RISK MANAGEMENT | 25 March 2024

How Credit Risk Insurance
Keeps Financial Institutions
Protected

Absa-CIB-Author

Doreen Fick

Product Lead: Trade and Working
Commercial Insurance and
Syndication, Absa CIB

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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.”

Absa-CIB-Author
Doreen Fick

Product Lead: Trade and Working Commercial Insurance and Syndication Absa CIB

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