Row rect Shape Decorative svg added to bottom RISK MANAGEMENT | 25 March 2024 How Credit Risk Insurance Keeps Financial Institutions Protected Absa | Corporate and Investment Banking > Insights and Events > How Credit Risk Insurance Keeps Financial Institutions Protected Doreen Fick Product Lead: Trade and Working Commercial Insurance and Syndication, Absa CIB SHARE The vital role of credit risk insurance in navigating the African trade finance landscape Doing business across borders comes with its own set of risks. One of those is non-payment by debtors or clients to whom you have extended a line of credit. “Within the intricate realm of African trade finance, credit risk insurance (CRI) – or ‘non-payment insurance’ – assumes a pivotal role,” says Doreen Fick, Product Lead: Trade and Working Commercial Insurance and Syndication at Absa CIB. Credit risk insurance, she says, is an insurance contract of indemnity that acts as a guarantee against non-payment events, specifically crafted for financial institutions (FI’s). “CRI functions as an unfunded distribution method, offering coverage to banks in the event of default under their clients’ bank facility,” Fick explains. “These bank facilities encompass various aspects, from long-term lending to risk-mitigating tools like letters of credit, bank demand guarantees or short-term trade loans.” A benchmarking survey within the trade finance industry underscores CRI as the second-most significant risk mitigant – surpassing risks such as securitisation, credit default swaps and risk participations. “Many banks, including development banks and multilaterals, rely on CRI, aligning with the Basel Framework and capital requirements regulations,” Fick says. “This distribution channel proves economically viable for achieving limit relief through highly rated (A- to AA-rated) uncorrelated counterparties.” Credit risk insurance vs trade credit insurance Although CRI has much in common with trade credit insurance (TCI), it’s imperative to distinguish the two. “While TCI often involves a seller securing its debtors’ books, CRI specifically addresses risks linked to a client’s default under a bank facility,” Fick explains. “The CRI policy resides in the bank’s name, granting the bank full control over the terms and conditions of the facility. In contrast, a TCI policy sees the seller ceding its TCI policy to the bank, typically under receivable finance facilities.” TCI policies also centre on the seller’s due diligence in understanding and granting credit terms to its debtors – an aspect that lies beyond the bank’s control. Consequently, Fick says, the indemnification from CRI against non-payment events sets it apart as a targeted and powerful risk management tool, helping to optimise the bank’s balance sheet. Accessing the London-based CRI market Despite the continent’s strategic significance, African-based financial institutions often face hurdles when they venture into the London-based CRI market. “London insurers, many of whom are unfamiliar with large regional African corporates, exhibit reluctance in providing affordable coverage,” says Fick. “They exhibit a preference for FI counterparty risk but limit their appetite for coverage to confirmed letters of credit because of their short-term nature and transparency. This preference poses a challenge for financial institutions, given that a substantial portion of their trade finance portfolio comprises trade-related loans between banks.” To bridge that gap, African banks have to motivate insurers by addressing concerns related to political stability, economic outlook and US dollar liquidity shortages. Assisted by insurance brokers who are familiar with the African landscape, banks play a pivotal role in negotiating coverage for new risk areas at reasonable rates. The emphasis is on building partnerships with insurers, going beyond a mere transfer of high-risk transactions. “In navigating the African trade finance landscape, CRI emerges as a key instrument for risk mitigation and capital relief,” Fick concludes. “African banks strategically position themselves to overcome challenges, accentuating the unique benefits of large regional corporate clients and addressing insurers’ concerns. As dialogue progresses, fostering a comprehensive understanding and collaboration between African banks and London-based insurers becomes a catalyst for creating a resilient and dynamic trade finance ecosystem.” Doreen FickProduct Lead: Trade and Working Commercial Insurance and Syndication Absa CIB https://cib.absa.africa/wp-content/uploads/2020/07/file_example_MP3_700KB.mp3 Related Articles RISK MANAGEMENT How Finance Can Help Build More Integrated African Supply Chains If one were to speak to African suppliers who trade across borders, many would say that doing business within the continent can feel riskier than exporting beyond it. Especially for small and medium-sized enterprises (SMEs), information on counterparties is not always easy to obtain, regional currencies can be volatile and difficult to hedge, forward markets offer little depth, and access to affordable finance is often limited at precisely the moment it is needed most. Read more RISK MANAGEMENT What Bidvest’s Eurobond Tells Us About the Maturation of SA’s Debt Capital Market The international high-yield bond market functions as one of the largest and most technically evolved sources of corporate funding in the global financial system. Read more RISK MANAGEMENT Africa’s Capital Markets Are Moving Again. Here’s How. Kenyan beverages giant East African Breweries recently refinanced an existing KES 11 billion corporate bond through a medium-term note priced at 11.8%, marking the first issuance under its newly approved KES 20 billion programme. Read more
