CAIIB BFM Module A Unit 7 : Risk In Foreign Trade- Role Of ECGC

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Sep 5

CAIIB Paper 2 BFM Module A Unit 7 : Risk In Foreign Trade- Role Of ECGC (New Syllabus)

IIBF has released the New Syllabus Exam Pattern for CAIIB Exam 2023. Following the format of the current exam, CAIIB 2023 will have now four papers. The CAIIB Paper 2 (Bank Financial Management) includes an important topic called "Risk In Foreign Trade- Role Of ECGC". Every candidate who are appearing for the CAIIB Certification Examination 2023 must understand each unit included in the syllabus.

In this article, we are going to cover all the necessary details of CAIIB Paper 2 (BFM) Module A (INTERNATIONAL BANKING) Unit 7 : Risk In Foreign Trade- Role Of ECGC, Aspirants must go through this article to better understand the topic, Risk In Foreign Trade- Role Of ECGC and practice using our Online Mock Test Series to strengthen their knowledge of Risk In Foreign Trade- Role Of ECGC. Unit 7 : Risk In Foreign Trade- Role Of ECGC

Definition of Risk And Risks In International Trade

A risk can be defined as an uncertain event with financial consequences resulting in loss or reduced earnings. An activity which may give profits or result in loss may be called a risky proposition, due to the uncertainty or unpredictability of the activity or trade in future. While, in human life, risk is related to illness, impairment or loss of life, in commercial and business activities, the business profit or loss would depend upon how the business is run or its affairs managed.

Buyer Risk:The seller faces risks relating to non-acceptability, non-payment, quality acceptance, credit risk, etc.
Seller Risk:The buyer faces the risk relating to the seller not shipping the goods after receiving advance payment, may ship poor quality goods and may ship the goods after considerable delay, which may either lead to cancellation or delays in further orders taken by the buyer or even penalties in delays/non-shipment.
Shipping Risk:Includes risks arising due to other intermediaries in the international trade, like shipping companies, handling agents, port authorities, local transporters, or even loaders, etc.
Other Risks:Some of the other risks like bank failure risk, settlement risk, risk of competition, genuineness of documents, price risk, legal risk, spread risk, market risk (absorption/rejection), etc. could affect the parties to the international trade.

We can also categorise the risks in International trade as under:

Credit Risk: Relates to credit worthiness of the buyer, and could result in non payment of export bills due to any reasons, like financial crunch, defaults, insolvency, etc.
Legal Risk:Relates to any amendment in the laws of the sellers or buyer's country, which could result in inability of the seller to export or of the buyer to remit proceeds of invoices. This could be due to embargoes on countries, ban or restriction on export of particular goods, ban or restriction on remittance of funds to particular countries, etc.
Country Risk and Political Risk: Relates to the developments in the country of buyer or seller, leading to default in export or payments. This could be due to uncertainty in laws, uncertainty in financial position of the countries, inharmonious relationship between countries, or fluid political situation. Countries' bad forex reserves position could lead to shortage of foreign exchange and inability to buy foreign exchange, resulting in externalization issues.
Operational Risk: Relates to operational issues at both ends or even at supporting organizations place. Strikes at seller's factory or even at sellers' raw material suppliers' factory, transporters, loaders, banks, clearing agents, etc.
Exchange Risk: Relates to adverse movement in currencies. Any exporter or importer faces exchange risk, directly or indirectly. Invoicing in currency, other than home currency, strengthening or weakening of currency in which imports are billed, weakening of currency from where competitors import goods or supply goods to the same buyers/countries, etc.

Export Credit Insurance In International Trade

Exports grow on the backing of export financing by banks. Governments, in order to support exports, provide cheap financing options and provide comfort to exporters and financing banks, by way of export credit insurance. Export credit insurance, provides protection against losses from political and commercial risk to the exports and financing institutions.
Countries have set up special corporations to provide these services of export credit insurance. Some general insurance companies also provide credit guarantee for exports. Credit insurance lowers the cost of borrowing/financing, as the government agency bears the risk of default as per policy terms. Usually, the insurance is on risk sharing basis—as such it covers a large part of credit default, but requires the insured exporter/financer to bear some part of the loss.

ECGC LTD. – Role And Products

About ECGC Ltd (earlier known as Export Credit Guarantee Corporation Ltd.)

ECGC Ltd is a credit guarantee institution, set up for the promotion of exports, by protecting the exporters from any financial loss due to the buyer's failure to pay or due to the problem of externalization in the country of import, by issuing various types of policies to the exporters. At the same time, ECGC issues various types of guarantees to banks, financing exporters, which protect banks in case of loss from their advances to exporters

At present, ECGC has set before itself the following objectives:

To encourage and facilitate globalization of India's trade.
To assist Indian exporters in managing their credit risks by providing timely information on worthiness of the buyers, bankers and the countries.
To protect the Indian exporters against unforeseen losses, which may arise due to failure of the buyer, bank or problems faced by the country of the buyer by providing cost effective credit insurance covers in the form of Policy, Factoring and Investment Insurance Services comparable to similar covers available to exporters in other countries.
To facilitate availability of adequate bank finance to the Indian exporters by providing surety insurance covers for bankers at competitive rates.
To achieve improved performance in terms of profitability, financial and operational efficiency indicators and achieve optimum return on investment.
To develop world class expertise in credit insurance among employees and ensure continuous innovation and achieve the highest customer satisfaction by delivering top quality service.
To educate the customers by continuous publicity and effective marketing.

Main Activities of ECGC

ECGC provides a wide range of credit risk insurance cover to exporters against loss in export of goods and services. It also offers guarantees to banks and financial institutions to enable exports to obtain facilities, credit or otherwise, from banks They provide credit reports of overseas buyers also.

Some of the main policies offered by ECGC to the exporters are:

Standard Policies to exporters to protect them against payment risks involved in exports on short-term credit.
Small Exporters Policy basically a Standard Policy, but incorporating certain improvements in terms of cover to enable to encourage small exporters.
Specific Shipment Policies designed to protect firms in India, against payment risks involved in

(a) Exports on Deferred Payment Terms

(b) Insurance for Buyers' Credit and Lines of Credit

(d) Construction Works and Turnkey Projects Undertaken Abroad.

Exports (Specific Buyer) Policy.
Export Turnover Policy.
Buyer Exposure Policy.
Consignment Exports Policy.
Multi-buyer Exposure Policy.
IT-Enabled Services Policy-Single Customer (SITES).
Policy for SME Sector.

(B)The guarantees policies offered by ECGC to the banks are:

Export Credit Insurance for Banks (Whole turnover – Packing Credit)-ECIB (WT-PC).
Export Production Finance Guarantee.
Export Credit Insurance for Banks (Whole turnover- Post shipment Credit)-ECIB (WT-PS).
Export Finance Guarantee.
Export Performance Indemnity.
Export Finance (Overseas Lending) Guarantee.
Transfer Guarantees.

Besides the above, ECGC also offers some Special Schemes, such as Factoring, Buyer's Credit Cover, Lines of Credit Cover, Overseas Investment Insurance, Transfer guarantees, (covering risk on transfer of funds), Scheme for Small Exporters, Exchange Fluctuation Risk Insurance Scheme, Customer Specific Covers etc.

ECGC Policies

Standard Policies

The Standard Policies of ECGC provide cover for exporters for short-term exports. The different types of policies are:

Shipment (Comprehensive Risk) Policy– to cover both commercial and political risks from of shipment.
Shipment (Political Risks)– to cover only political risks from the date of shipment.
Contracts (Comprehensive Risks) Policy– to cover both commercial and political risks from the date of contract.
Contracts (Political Risks) Policy– to cover only political risks from the date of contract.

Standard policies cover following risks:

Commercial Risks– covering Insolvency of the Overseas Buyer, Protracted Default by the overseas buyer to pay for goods accepted by him within a specified period usually 4 months from the due date, – Buyers' failure to accept goods subject to certain conditions.
Political Risks– which covers imposition of restrictions on remittance by the Government in buyers' country or any Government action which may block or delay payment to exporter, war, revolution or civil disturbances in buyers' country, New Import Licensing restrictions or cancellations of a valid import license in the buyers' country, interruption or diversion of voyage outside India resulting in payment of additional freight or insurance charges which cannot be recovered from the buyer, any other cause of loss occurring outside India, not normally insured by general insurers and beyond the control of both the exporter and the buyer.

Standard policies do not cover following risks:

Commercial disputes raised by the buyer.
Causes inherent in the nature of goods.
Buyer's failure to obtain necessary import or exchange authorization from authorities in his country.
Default or insolvency of any agent of the exporter or collecting bank. Loss or damage to goods which can be covered by general insurers.
Exchange rate fluctuation risk.
Failure of the exporter to fulfill the terms of the export contract or negligence on his part. The cover granted by ECGC on Standard policies is 90% of the value of exports. The premium for such policies varies for different countries and payment terms.

Small Exporters' Policy

The Standard Policy (Shipments comprehensive Risks Policy) issued by the Corporation to exporters is a declaration type of policy and is issued to cover shipments that may be made in period of 24 months ahead. For the purpose of issuing the Policy, a Small Exporter is defined as an exporter whose anticipated total export turnover for the period of 12 months ahead is not more than Rs. 50 lacs. (Projected Export Turnover)
This policy provides cover against Commercial risks, covering insolvency of the buyer, failure of the buyer to make the payment due within 2 months from the due date, buyer's failure to accept the goods, due to no fault of the exporter, provided that legal action against the buyer is considered to be inadvisable.

It also provides cover against Political risks, covering:

Imposition of restrictions by the Government of the buyers' country or any Government action which may block or delay the transfer of payment made by the buyer.
War, civil war, revolution or civil disturbances in the buyers' country.
New import restrictions or cancellation of a valid import license.
Interruption or diversion of voyage outside India resulting in payment of additional freight or insurance charges which cannot be recovered from the buyer.

Small exporters policy does not cover losses arising due to the following risks:

Commercial disputes including quality disputes raised by the buyer, unless the exporter obtains a decree from a competent court of law in the buyers' country in his favour.
Causes inherent in the nature of the goods.
Buyer's failure to obtain necessary import or exchange authorization from authorities in his countr
Insolvency or default of any agent of the exporter of the collecting bank.
Loss or damage to goods, which can be covered by general insurers.
Exchange rate fluctuation.
Failure of the exporters to fulfill the terms of the export contract or negligence on his part.
Non payment under LC due to any discrepancy pointed out by the LC opening bank.

This policy is issued for a period of 12 months,

Specific Shipment Policies – Short-Term

The Specific Shipment Short-Term Policies provides cover against commercial and political risks involved in export of goods on short-term credit not exceeding 180 days. Cover under these policies can be taken for shipment(s) made/to be made by the exporter to a buyer under a contract. These policies can be availed of by exporters who do not hold Comprehensive policy covering shipments in the specific contracts.

Short-term policies could be:

Specific shipments policy covering commercial and political risks
Specific shipments (political risk) policy, to cover only political risk at the Post-shipment stage in cases where the buyer is an overseas government or payments are guaranteed by a Government or by banks or are made to associates, and
Specific Shipments (insolvency and default of L/C opening bank and political risks) Policy.

Commercial risks covered by the Short-Term policies, include:

Insolvency of the buyer,
Failure of the buyer to make the payment due within a specified period normally 4 months from the due date,
Buyers' failure to accept the goods (subject to certain conditions).

Political risks covered under this policy are:

Imposition of restrictions by the Government of the buyer's country or any Government action, which may block or delay the transfer of payment made by the buyer,
War, civil war, revolution or civil disturbances in the buyer's country,
New import restrictions or cancellation of a valid import licence, interruption of voyage outside India, resulting in payment of additional freight or insurance charges which cannot be recovered from the buyer,
Any other cause of loss occurring outside India, not normally insured by general insurers and beyond the control of both the exporter and the buyer.

Short-Term policies do not cover following losses:

Commercial disputes including quality disputes raised by the buyer unless the exporter obtains a decree from a competent court of law in the buyer's country in his favour,
Causes inherent in the nature of goods,
Buyer's failure to obtain necessary import or exchange authorization from authorities in his country,
Insolvency or default of any agent of the exporter or of the collecting bank,
Loss or damage to goods,
Exchange rate fluctuation,
Failure of the exporter to fulfill the terms of the export contract or negligence on his part.

Exports (Specific buyers) Policy

Exports-Buyerwise Policies – Short Term (BP-ST) provides cover to Indian exporters against commercial and political risks involved in export of goods on short-term credit to a particular buyer. All shipments to the buyer in respect of whom the policy is issued will have to be covered However, there is a provision to permit exclusion of shipments under LC. These policies can be availed of by exporters who do not hold Standard Policy and also by exporters already having Standard Policy. These policies are of three types:

Buyerwise (commercial and political risks) Policy – short-term.
Buyerwise (political risks) Policy – short-term.
Buyerwise (insolvency & default of L/C opening bank and political risks) Policy short-term,

Buyer Exposure Policy

A variant to this policy is Buyer Exposure policy, which is specifically designed for large exporters to enable them to cover their exposure on a particular buyer on the basis of expected exposure. Two types of exposure policies– one for covering the risks on a specified buyer and another for covering the risks on all buyers – are offered.

Export Turnover Policy

Export Turnover policy is a variation of the standard policy for the benefit of large exporters who contribute not less than Rs. 10 lacs per annum towards premium. Therefore, all the exporters whose turnover is likely to exceed the premium payable to ECGC by Rs. 10 lacs in a year are entitled to avail of it.

ECGC'S Products For Banks

While it is essential that exporters continue to get timely and adequate export credit both at pre-shipment and post-shipment stage, so that the best possible potential for exports can be realized, banks will be willing to release such facilities freely only if the advances are utilized properly and realized in time.
ECGC, with the intention of giving protection to the bankers against losses on account of their financial lending to their exporter clientele, has been providing credit insurance to financial institutions/banks.
This in turn leads to an additional security for the bankers and thus translates into adequate financial support to exporters. ECGC issues following types of insurances looking to the various needs of exporters/financial institutions

Packing Credit Insurance

Any loan given to an exporter for the manufacture, processing, purchasing or packing of goods meant for export against a firm order or letter of credit qualifies for packing credit guarantee.
It is issued for a period of 1 year against a proposal made for the purpose and covers all advances that may be made by the bank during the period to a given exporter within an approved limit.
The claim is payable, in case the pre-shipment credit granted is not paid within 4 months from the due date of the loan.
Export Credit Insurance for Banks (Whole turnover – Packing Credit)-ECIB (WT-PC), is issued by ECGC to banks wherein a higher percentage of cover is available at a lower premium since a large volume of business is offered to cover in this guarantee.
Bank is required to notify the limits sanctioned to their exporter customer within 30 days of the sanction and banks are required to take the approval of the Corporation if they exceed an agreed value, called the Discretionary limit.
The premium on WTPC insurance is borne by the exporters.

Export Production Finance Guarantee

This guarantee covers the advances given by banks against incentives/receivable at the Pre-shipment stage.
While the extent of cover and the premium are the same as for packing credit insurance, banks having ECIB (WT-PC) are eligible for concessional premium rate and higher coverage.

Post-Shipment Export Credit Insurance

A bank or a financial institution dealing with foreign exchange is eligible to obtain this Whole-turnover Cover for all its accounts (ECIB – WT-PS). The period of cover is 12 months and all post-shipment advances granted to exporters by way of purchase/discount/negotiation of export documents or advances granted against export bills sent on collection basis, as per RBI guidelines are eligible to be covered by this insurance.
The insurance protects banks against losses that may be incurred in extending post-shipment advances due to protracted default or insolvency of the exporter-client.
The extent of cover varies from 90% to 95% in respect of exporters who are Policyholders of ECGC and 50% to 75% for non-Policyholders, depending upon the claim premium ratio of the bank.
For bills drawn on Associates of Policyholders coverage is 60% and of non-Policyholders it is 50%.
The premium on WTPS insurance is borne by the Banks.

Export Finance Guarantee

When banks grant post-shipment advances to their exporters against export incentives receivables in the form of cash assistance, duty drawback, etc., it can be covered under this guarantee.

Export Performance Indemnity

It is issued by ECGC in the nature of a counter guarantee to the bank against possible losses that they may suffer on account of the guarantees issued by them on behalf of its exporter clients.
Guarantees are required to be issued on account of exporters clients, in favour of overseas buyers, for performance of contracts, Bid-bonds, quality, etc.
Guarantees are also required in favour of customs, for import of capital as well as raw material free of customs duty, or on reduced duty, against export commitments.

Export Finance (Overseas Lending) Guarantee

If a bank financing an overseas project provides a foreign currency loan to the contractor, it can protect itself from the risk of non-payment by the contractor by obtaining Export Finance (Overseas Lending) guarantee.
The premium on such guarantee are payable in Indian Rupees.

Other Special Guarantees and Schemes

Exchange Fluctuation Risk Cover Scheme

The cover under the scheme is available for payment scheduled over a period beyond 12 months up to a maximum period of 15 years.
Cover under the scheme is available for payments specified in US dollar, Pound Sterling, EURO, Japanese Yen, Swiss Francs, UAE Dirham and Australian Dollars.
However, cover can be extended for payments specified in other convertible currencies at the discretion of the ECGC.
The contract cover provides a deductible of 2%. Loss or gain within a range of 2% of the reference rate will go to the exporters' account.
If loss exceeds 2%, then ECGC will make good the portion of loss in excess of 2%, but not exceeding 35% of the reference rate.
In other words, gains/losses up to 2% and beyond 35% of reference rate will be to the exporters' account.
Gains or losses over 2% and up to 35% will be to ECGC's account.

Maturity Factoring

ECGC's full-fledged factoring service takes care of the export credit guarantee for the exporters, besides their financing needs. Factoring service covers financing and collection of series of receivable transactions between the buyer and the seller. It also includes credit protection, thereby improving exporter's cash flows.

ECGC factoring service provides:

Facilitates purchase of account receivables.
Provides up to 90% finance against approved transactions.
Full credit guarantee on buyer's default or insolvency.
Maintenance of sales ledger.
Follow-up for collection of export proceeds.

Eligibility:

Exports with good track record.
Dealing on DA terms/open account terms with buyers.
Having unexpected bulk orders to execute.
Exporters facing large working capital shortfall by way of bill financing.

The facility allows exporters to avail additional finance, eliminates the need for routing export bills through commercial banks and also the need for following up with the buyers for payments. Export factoring also reduces the administrative costs to the exporters.

Insurance Cover for Buyer's Credit and Line of Credit

Buyer's Credit is a credit extended by a bank in India to an overseas buyer enabling the buyer to pay for machinery and equipment that he may be importing from India for a specific project.
A Line of Credit is a credit extended by a bank in India to an overseas bank, institution or government for the purpose of facilitating import of a variety of listed goods from India into the overseas country.
ECGC has evolved schemes to protect the lending banks from certain risks of non-payment.
These covers take the form of an agreement between the lending bank and ECGC and are issued on a case to case basis.
Credit terms and the length of the credit period should be in conformity with what is appropriate for the export of the relevant items.
Risks Covered: Political and Loss Coverage is 90%. Period of Cover can be as per the agreement.

Overseas Investment Insurance Cover

ECGC has evolved a scheme to provide protection for Indian Investments abroad.
Any investment made by way of equity capital or untied loan for the purpose of setting up or expansion of overseas projects will be eligible for cover under investment insurance.
The investment may be either in cash or in the form of export of Indian capital goods and services.
The risks of war, expropriation and restriction on remittances are covered under the scheme.
As the investor would be having a hand in the management of the joint venture, no cover for commercial risks would be provided under the scheme.

Main features of the Overseas Investment Insurance

For investment in any country to qualify for investment insurance, there should preferably be a bilateral agreement protecting investment of one country in the other.
ECGC may consider providing cover in the absence of any such agreement provided it is satisfied that the general laws of the country afford adequate protection to the Indian investments.
The period of insurance cover will not normally exceed 15 years in case of projects involving long construction period. The cover can be extended for a period of 15 years from the date of completion of the project subject to a maximum of 20 years from the date of commencement of investment.
Amount insured shall be reduced progressively in the last five years of the insurance period.

Only political Risks are covered as under:

War, Civil War, Revolutions in buyer's country
Expropriation
Restrictions on remittances
Loss Coverage is up to 90%.
Cover is available up to 15 years, expandable up to 20 years with reduced insured amount and reduced
loss coverage with proportionate reduction in premium.

Customer Specific Policy Cover

In order to cater to the specific need for export credit insurance cover, of reputed large value exporters which otherwise could not be fully addressed under any one of standard products, the customer specific policies have been introduced and are issued to large exporters on a selective basis on the merits respective requests for such cover.
Normally such policies are issued without changing the basic risk cover profile of the export transaction.

Some of the features of customer specific policies are as under:

Policies can be issued combining feature of more than one standard type (Off the shelf) policies;
Policies are issued with the base cover of an appropriate standard policy with added feature from other standard policies if required;
Customer specific policies are considered only in respect of cases where anticipated annual premium is more than Rs. 10 lakhs. The customer's policies are issued in line with the credit insurance covers approved by IRDA.

CLAIMS

Exporters to submit the claim forms within 12 months from the due date of the unpaid bills and ensuring that the premium on the policies are up to date.
Claims will not be settled by ECGC for more than four buyers during the policy period.
Claims will be paid directly to the Bank who had handled the export documents.
Bank can appropriate the claim amount directly to post shipment advance account, if any.
Settlement of claim amount by ECGC does not relieve the Exporter of the responsibility of realizing the proceeds and all further recoveries to be shared with ECGC on a pro-rata basis as and when received.

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CAIIB BFM Module A Unit 7- Risk In Foreign Trade- Role Of ECGC (Ambitious Baba)