INSTITUTE OF MANAGMENT STUDIES, DAVV, INDORE

FINANCE AND ADMINISTRATION – SEMESTER IV

CREDIT MANAGEMENT AND RETAIL BANKING

RISK IN FOREIGN TRADE – ROLE OF ECGC

 Any activity done is associated with uncertainty which may result in some loss or some gain.
 Arena of International trade is also not free from risk. International trade is largely dependent on
financing by banks, and so many countries have developed export credit guarantee corporations
to take care of such risks.
 In India this role is being played by ECGC of India ltd.
 Arena of international trade and foreign exchange is more risky due to complexities in operations.
 Forex operations and markets are different from other commodity markets due to following
reasons
- They are largely over the counter (OTC) market
- Open 24 hours a day
- No location barrier
- Fluctuation almost every 4 seconds
- Movement of other markets
- Effect of control and policies of respective government
- Delay in settlement due to time difference.

SOME OF THE IMPORTANT RISKS FACE IN FOREIGN EXCHANGE

 EXCHANGE RISK :
 Movement of exchange rate can adversely affect value of our foreign exchange holding. Normally
dealer is expected to cover the transaction immediately by entering into matching and opposite
transaction, without loss of time. If this not done bank is exposed to exchange risk.
 SETTLEMENT RISK
 International financial system evolves around foreign exchange market where huge daily turnover is
transacted between market participants worldwide without use of single central clearing house – it is
truly over the counter market.
 In absence of such centralized clearing house each participant has to make and receive payment
on an individual basis. This entails counter-party credit risk for each transaction.
 Thus credit risk in foreign exchange operations, is the risk of failure of a counter party, whether bank
or customer to meet obligation at maturity of contract.
 LIQUIDITY RISK
 When a party to a foreign exchange transaction is unable to meet its funding requirements it creates
Liquidity Risk.
 For protecting against liquidity risk, bank is required to monitor mismatch of maturities between
asset and liabilities, which is done by fixing suitable mismatch limits.
 COUNTRY RISK/ SOVERIGN RISK
 Country risk arises when a foreign entity or a counter party, private or sovereign is unwilling or
unable to fulfill its obligation.
 Dealing with counter party in other country generates country risk if there is imposition of exchange
control by central bank or govt. of that country.
 Country risk is high in case of countries which are facing problems of foreign exchange reserves or
balance of payment etc.
 Sovereign risk is larger, when counter party is a foreign government itself.
 INTEREST RATE RISK
 Interest rate risk or GAP risk arise due to adverse movement of interest rate or interest rate
differentials.
 Interest rate risk occur when different bases of interest rates are applied to assets and
corresponding liabilities (fixed in case of liability and floating in case of assets). If degree of
fluctuation in two different interest rates is different, will affect spread originally envisaged.
 OPERATIONAL RISK
 It is another critical area and important risk for dealing room. It may occur due to deficiencies in
information system or internal control or human error or other infrastructure problems like computer
or communication system etc fail to function due to some error or fault.
 Operation risk can be controlled by providing state of art systems, contingency plans, disaster
control procedures, sufficient back-up arrangements for man and machine and a duplicate process
at a different site (mirroring).
 LEGAL RISK
 Legal risk arise due to non compliance of regulations and guidelines or breach of govt. rules leading
to wrong understanding or penalties imposed by enforcing agency.

 Additional risks can be:

 Buyer risk - buyer faces risk relating to seller not shipping goods after receiving advanced
payment, may ship poor quality goods or ship goods after considerable delay.
 Seller risk – seller faces risk relating to non acceptability, non payment, credit risk etc.
 Shipping risk – risk arising due to other intermediaries like shipping companies, handling agents,
port authority or local transporter which may lead to delay or wrong delivery of goods etc.
 Other risks like bank failure risk, settlement risk, risk of competition, genuineness of documents,
price risk etc.
 Credit Risk – relates to credit worthiness of buyer which may result in non payment of export bill.
 Country risk and Political risk – due to financial position of country, fluid political situation,
countries bad forex reserves position.

 EXPORT CREDIT INSURANCE IN INTERNATIONAL TRADE

 Exports grow on backing of export finance by banks. Govt. support exporters by providing cheap
finance options, and comfort to exporter and financing banks by way of export insurance.
 In India export credit is guaranteed by ECGC which was set up by Govt. of India, to support
growth of exports.
 It is a credit guarantee institution, set up for promotion of exports, by protecting exporter from any
financial loss due to buyers failure to pay or problem of externalization of country of import by
issuing various types of policies to exporter.
 At the same time ECGC issue various types of guarantee to banks, financing exporters which
protect banks in case of loss from their advance to exporter.
 ECGC was established with a goal to support export promotion drive in India and reduce trade
gap between export and import.

 Activities of ECGC
 Main activities of ECGC are:
- Provide credit risk insurance cover to exporter against loss in export of goods and services
- Guarantee to banks and FIs to enable exporter to obtain credit facility.
- ECGC have also started giving credit reports of overseas buyers.

 ECGC POLICIES
 Standard Policies:
 These policies provide cover for exporters for short term exports. Different types of policy are:
- Shipment (Comprehensive Risk) Policy – to cover both commercial and political risk from the
date of shipment.
- Shipment (Political Risk) Policy – to cover only political risk from the date of shipment.
- Contract (Comprehensive Risk) Policy – to cover both commercial and political risk from the
date of contract.
- Contract (Political Risk) Policy – to cover only political risk from the date of contract.
 Commercial risk - cover Insolvency of Overseas Buyer, Default by overseas buyer to pay for
goods accepted by him within a specified period usually 4 months from the due date, and
Repudiation i.e. buyers’ failure to accept goods subject to certain conditions.
 Political risk – cover imposition of restriction on remittance by Govt. in buyers’ country or any
govt action which may block or delay payment to exporter, war, revolution or civil disturbance in
buyers’ country.
 Standard policy do not cover following risks:
- Commercial disputes raised by the buyer
- Causes inherent in the nature of goods.
- Buyers’ failure to obtain necessary import or exchange authorization from authorities of his
country.
- Default or insolvency of agent or collecting bank.
- Exchange rate fluctuation risk
- Failure of exporter to fulfil terms of export contract or negligence on his part.

 Other policies issued by ECGC are

 Small Exporters’ Policy
 Specific Shipment Policies – Short Term
 Exports (Specific buyers) Policy
 Buyer Exposure Policy
 Export Turnover Policy
 Consignment Export Policy

FINANCIAL GUARANTEES ISSUED BY ECGC

 ECGC with intention to giving protection to bankers against possible loss on account of financial
lending to their exporter client issue different kinds of financial guarantees.
 Packing Credit Insurance (Whole Turnover Packing Credit)
 Any loan given to exporter for manufacturing, processing, purchasing or packing of goods meant
for export against firm order or LC qualifies for packing credit guarantee.
 It is issued for a period of 1 year
 Claim is payable in case of shipment credit granted is not paid within 4 months from the due date
of loan.
 Export Credit Insurance for Banks (Whole turnover – Packing credit ) is issued to banks at low
premium and covers high percentage of risk for large business offered by banks.
 Bank is required to notify ECGC, limits sanctioned by banks to export customers within 30 days
of sanction.
 For amount disbursed more than sanctioned limit, (discretionary limit by ECGC) approval of
ECGC is required.
 Premium ranges from 6 to 10 paise per Rs.100/- per month.
 Cover ranges from 50 to 75%
 Post Shipment Export Credit Insurance
 Advance against export bill by way of purchase, negotiation or discount or rupee finance by
banks are covered.
 Export Performance Indemnity
 It is issued in form of counter guarantee to bank against possible losses that they may suffer on
account of guarantee issued by them on behalf of exporter clients. Guarantees are required to be
issued on account of exporter clients in favour of overseas buyer for performance of contracts,
bid-bond etc. guarantees are also issued in favour of customs, for import of capital.
 Export Finance (Overseas Lending) Guarantee
 If bank financing an overseas project provide a foreign currency loan to contractor, it can protect
itself from risk of non-payment by contractor by this policy.
 Exchange Fluctuation risk cover scheme
 Cover under the scheme is available for payment scheduled over a period beyond 12 month upto
15 years.
 Cover is available for payments specified is US Dollar, Pound Sterling, EURO, Japanese Yen,
Swiss Francs, UAE Dirham and Australian Dollar. Other country currencies can be permitted by
ECGC.
  Loss or gain within range of 2% of reference rate will go to exporter.
 If loss exceeds more than 2% but upto 35% of reference rate loss will be borne by ECGC
 If loss exceeds more than 35% of reference rate loss will be borne by exporter.
 Insurance cover for Buyer’s credit and Line of credit
 Buyer’s credit is credit extended by bank in India to overseas buyer enabling buyer to pay for
machinery imported from India.
 Line of credit is credit extended by bank in India to overseas bank, institution or government for
import of variety of listed goods from India to overseas country.
 ECGC cover political and commercial risk for non payment.
 Other aspects relating to ECGC policies and guarantees
 Credit guarantee/ policies are on risk sharing basis. 100% cover is not available, but maximum
90-95% cover is available and rest amount is to be borne by bank.
 Policies are issued subject to regulatory control of IRDA. As per guidelines of IRDA, upfront one
month premium is required to be paid based on previous years average.
 Monthly declaration to be submitted by exporter for policies and by banks for guarantees.
 Since policies are on risk sharing basis recovery made by exporter or financing bank to be
refunded to ECGC in same proportion.

Prepared by:
Arvind Paranjape, M.Sc. CAIIB
paranjape.arvind@yahoo.com
9425067026