INSTITUTE OF BRAZILIAN BUSINESS
AND PUBLIC MANAGEMENT ISSUES
The Minerva Program – Fall 2011
THE ROLE AND IMPORTANCE OF EXPORT CREDIT
AGENCIES
By Raquel Mazal Krauss
Advisor: Prof. Steven Suranovic
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Export Credit Agencies: History, Functions, and Key Factors for Success, Schemes and Mind Maps of Finance
An overview of Export Credit Agencies (ECAs), their history, functions, and the key factors for their success. ECAs offer export credit insurance policies to reduce repayment risks on foreign receivables due to political and commercial events. They were established to re-establish export trade and revitalize industries after World War I and to facilitate exports to high-risk countries. The document also discusses the role of the Berne Union, the mechanics of ECA operations, and environmental considerations.
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INSTITUTE OF BRAZILIAN BUSINESS
AND PUBLIC MANAGEMENT ISSUES
The Minerva Program – Fall 2011
THE ROLE AND IMPORTANCE OF EXPORT CREDIT
AGENCIES
By Raquel Mazal Krauss
Advisor: Prof. Steven Suranovic
ii
TABLE OF CONTENTS
1. PREFACE …………………………………………………………………….….iii
2. INTRODUCTION ………………………………………………………….…….
3. HISTORY OF ECAs ………………………………………………….…….……
4. ECA POLICY CONSIDERATIONS……………………………………….…..
5. ORGANIZATION FOR ECONOMIC COOPERATION
AND DEVELOPMENT (OECD) ……………………………………………….
6. KEY FACTORS FOR SUCCESS OF EXPORT CREDIT…………….……
7. CONCLUSION…………………………………………………………………..
8. BIBLIOGRAPHY…………………………………………………………………
2. INTRODUCTION
Export credit agencies (ECAs) provide three basic functions. First, they help exporters meet officially supported foreign credit competition. (When foreign governments subsidize their companies’ exports by offering buyers below-market, fixed-rate financings, exporters often find it difficult to offer financing that matches those subsidized rates.) Secondly, ECAs provide financing to foreign buyers when private lenders cannot or will not finance those export sales, even with the risks removed. Third, and perhaps their most important function, ECAs assume risks beyond those that can be assumed by private lenders. ECAs do not compete with private financial institutions. To the contrary, they enhance the ability of their country’s lenders to compete internationally. It should also be noted that they do not offer development assistance to other countries; other agencies typically fulfill this role.
The approximately 100 officially supported ECAs share common features in their application process, eligibility criteria, risk classifications, terms, and pricing. They also have essentially the same mission: to increase jobs through exports while not competing with the private sector. The similarities among the ECAs are a result of common business practice, as well as an international treaty signed by most governments and known as the OECD Arrangement (Organization for Economic Cooperation and Development). This is the organization through which regulations on official credit agencies are promulgated.
Generally ECAs are accessed through a country’s banking institutions, where the international divisions of larger financial institutions typically have a person or staff that specializes in their use. Essentially banks extend this type of export based on the support being provided to them by their governments. Increasingly, ECAs work directly with the exporters, consultants, attorneys, and advisors. This is particularly the case in the United States where financial intermediation tends to be more fragmented and no longer the exclusive role of banking institutions. For instance, the U.S. Ex-Im Bank permits companies to obtain preliminary financing commitments directly without any involvement of a financial institution.
ECAs address two fundamental risks involved in an export transaction. The first is political risks, which refers to those events that occur due to political actions taken by the government that impact payment by the buyer. These may include transfer risk (inability to exchange the local deposit to that of the ECA country), expropriation, war risks, cancellation of an existing import and export license, and/or political violence. The risks of countries are usually evaluated by OECD and classified into seven categories depending on their risk profile. Countries rated 1 have the lowest risk and those rated 7 have the highest risk. The second risk ECAs address is commercial, which refers to nonpayment as a result of bankruptcy, insolvency, protracted default, fluctuation in demand, unanticipated competition, shifts in tariffs, and/or failure to take up goods that have been shipped according to the supply contract and other factors not covered under political risks.
The solutions ECAs provide targets five basic financing needs of an exporter:
. Pre-export working capital; . Short-term export terms extended to importers; . Medium- to long-term financing support to overseas importers; . Project financing; . Special export structures (e.g., leases, aircraft financing, on-lending credit facilities, etc.).
Working capital support from ECAs significantly reduces a lender’s risk on the goods or services for export. This support may also assist in posting standby letters of credit needed to secure down payments, post bid bonds, or other activities required in anticipation of an export sale. An ECA’s primary function is to shield the exporter from the commercial and political risks of selling overseas. This can be done as a supplier credit, where the ECA guarantees the obligation of the importer on terms extended by the exporter; or it can take the form of a buyer credit where the ECA supports the obligation of the importer directly. Finally, ECAs have recognized the need to support turn-key solutions with project financing support, as well as tailoring their support to work with the special financing needs of specific industries.
3. HISTORY OF ECAs
The first export credit insurance programs in the world were offered by Federal of Switzerland starting in 1906. Federal is a privately owned company still operating as of today. The first government export credit insurance programs were established in the United Kingdom thirteen years later in 1919. The rationale for the British programs then, which were copied by other countries, was “to aid unemployment and to re-establish export trade disrupted by the conditions of war”. In addition to export credit insurance, the British government established a trade finance program, offering up to six-year financing of exports at a preferential rate (1 percent above the Bank of England rate or a minimum of 8 percent). The British programs were administered by the Board of Trade with the consent of the Treasury, with the provision that income should be sufficient to meet possible losses.
As the Swiss and British programs proved themselves of their worthiness, other nations realized the efficacy and need for this type of government stimulation of trade. Accordingly, several other European countries established guarantee and insurance schemes, including Belgium (1921), Denmark (1922), the Netherlands (1923), Finland (1925), Germany (1926), Austria and Italy (1927), France and Spain (1928), and Norway (1929). The major rationale for establishing these programs was to re-establish export trade and revitalize industries devastated by World War I and to facilitate exports to the then existing Soviet Union, a country that posed special risk factors to Western European business and that needed credit.
With the onset of worldwide economic depression after 1929, a new impetus was given to the establishment of official export credit, guarantee, and insurance facilities as a method of keeping up flows of trade and thus maintaining employment and output. During the 1930’s, the following countries established such programs: Japan (1930); Czechoslovakia, Latvia, and Poland (1931); Sweden (1933); the United States (1934); and Ireland (1935). It is worth to note that the United States had only official direct credit programs and not guarantee and insurance facilities in the first thirty years of operation of its Export-Import Bank (Eximbank). The other countries concentrated heavily on guarantees and insurance, with back-up discount lending to commercial banks to reduce interest rates. In 1934, a new international organization,
the Berne Union (International Union of Credit and Investment Insurers), was established to encourage cooperation among national export credit insurers; to exchange information on buyers, countries, and technical matters; and to improve the level of competence of member countries.
By the mid-1930’s, most export credit agencies were granting the majority of their insured credits to the Soviet Union, and despite the Depression, export credit insurance had proved very profitable. Most of the ECAs at that time were owned and operated entirely by governments. However, four could be classified as “semiprivate” (Czechoslovakia, Germany, Netherlands, and Spain) and were operated by private firms with government financial and administrative assistance.
A major event of 1937 was the establishment of Banco Mexicano de Comercio Exterior (BANCOMEXT) in Mexico – the first ECA to be set up in a developing country. It concentrated on financing trade with North America and Europe in its early years and provided an example of official support, which was subsequently followed by many other Latin American countries.
The outbreak of World War II put a halt to the development of new export credit, guarantee, and insurance agencies from 1939 to 1945. Existing agencies turned their attention to financing activities that would help win the war. In the United States, for instance, Eximbank financed exports that would help develop the rubber industry of Brazil and the mining industries of other Latin American countries whose outputs were vital for the war effort. The Burma Road to China was financed by the U.S. Eximbank, along with other projects that would contribute to military success.
At the end of World War II, the former Axis countries’ powers were confronted not only with rebuilding domestic economies but also with restoring their foreign trade. In the late 1940s and early 1950s, Japan established a full range of new insurance and financing programs as an essential aid to restoring exports and assisting in postwar reconstruction. Germany, Italy, and Austria also established new credit, guarantee, and insurance programs in the same time frame and for the same reasons.
In the latter half of the 1950s, significant further developments were realized. In 1956, South Africa established the first African export credit insurance program. In 1957,
credit insurance company. In Africa, a regional export-import bank was formed to help and encourage the development of national ECAs, and in Asia, both China and Thailand formed export-import banks to consolidate and strengthen their dynamic export growth industries.
Throughout the 1980s, most OECD countries experienced heavy operational losses in their export credit, guarantee, and insurance programs. These losses were caused partly by the growing disparity between borrowing rates to fund the programs and the rates at which the funds were lent to finance exports. At the same time, nonpayment of officially supported export loans reached unprecedented magnitudes, as a result of developing country debt problems, defaults, and reschedulings. It was only in the 1990s that most industrial country ECAs returned to profitability as the Third World debt crisis gradually abated, fees and underwriting policies were adjusted, and export credit interest rates were raised to market values.
Most industrial country ECAs have now been in operation for more than fifty years. More than half of the developing country ECAs have been in business for at least a decade and thus can be considered fully experienced in the appraisal and administration of export credit, guarantees, and insurance. The differences between industrial and developing countries in this field, which were tremendous in earlier years, are gradually narrowing and approaching common ground. The industrial countries have pulled back from overexpansion of credit to marginal markets, while the developing countries have sought to take more risk on credit sales with jeopardizing their financial soundness. Both developing and industrial countries have raised their interest rates to market-related levels and their common interest in avoiding a credit trade war has helped lead to greater harmonization of programs, policies, and procedures. With a few exceptions, developing country ECAs have been profitable in recent years, and as a group, they have shown a substantial surplus. Industrial country ECAs have shown steady improvement in financial results during the 1990s, and in 1996, for the first time in seventeen years, they showed a profit as a group, with only a handful continuing to record losses. During the balance of the 1990s, most industrial country ECAs were profitable.
Some common features
Although they might have some local characteristics, ECAs around the world share many features between themselves, including a common set of objectives, which are both economic and financial. The main economic objectives of ECAs usually include:
. expand nontraditional exports of private sector goods and services; . help to finance nontraditional exporters of all sizes, of all products, and of all regions of the country; . provide assistance to indirect exporters to encourage development of linkage industries; . supplement and complement, and not compete with, the commercial banks and other private institutions; . seek to improve the country’s balance of payments and to increase domestic employment; . help to diversify the products and foreign markets of nontraditional exporters; . improve the financial skills of nontraditional exporters and reduce their risks in extending credit to foreign buyers; . increase the knowledge and sophistication of the country’s banks in the area of export credit; . encourage the national insurance industry to participate in coverage of the risks of nonpayment of export credits; . provide assistance for exports that are deemed to be in the national interest; . help national firms to make investments abroad in order to increase the nation’s foreign exchange earnings; . seek to match officially supported foreign financial competition;
number of other restrictions imposed by their authorizing legislation, guardian authorities in government, or private shareholders. The ECAs’ own financial condition
- particularly the size of their capital and reserves – serves to limit the total amount of exports they can support. A final major constraint is the size of the ECAs’ trained staff. Executives, managers, officers, and technicians who are skilled in export credit matters are in very short supply, and their availability represents a severe constraint upon the expansion of ECA operations in most countries.
Official export credit, guarantee, and insurance agencies also share many features with regard to the mechanics of their operations. They have similar eligibility criteria, term differentiation, risk classification, degree of coverage, underwriting techniques, premium and interest rate systems, policy administration, risk-sharing methods, and reinsurance. This is not by chance. The techniques, terms, and conditions of export credit insurance and guarantees have been largely “internationalized” by regular exchanges of information and agreements reached through the International Union of Credit and Investment Insurers (Berne Union) and the Organization for Economic Cooperation and Development (OECD), and there is a growing level of comparability among individual national schemes.
ECAs can help finance short-, medium-, or long-term transactions, and the conditions of financing assistance are usually quite different depending on the tenor. A short- term transaction is usually defined as up to one year, medium-term as one to five years and long-term as over five years. The OECD Agreement on Export Credit currently limits the maximum term to ten years.
Repayment terms supported by ECAs around the world tend to be similar, since they are based upon competitive realities and the needs of importing customers. Most financing is short term, with a maximum period of one year. However, larger sales of manufactured goods, particularly capital equipment and consumer durables, may receive longer terms dependent on contract price, as demonstrated by the following table:
Typical Repayment Terms, by Contract Price
Contract Value Maximum Term Up to US 80,000 2 years US$ 80,000 to US$ 175,000 3 years US$ 175,000 to US$ 350,000 4 years Over US$ 350,000 5 years
Source: Export-Import Bank of the United States
Major projects and multimillion-dollar equipment sales are often financed on terms of five to ten years. Also, certain products routinely receive terms longer than five years. For example, twin-engine turbo-powered aircraft, including executive jets, are typically financed on a seven-year term. Ships receive an eight-year term, and commercial jet aircraft may be financed by ECAs on a ten to twelve-year term.
Normally, export credit agencies provide assistance that does not exceed 90 percent of postshipment financing, with the exporter or bank taking the balance of the risk for its own account. Pre-shipment assistance is also usually limited to a maximum of 90 percent of required credit.
On medium- and long-term transactions, official schemes require the foreign buyer to make an advance payment of at least 15 percent. On short-term coverage, no advance payment is required from the foreign buyer.
A number of different premium systems are employed by credit insurance schemes. On medium- and long-term transactions, the premiums are normally a function of country, term, and type of buyer (either public or private). On short-term transactions, premiums may be based on such things as experience with the exporter, volume, size of the deductible, country spread, and average term. Some or all of these factors are taken into consideration by every official scheme, with greater or lesser weight being given to individual components.
Interest rates on ECAs’ loans are much less subject to variance for individual transactions. They are usually the same for all credits and are normally at fixed rates of interest, related to prevailing market rates of interest.
Countries with Officially Supported Export Credit, Guarantee, and Insurance Programs Developing Countries Industrial Countries Transition Countries
Low-income Upper Middle Income Bangladesh Argentina Australia Albania Ghana Barbados Austria Bosnia-Herzegovia India Brazil Belgium Bulgaria Pakistan Chile Canada China Senegal Costa Rica Denmark Croatia Sri Lanka Cyprus Finland Czech Republic Uganda Hong Kong France Cuba Vietnam Iran Germany Estonia Zambia Jordan Greece Hungary Malaysia Iceland Kazakstan Lower Middle Income Malta Ireland Latvia Bolivia Mexico Israel Lithuania Cameroon Oman Italy Moldova Colombia Sierra Leone Japan Poland Cote D’Ivoire Singapore Luxembourg Romania Ecuador South Africa Netherlands Russia El Salvador South Korea New Zealand Slovakia Egypt Taiwan Norway Slovenia Indonesia Thailand Portugal Ukraine Jamaica Trinidad & Tobago Spain Uzbekistan Kenya Turkey Sweden Yugoslavia Lesotho Uruguay Switzerland Liberia Venezuela United Kingdom Maurithius United States Morocco Nepal Nigeria Peru Philippines Senegal Swaziland Tunisia Zimbabwe Source: First Washington Associates, Ltd.
4. ECA POLICY CONSIDERATIONS
Unlike private lending institutions, ECAs have a political agenda. While their primary role is to sustain their country’s exports, in carrying out this mandate they are also required to adhere to certain policies and guidelines, some imposed by their governments, others imposed by the OECD Arrangement. These policies are unique to each ECA but generally fall into the following broad categories.
Foreign Content Policy
ECA programs support sales of goods and services produced in their country. However, as globalization has occurred, sourcing of components and services from around the world have made this policy evolve into a more loosely defined view of what is “manufactured/produced/built” in a given country. In many countries ECAs now support goods and services that provide a “substantial benefit” to their economy. Other countries take the view that if the majority of the good or service is made in their country then the entire amount of the sale can be supported. In the case of the United States, however, there are fairly rigid rules of what the U.S. Ex-Im Bank is willing to support.
When providing medium-term or long-term financing support, if the U.S. export contains foreign-made components, EX-Im Bank will provide support only for the U.S. content, as long as the total U.S. content is at least 50 percent of the entire cost of the exported good or service. Of course, under the OECD Arrangement the total supported by the Ex-Im Bank must not exceed 85 percent of the contract price. When supporting short-term transactions (less than 360 days), Ex-Im Bank will support the entire gross invoice value, assuming the product is at least 50 percent U.S. content, exclusive of price markup.
Military Sales
Generally, ECAs do not support sales of military equipment or services. However, the following are some exceptions for financing the sale of defense articles and services to less-developed countries: drug interdiction purposes, dual use items and humanitarian purposes.
Economic Impact
Some ECAs, most notably the U.S. Ex-Im Bank, are required by law to assess whether supporting an export is likely to cause substantial direct injury to the country’s industry. For example, Ex-Im Bank will not extend support that would have a net adverse economic impact on U.S. production and employment. (This prohibition does not apply if benefits to industry and employment in the United States resulting from the export transaction outweigh the injury to U.S. producers.
Additionality
The concept of additionality within the context of export finance is defined as the probability that a transaction would not go forward without the ECA’s support. Ex-Im is the only significant ECA that applies this policy, and there are a variety of influences and circumstances that can affect the degree of additionality associated with a given transaction.
Ex-Im Bank supports transactions when at least one of the following two conditions exists:
A lack of adequate financing available from other sources, such as commercial banks or the capital markets;
A foreign ECA is offering financing support on behalf of a foreign exporter that is competing with a U.S. exporter for the same transaction.
At the same time of application, Ex-Im Bank must make a positive determination that at least one of these conditions applies. Because the factors, which influence the degree of additionality present in a given transaction, are not always quantifiable or precise, the measurement of additionality is typically a probability of additionality related to an export transaction rather than to an absolute.
Risk Premium (Exposure Fees)
ECAs charge a fee for supporting export transactions. The basic sovereign risk exposure fee (i.e., the minimum fee for a country) is determined by several variables: exposure fee level of the country, percentage of cover, the quality of the product
provided, the length of the draw down and repayment periods, and how the fee is to be paid. Exposure fee levels are established for all markets where it is possible for ECAs to provide cover consistent with OECD country classifications.
Percent of Cover
The OECD norm for coverage is 95 percent. However, the U.S. Ex-Im Bank’s normal coverage is 100 percent for medium-term insurance, guarantees and loans. A premium is applied for this additional coverage. Ex-Im Bank is in the process of evaluating the merits of offering a long-term insurance product that may provide less than 100 percent cover.
ECA Products Offered (from least to most expensive)
There are three quality levels of financing product:
Below Standard (conditional insurance product that does not cover post-default interest). The U.S. Ex-Im Bank does not currently offer a below standard product;
Standard (conditional insurance product that covers post-default interest);
Above Standard/Superior (unconditional coverage). Guarantees and direct loans are priced as “above standard”.