16.3 Risk and Trade Finance

As already highlighted in the previous section, the stakeholders of trade finance are always exposed to risks. These risks could be related to non-payment and non-performance of the users or could be about risks associated with banks, financial institutions, and intermediaries with respect to complexity in trade. It is critical that financial managers are aware of the risks present in the countries with which they are trading so they can have preventive measures and mitigation strategies in place.

The growing tendency towards the opening of economies and increasing volumes of international business mean that businesses face many risks that must be managed effectively. The risks firms face when doing business internationally fall into four main categories: technical, management, commercial, and external. Table 16.1 lists the various types of risks included in these main categories.

Technical risk, for instance, highlights the importance of technology in creating contracts and understanding markets by defining requirements, assessments, and assumptions. Management risk becomes even more important when organizations are dealing with international parties. The common issues that organizations face while managing international projects are trust resource availability, communication, and bank risk. Commercial risk plays a vital role in business success. It is one of the areas in trade finance that can make or break a business. External risk is the risks which are not in an organization’s control, for example, country risk, foreign exchange risk, weather, and ecology, etc.

Let’s investigate some risks that have a direct role to play in trade finance.

Commercial Risk

Commercial risk is the risk to which exporters and importers are commonly exposed. Commercial risk involves the risk of non-payment faced by exporters and the risk of non-performance faced by importers. Exporters are always concerned about the receipt of payment for their goods on a timely basis. In cases where the importer does not pay or delays the payment, an exporter is exposed to non-payment or buyer’s risk. Importers are always concerned about the goods they will receive and want to be certain that the items they are receiving are in line with the contract they have signed. In cases where the exporter does not meet their obligations and fails to deliver goods as per contract, the importer is exposed to non-performance risk.

It is hard for a trading partner to assess commercial risk if working with the other party for the first time. That is why it is important to exercise due diligence before signing the contract to reduce or limit commercial risks in trade finance.

Exchange Rate Risks

Volatile exchange rates make international trade and investment decisions more difficult because volatility increases exchange rate risk. Exchange rate risk refers to the potential to lose money because of a change in the exchange rate. Such volatility not only increase the risk of losses relative to plans for traders but also increases the costs to protect against those risks.

Country Risk

Country risk is the risk of loss that stems from economic and political events or circumstances in a country that affect payments for imports or the receipt of exports or that can generally hamper an international trade transaction. Some of the more significant factors in country risk are various kinds of export and import restrictions, exchange rate restrictions, expropriation, and political upheaval.

Financial/Bank Risk

Even though banks play an important role in domestic economies as well as in international trade, there are risks for firms that stem from their involvement with banks. Bank risk arises when banks fail to perform their duties in support of trade transactions and pay as per the contract. Banks become involved in trade transactions when importers and exporters do not have established relationships and cannot trust another party. In such a case, banks act as intermediaries, facilitating the movement of documents, products and payments between exporters and importers.

References

Nezhyva, M., Zaremba, O & Mysiuk, V. (2021). International trade risk management under the impact of globalization. SHS Web of Conferences, 111, 01016. http://dx.doi.org/10.1051/shsconf/202111101016

Attributions

“16.3 Risk and Trade Finance” is adapted from the following:

• “Chapter 1 The Nature of Risk: Losses and Opportunities” from Risk Management for Enterprises and Individuals by Saylor Academy, licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 License , except where otherwise noted.
• “International trade risk management under the impact of globalization” by Mariia Nezhyva, Olha Zaremba & Viktoriia Mysiuk, published on Research Gate, licensed under a Creative Commons Attribution 4.0 License , except where otherwise noted.