Stimulating trade activity.
Increased use of trade credit insurance and trade finance insurance could be a vital tonic for UAE companies' flagging confidence and could help see the UAE economy securely through volatile times. These instruments protect companies against the default of payment arising from the sale of goods and services on credit terms. This is an important and growing concern in the region. The ripples through economies of the oil price slump threaten an increased risk of defaults and cases of absconding.
Trade confidence in the UAE fell by 19 points in the second half of last year, according to an index from HSBC. Cited as a key factor was an expected increase in the risk of buyers and suppliers not honouring agreements. Trade credit insurance and trade finance insurance provide balance sheet protection and enable companies to identify new credit- worthy customers, enter new markets with confidence, extend better credit terms to them, and secure the finance that they need.
Here is how they work--trade credit insurance provides sellers with the accounts-receivable protection needed to safeguard themselves against a customer default due to financial or political events. Accounts receivable-- money owed by customers--is often the largest asset on a company's balance sheet. Firms naturally become reliant on their customers' payment habits. Globalisation has increased competition and has fuelled corporate buyers to demand longer credit terms. To remain competitive, companies need to meet those needs.
The prospect of a large customer being unable to pay is alarming and potentially catastrophic. Profits would suffer, but the shock on cash-flow may well result in the corporate seller being unable to pay its own vendors. They may have to borrow or invest cash to sustain business operations. A company with a 10 per cent profit margin would need to increase its sales 10 times the value of the bad debt, just to bring it back to the same position.
Trade credit insurance protects the seller's balance sheet, bottom line and ultimately its future success. Even in good economic times, many businesses in the region find that some of their customers are tardy payers. A recent survey by Gulf Finance showed that one-in-three firms in the region are seeing worsening payment collections.
Outright customer default can quickly impact liquidity and send companies to the wall. Especially when combined with an increasing reluctance from banks to lend in the current economic climate. Over recent months, banks have been tightening their approval criteria, reducing facilities or even withdrawing completely from some markets.
The same Gulf Finance study showed that two in five firms are finding that credit availability is tightening. There is more need than ever for an innovative, robust approach that provides a high degree of protection for banks and companies. Banking lines drive trade, so there will always be a need for adequate levels of trade finance. Receivables finance enables companies to access sufficient working capital.
Many credit insurance policies are not designed to support bank finance. Standard credit insurance products are risk transfer policies designed for the corporate, and for the funder, the operational risk remains on their corporate client policy compliance. Many insurance companies write policies for companies without considering the underlying funding agreement and the potential discrepancies in the terms and language between the insurer and the bank. The majority of insurers reserve the right to withdraw or cancel limits when times turn bad, directly reducing the level of funding available to the corporate at a time when they need the working capital the most.
AIG attempts to address this by introducing a trade finance product with non-cancellable limits that offer insurance designed to specifically support trade finance as a solution. We also created technology to qualify invoices prior to funding, so there is absolute certainty that an individual transaction with a customer is covered under the policy.
In the UAE, the development of the trade credit insurance and trade finance insurance markets is at an early stage. Education and awareness are key to help unlock the potential benefits these instruments have for the economy. I believe the prospect of rapid adoption of these financial instruments is good news for the local economy by facilitating trade, especially as we face uncertain times ahead.
Not everything is rosy in the UAE market. In the good times, some insurers wrote policies that enabled them to cancel their clients' cover if their view of risk changed. Some companies are now finding that their insurers are leaving them high and dry, just when they need insurance most. The coming months could test these markets and shake out some bad practices, which can only strengthen trade credit insurance and trade finance insurance's ability to support sustainable economic growth in the UAE. These instruments are a commercial safety tool. It is time for insurers to deliver on their promises.
A company with a 10% profit margin would need to increase its sales 10 times the value of the bad debt, just to bring it back to the same position
The coming months could test these markets and shake out some bad practices, which can only strengthen trade credit insurance and trade finance insurance's ability to support sustainable economic growth in the UAE.
- Casey Bell, Head of Trade Credit GCC at AIG
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