focusing on the portfolio effect. The next question examined a particular behaviour in credit risk management, specifically: “Does your organisation conduct a more in-depth analysis of its open trade risk than before the financial crisis?”
The feedback behaviour in the regions is the same as in Question 1. Again 80% of respondents based in Asia-Pacific, CEE and ME&A said “yes”. Latin American corporates show an average result. However, western Europe/North American responses remain similar, with two-thirds of corporates operating in those regions saying that they conduct a more in-depth analysis of its open trade risk than before the financial crisis.
In contrast to Question 1, in operative credit management the larger corporates are more cautious as a result of the banking crisis then smaller ones. Companies with revenues below US$250m per annum are about 40% uninfluenced, while about 70% of the larger companies conduct a deeper analysis. Two theories could explain why:
In total, more than two-thirds of companies did more analysis than before.
Both possible reasons are confirmed in Question 3: “Compared to before the crisis in 2008, does your organisation currently spend more money to receive credit report information from banks and information brokers?”
Only one in four of the smallest companies have increased spend in order to obtain better data for credit decisions. In the four other revenue sizes, the ratio shows an increase of about 40%. Concerning the results in the different continents, CEE and ME&A show very different pictures. In ME&A the spending increased, while none of the CEE participants did so. Information data for CEE countries is readily available and risk can be high, which makes the result confusing to interpret.
As personnel costs are always an issue for corporates, they might react with new or old technology support for improving credit analysis and collection. Question 4 focused on this aspect: “Did your organisation halt programmes to automate its credit analysis due to the financial crisis?”
Surprisingly, the so-called emerging markets invested more in technology support for credit management. As the global average implementation rate was only 16%, about 40% of CEE, ME&A and Latin America respondents all continued automation programmes. In North America, only 10% of respondents continued with automation programmes, whereas in Asia-Pacific only 13% did so.
The behaviour breakdown of different revenue categories adds to the analysis: companies with turnover between US$50m and US$250m continued automating credit analysis with 26% strongest. As this ratio is still low, it is clear that the bulk of investment in credit management software is still to come.
The risk companies/groups take in credit management is based on the defined risk appetite, but also on the external alternatives. During a financial crisis, the probability of a credit default increases. Therefore corporates must theoretically reduce their risk appetite in order to achieve the same nominal risk volume. But in the financial crisis of 2008, corporates could not follow this logic because the financial industry (banks and credit insurers) reduced its risk as well and the risk-outsourcing opportunity is, therefore, not available. As corporates look to deliver products or services, they have to decide whether to take advantage of new larger external demand and expand their business or not.
The survey results show that almost a third (30%) of participating corporates expanded their business and increased their credit limits for customers during the financial crisis. This was most strongly the case in the ME&A, where two out of three participants built in higher credit limits. The situation in Asia-Pacific was closely similar, where 60% implemented higher limits, and Latin America, where 57% increased their limits.
In other continents, the situation is more similar to the one before the crisis: Europe (east, central and west) and North America survey results show that more than two out of three companies report unchanged credit limits.
In terms of revenue size, smaller companies (below €50m turnover) are the most affected, where every second company reported higher credit limits. Only 20%-35% of the larger companies/groups increased their credit limits.
In a financial crisis, companies re-think their financial strategy and business objectives. This re-think includes credit insurance, as every third company that responded to the survey reported changing their credit insurance policy. Companies based in ME&A (44%), Latin America (43%) and CEE (40%) most strongly illustrate this trend. There is less change in western Europe (34%), Asia-Pacific (33%) and finally North America (25%).
Examining company size shows stronger differentiation. Medium-sized companies most seldom report a new strategy (7%), while for companies in the smallest revenue category one out of two reports a change in strategy, similar to the question on credit limits. Second strongest are the ‘smaller’ multinationals (US$1bn-US$9.9bn), with 46% changing their credit insurance policy.
Letters of credit (L/Cs) are overwhelmingly for international sales transactions. With the expansion of globalisation, which has also given corporates access to credit information outside of their home country, L/Cs are only used for long distance sales or for deliveries, where a high credit risk exists. Therefore, the question concerning the impact of the financial crisis on L/C strategy is not applicable to all survey participants, as not all operate on a global basis. Under these circumstances, the 24% of participants who reported a different L/C strategy is presumably higher, than if the survey solely asked exporters.
Analysing the regional responses shows a differing impact for L/Cs. In ME&A, more than every second company (56%) reported a changing L/C behaviour. In CEE, it was 40%. This could be the result of banks and credit insurance companies having a lower risk appetite than in other regions, which tallies with other reports.
In the other regions, more than 70% of the responding companies report no change of strategy for L/Cs. The size of a company does not seem to affect its L/C behaviour. All revenue categories have ratios between 13% and 31%.
Management reporting is certainly more intensive when a new risk such as the financial crisis appears. On average, 58% say that they are reporting on trade finance and credit management topics now more regularly to top-level managers.
In ME&A, nearly nine out of 10 companies conduct deeper reporting due to the financial crisis of 2008. Latin America’s rate is close by with 86%. In addition, 75% of CEE corporates report with greater frequency. Only one in four companies across the globe have not changed the reporting information.
The effect of the crisis was strong in North America and western Europe, where roughly every second company/group has intensified their reporting behaviour. In Asia-Pacific, 57% of companies report an increase in reporting rate.
The global analysis on the intensity of reporting in terms of revenue size shows that medium-sized to large companies (€250m to €1bn turnover) are more likely to have retained old procedures; only 41% of these corporates have improved their analysis package. The other revenue groups – from small to very large – show that between 56% and 75% of the companies have increased reporting.
The most used key performance indicator (KPI) in receivables management is days sales outstanding (DSO), which is the time it takes to receive payment and includes the overdue period. The DSO time has to be financed by the seller. The DSO ratio is now used more often as a KPI than before the crisis.
Again companies based in the ME&A were in the lead, as nearly all companies (89%) report stronger usage of the DSO ratio. From the viewpoint of four years after the beginning of the crisis, the lead position of emerging markets is unusual as the financial crisis was felt more strongly in North America and western Europe, which were at the epicentres of the sub-prime and euro crises. But in these most affected regions, firms increase DSO reporting only in about one of three companies.
The revenue size of a company does not have a significant impact on the timing of DSO updates. Between 33% and 48% of each group report more frequent DSO reporting since the crisis.
The critical part of receivables management is the overdue period, as this lies outside of the sales contract. The seller is at a disadvantage when the default risk increases or the payment time is extended.
Fifty-nine percent of all companies surveyed try to avoid overdue dates by enforcing stricter collecting behaviour than before the crisis. All ME&A-based companies support that rule. The other regions each have quite different ratios: in CEE 80% of companies report stricter conditions; in Latin America it is 67%, Asia-Pacific 62%, western Europe 59% and the lowest is North America where only 45% say that they are stricter with collections.
Comparing company size shows more similarity. For each revenue category, between 50% and 65% of the firms have increased their collections activities since the financial crisis in 2008.
The stronger collection activities are supported in new collection strategies. Almost half of the companies/groups (49%) have created new strategies, while the remainder have left the old rules in place.
The behaviour in different regions is more diverse than in the questions before: Asia-Pacific (40%) and western Europe/Latin America (43%) have not changed their collections strategy as much as others. Is it because these regions generally wait longer to change? The other regions generally behave differently: ME&A (89%) and CEE (100%) are strongly in favour of implementing news organisational procedures to receive payments more quickly. North America sits on the fence at half saying they have implemented new procedures and half saying they haven’t.
Companies with turnover between US$50m and US$250m are the most likely to change their collection strategy. Sixty-two percent have developed a new strategy, while 52% of the corporates with turnover between US$1bn to US$10bn have also done the same. Companies with annual turnover from US$250m to US$1bn are the least likely to change their collection strategy (38%).
The final two questions focused on the next steps in receivables management and corporate trade finance. The first asked what the survey participants expect from the Basel III regulators plan to require more equity for the bank to reduce the possibility of a future financial crisis risk. Sixty-five percent of firms are concerned about Basel III in relation to corporate trade finance.
Asia-Pacific corporates are the most concerned, with 81% of respondents saying “yes”. Firms from all other regions are concerned about the new rules, and exhibit strong doubt about the fairness shown by regulators to trade finance. Fifty-seven percent to 67% are concerned.
In relation to firms’ revenue, the largest corporates have the highest doubt as to the impact of new regulations. Eighty-four percent of companies with turnover of more than US$10bn are concerned about the impact of Basel III on trade finance. The smallest firms follow second with 75%. The lowest rate of concern is for medium-sized corporates (only 59% are concerned).
The second question relates to the future in financial receivables management, which is very operative: “In credit management and collection, is it advantageous to your organisation if an open account debtor can electronically confirm the correctness of the liability before due date?” Today, the receivable payment is unconfirmed by the buyer until execution. As a confirmation leads credit management and collection, and influences auditors and analysts, the risk of not documenting and knowing the final truth is a serious issue.
Overall, 71% are interested in receiving the debtor’s confirmation soon after invoicing. It should be in an electronic form to automatic match with the open outstanding. Asia-Pacific (81%), CEE (100%), Latin America (100%) and ME&A (89%) companies exhibits the strongest demand for electronic confirmation. Perhaps this is because they have no ‘old system’, such as the US-lockbox or direct debit.
But even in the ‘old regions’, the demand is supported by almost two out of three companies: in North America 63% of companies are interested, while in western Europe the demand goes up to 66%. Interestingly, firms with the smallest turnover (up to US$50m per annum) support the request by 100%. For all other revenue segments, the positive answer varies around two out of three.
About 60 participants (40%) responded to the question regarding the biggest challenge during the financial crisis. Some reported that there was no impact. Many other answers are part of the earlier questions asked in the survey, such as automatic scoring, credit information, DSO/overdue, credit insurance and increased credit risk. Another said that their pain point is bank borrowing. Therefore, one lesson learned from the recent financial crisis is that a supplier is the most stable credit grantor for other companies.
The second most popular challenge is public sector companies and (late) payments. Last, but not least, the receivables-oriented additional challenges centre on training receivables experts and the right balance between credit risk and sales. More general challenges are liquidity management, local currency depreciation and decreasing product demand.
The survey shows that the financial crisis was felt in all regions and impacted small firms as well as global players, leading to many new ideas and some changes in receivables management. The question is whether the new activity can been seen as best practice for the foreseeable future, or whether there will be further development. This is of course strongly influenced by external development, such as the euro crisis, etc. In addition, it strongly depends on the future financial conditions of companies and banks.