30 years: Commodity & trade finance
Aidan outlines the significance of credit support in trade finance. He critiques traditional credit analysis, explains the components that makeup credit analysis and outlines the value of focusing on these components.
Aidan outlines the significance of credit support in trade finance. He critiques traditional credit analysis, explains the components that makeup credit analysis and outlines the value of focusing on these components.
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10 mins
In this video, Aidan outlines the traditional credit risk review of balance sheet analysis and identifies the flaws associated with this, and then introduces the trade financing solutions, how they differ to general corporate lending and the reason for their relatively low loss-default rate.
Key learning objectives:
Identify the traditional credit risk analysis used by credit managers
Discuss the flaws associated with traditional credit analysis
Explain the focus of trade finances’ credit analysis, and its benefits
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Traditional credit analysis falls back on the quality of a borrower’s balance sheet. This may work well for the larger, more established investment-grade corporates which can demonstrate net worth, net current assets and profitability, however, for sub-investment grade corporates and SMEs who are typically light on fixed and net current assets, balance sheet lending rarely justifies the sort of funding needs these firms require to deliver on their day to day activities.
It means that SMEs in particular have to resort to alternative financing options - options which are less ‘backward looking’ into last year’s audited results and more ‘forward looking’ into the operationalisation of the individual transactions requiring finance.
Credit managers must be trained to show that a reliance on backward dated numbers has its limitations, whilst a focus on the forward looking operationalisation of a trade finance transaction offers a more relevant and practical approach, which not only leads to finding sensible mitigants, but can also lead to further lending opportunities.
Where the corporate credit office looks to the balance sheet for creditworthiness, the trade finance credit office also looks to the balance sheet for vulnerability, and to the pros and cons of the transaction being financed for creditworthiness.
This is a necessary mindshift because the risk of the trade transaction to be financed is in the operationalisation of the transaction being considered, and in most cases, repayment doesn’t come from the borrower of the record, but from the receivable due from the buyer at the end of the transaction chain - self liquidating transactions. For this reason trade loan default rates are comparatively lower.
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