What Hong Kong can do about trade credit and bank finance risk

When I owe the bank US$100,000 it’s my problem; when I owe the bank US$100,000,000…it’s the bank’s problem.

The Hong Kong Business Review’s recent piece on corporate entities struggling to pay debt is a timely reminder that issues relating to cash flow and credit impact all businesses – both big and small.

The HKBR report and the Hong Kong Monetary Authority’s recent statement that local companies’ ability to pay debt had deteriorated markedly is a sobering reminder that both mature and emerging markets have some major economic issues to address.

On top of this, in Singapore, DBS has recently reported that a local recovery looks to be a ‘slow grind’.

The HKMA noted that while business lending grew 13.2% over 2012, company debt now made up 70% of Hong Kong banking loans. This lending data comes on the back of a difficult period for the wider Asian markets.

A few of the emerging markets ‘stars’ —India, Indonesia, and Malaysia (and wider afield, even Brazil), are all facing various degrees of economic turmoil.

Added to this, the uncertainty around US debt (and the threat of a Government shutdown), and the possible end of quantitative easing and the overall ‘big-picture’ situation does highlight a few concerns.

How companies and banks deal with debt, especially the risk of bad debt, should be factored into general commercial strategy and operations.

After all, debt like many other risks can be insured against. If an international recovery does indeed take on a ‘slow grind’ form, both companies and lenders will need to ensure they are prepared for a worst case scenario.

Trade Credit Risk

Trade Credit risk is the threat of bad debt from a buyer (or buyers). If a supply chain is under increasing pressure, non payment of debt can have a cumulative impact on a business’s ability to perform. This form of commercial risk is becoming an increasingly sensitive concern for the business community—as can be highlighted in the HKBR report.

Sovereign debt holders (mostly financial institutions), concerned about the impact of possible defaults on their balance sheets, are further restricting their lending and financing activities.

This may cause another credit crunch, which could have an impact on the ability of buyers to make payments across a business’ supply chain. For companies without Trade Credit insurance which covers possible bad debts, these the non payment of such debts could threaten the survival of the companies.

Bank Trade Finance Risk

Bad debts bring us full circle. With company debt now sitting at a reported 70% of Hong Kong banking loans, there is an increased exposure to bad company-debt.

Bank Trade Finance Risk covers the threats of non payment of bank loans from trade and commodity financing to corporate borrowers.

It can also cover the risks related to interbank trade advances or letters of credit re-financing to other financial institutions or banks where the Insured party is a financial institution and the counterparty obligor is another financial institution which may not be able to fulfill its repayment obligations to other financial institutions on the maturity date of the interbank trade loans or letter of credit issued

Given the risks and exposure of Hong Kong banks identified in the HKMA report, bank insurance seems to be something everyone should be paying attention to.

It is safe to say that, due to regulatory changes, there has never been a greater convergence of bank and insurance capital.

Increased capital requirements for banking, driven mainly by Basel III, mean that most financial institutions now realise that using insurance capital as a contingent call capital is more efficient, and offers a lower cost of capital than its own bank capital.

By leveraging on Bank Trade Finance Insurance, banks can now do more trade business with the same amount of available bank capital by arbitraging on the lower cost of capital through the use of such insurance.

This may very well help keep the momentum going in more banks and financial institutions using contingent insurance capital to supplement their internal capital resources when providing various forms of trade and commodity financing.

As identified by the HKMA, the current situation does include a number of risks and opportunities that the insurance sector is well positioned to participate in and to syndicate various risks emanated through the trade financing activities of the banks.

Through such increasing trade loan risks syndication from the banking sector into the insurance sector market, it helps to diversify some of the trade loan risks into the insurance market.

This makes the trade banking sector more robust in the event of any systemic downturn and also optimizes the cost of trade financing to the end trade users like corporates and commodity traders.