Credit risk management Foreign Trade Transaction Lecture 11th Dr. Katalin Csekő

Definitions Risk management deals with: evaluating and minimizing the risks of non payment, or partial payment faced by a seller/creditor; The credit risk can be accompanied with: Loss of possession of the goods; Loss of possession of the goods; Reduction (or loss) of income due to fluctuation of exchange rate of the agreed currency; Reduction (or loss) of income due to fluctuation of exchange rate of the agreed currency; Costs of litigation procedure in order to enforce the payment; Costs of litigation procedure in order to enforce the payment; Liquidity problems; Liquidity problems; The injury of intellectual property rights; The injury of intellectual property rights;

Types of risk management The risks are inherent; The obligation to mitigate the losses is a fundamental of international trade law; Approaches to handle the risks : To refuse risks=risk avoidance; To refuse risks=risk avoidance; To accept risks=loss prevention; loss reduction; To accept risks=loss prevention; loss reduction; How to handle/cover risks ? By self insurance: a company is accumulating funds for any losses; By allocation of the risks: securities; By legal measures: retention of title, compensation provision; By insurance cover;

Security tools Proprietary right in assets; Proprietary rights in tangible or intangible assets: Personal securities; Personal securities can be divided: Dependent= surety-hip or (bank)guaranty; Dependent= surety-hip or (bank)guaranty; Independent= (bank)guarantee Independent= (bank)guarantee The value of the personal security= value of the security provider; The actors: Debtor, creditor and security provider nominated and appointed by the debtor;

(Bank)-Guarantee Independent personal security; Irrevocable payment obligation of the security provider= guarantor, on first demand; In Europe only bank are authorized to issue; In USA and other countries: corporates, and rich families as well; It is a default instrument= a bank promises payment if his principal does not fulfill its obligation. This obligation can be of different nature (above all payment obligation); Beneficiary: The party (seller), to whose benefit the bank guarantees the payment in the event of non- performance by his principal. Principal: The debtor of the original obligation, and the bank’s customer that appoints the issue of the guarantee;

The bank-guarantee A bank guarantee should be: irrevocable, unconditional, divisible ; Irrevocable=the Guarantee can not be modified or cancelled without the permission of the beneficiary; Unconditional= the bank pays irrespective of the underlying transaction only upon the first demand or some documents of the beneficiary; within the validity of the bank guarantee; after the expiry date the guarantor has no more obligation; To call upon the guarantor to pay, the beneficiary has to present (through bank channel): documents indicated in the letter/contract of bank guarantee. There is only one exception: evident fraud;

Types of bank-guarantee Beneficiary is the seller: Payment guarantee; Payment guarantee; Beneficiary is the buyer: Good-performance guarantee: for the risk that exporter/contractor will fail to perform adequately. The guarantee amount is up to 10% of the contract price; It is to be opened as contracting provision; Good-performance guarantee: for the risk that exporter/contractor will fail to perform adequately. The guarantee amount is up to 10% of the contract price; It is to be opened as contracting provision; Warranty guarantee; Warranty guarantee; Tender guarantee; It is 5-10% of the proposed contractual price; it should be provided as a part of the proposal; Tender guarantee; It is 5-10% of the proposed contractual price; it should be provided as a part of the proposal; Advance payment guarantee; for the case if the seller had had down payment from the buyer; Advance payment guarantee; for the case if the seller had had down payment from the buyer;

Issuance of the guarantee ( payment guarantee) Importer/debtor 1. Exporter/creditor Principal↔beneficiary underlying transaction underlying transaction2. 4. Notice of the guarantee 4. Notice of the guarantee Guarantee application + deposit Bank, guarantor guarantee contract 3. Advising/Confirming Bank

Call/ demand of the guarantee ( payment guarantee ) Demanding the guarantor to pay, the beneficiary has usually to present through its bank beneficiary has usually to present through its bank channel the following documents: channel the following documents: Its demand supported by: Its demand supported by: a statement that the beneficiary delivered the goods and has never received the counter value; a statement that the beneficiary delivered the goods and has never received the counter value; commercial invoice on goods delivered, not paid, commercial invoice on goods delivered, not paid, copy of the transport document; copy of the transport document;

Dependent personal security Its roots trace back to the Roman Empire=Guaranty; The guarantor undertakes the payment if the original debtor did not/would not pay, BUT The guarantor steps into the position (shoes) of the original debtor and MUST invoke all objections to the contract/underlying transaction (denying the legal ground of payment such as defective goods etc.) which the original debtor could have invoked! ↔ The independent security! The bank-guarantor has to be jointly and severally liable towards the beneficiary= has to pay irrespective of the fact whether or not the original debtor can be liquidated IF there is no failure on the side of the original creditor )e.g. seller) ↔ The independent security!