How factoring and credit insurance symbiotically drive trade finance

The factoring services industry is undergoing a significant shift toward integrated financial solutions. By merging the robust risk management of credit insurance with the liquidity advantages of factoring, businesses and countries are poised to thrive in an increasingly complex global marketplace.

In 2023, the factoring industry experienced steady growth, with a single digit increase of 3.6%, a major contrast with the booming 18.3% growth seen in 2022. Despite this modest growth, the industry’s GDP penetration held steady, with a slight rise to 4.27% from the previous year’s 4.09%. Europe maintained its lead with a 10% GDP penetration rate, the highest among all regions, reflecting the maturity of its factoring market. While factoring volumes grew, the industry faced several challenges, including limited knowledge and expertise, regulatory and legal hurdles, economic pressures such as inflation and high-interest rates, and difficulties in securing reliable credit information and insurance coverage in certain markets.

Credit insurance is not a competitive product for the factoring industry but rather a complementary one. This year, we introduced a new survey for our members, asking them to share the percentage of their buyer portfolios covered by credit insurance companies. The results reveal that 45% of our members use credit insurance to cover their buyers, with an average of 42% of buyers being insured. These results reflect only those members that elected to respond to the survey. These results highlight the critical role credit insurance plays in the factoring industry, providing essential risk management and enhancing the security of receivables. By mitigating the risks associated with buyer defaults, the use of credit insurance enables factoring companies to offer more competitive financing solutions, ultimately supporting the growth and stability of the industry.

For the Africa region in particular, despite the growth in factoring volumes, several challenges remain. These include insufficient product knowledge, education, skills, and experience in the factoring industry; legal environment and regulation; lack of legal frameworks in certain countries and capital requirements; economic environment and access to working capital in some countries; inflation, high interest rates, cost of lending, and securities; and difficulties in obtaining reliable credit information and credit insurance coverage in certain countries and with certain buyers.

Factoring services have evolved significantly over the years, playing a crucial role in global trade and finance. Integral to the growth and sustainability of these services is the strategic use of credit insurance. The symbiotic relationship between factoring and insurance has fostered a robust financial ecosystem, particularly evident in Europe, which leads the world with the highest percentage of credit insured exports.

Credit insurance’s role in factoring and the benefits of symbiosis

Credit insurance has been a cornerstone in the development and expansion of factoring services. It provides a safety net against the risk of debtor non-payment, ensuring that businesses can confidently extend credit to their customers. This assurance is vital for the smooth operation of factoring, where receivables are purchased and converted into immediate cash flow for businesses.

Europe has been at the forefront of integrating credit insurance with factoring services. The region’s high percentage of credit insured exports underscores its commitment to risk management and financial stability in international trade.

The integration of factoring and credit insurance offers multiple benefits, creating a mutually beneficial relationship:

1. Comprehensive risk mitigation: Credit insurance provides a robust mechanism to manage and mitigate the risk of non-payment, making factoring a more secure financial service.
2. Improved financing terms: The reduced risk profile resulting from credit insurance allows businesses to secure better financing terms, as lenders are more willing to extend credit under safer conditions.
3. Enhanced market access: With the backing of credit insurance, businesses can venture into new markets with greater confidence, knowing that their receivables are protected.
4. Risk sharing and capital optimisation: The risk-sharing aspect between insurers and factors optimises the use of capital. This reduces the need for extensive reserves, making financial operations more efficient.
5. Market expansion and customer acquisition: The security provided by credit insurance facilitates market expansion and attracts more clients, as businesses are assured of a safer financial environment.

FCI initiatives and current issues

Despite the evident benefits, there are ongoing discussions and initiatives to further enhance the relationship between factoring and credit insurance. The primary issue revolves around the use of credit insurance as a guarantee to support factoring and receivables finance. Collaborative advocacy efforts are underway to clarify to the Basel Committee and the EU how credit insurance and factoring work hand-in-hand to mitigate risk. The focus is on demonstrating how credit insurance improves capital efficiency under Basel III regulations by reducing risk-weighted assets (RWA). This advocacy aims to showcase the effectiveness of credit insurance in enhancing the overall stability and efficiency of factoring activities.

A business case for ECA and factoring cooperation

To illustrate the collaboration between ECAs and the factoring sector, I will briefly describe the business models of post-shipment export financing and the financing of factoring companies within the Turkish factoring sector, led by the Türk Eximbank under their “Enhancing Trade Finance through Eximbank Funding and Factoring Services” initiative.

Integrating Eximbank funding with factoring services presents a robust business model that can significantly enhance trade finance, particularly for export-oriented businesses. This approach expands client reach and facilitates post-shipment export funding, creating a robust framework for financial support in international trade.

Eximbank funding for factoring companies enables these institutions to extend their services to a broader client base. This financial backing allows factoring companies to offer more competitive terms and comprehensive services to exporters, thereby increasing their market presence and operational capacity.

Factoring transactions, with or without recourse, are vital in providing immediate cash flow to exporters after shipment. This financial solution helps businesses manage their working capital more effectively, reducing the gap between shipment and payment. By leveraging Eximbank funding, factoring companies can offer enhanced post-shipment export funding options, ensuring exporters have the necessary liquidity to continue their operations smoothly.

Credit limits for factoring transactions are determined based on assessing the factoring companies' balance sheets. This evaluation ensures that the factoring company's financial health is robust enough to support the transactions, thereby mitigating risks for all parties involved.

Eximbank and factoring companies strongly collaborate, particularly under short-term export credit insurance schemes. This cooperation minimises the risk of non-payment, providing a safety net for exporters and encouraging more businesses to engage in international trade.

Challenges of integrating Eximbank funding and factoring

While the integration of Eximbank funding and factoring services offers numerous benefits, several challenges need to be addressed:

1. Trained personnel: Ensuring sufficient expertise within the workforce is crucial. Training programmes and continuous professional development are necessary to maintain high service and operational efficiency standards.
2. IT infrastructure: Robust IT infrastructure is essential for efficient operations. Factoring companies need to invest in advanced technological solutions to streamline their processes and ensure seamless transactions.
3. Mutual recognition of products: Overcoming discrepancies in product standards and regulation is a significant challenge. Harmonising these areas can facilitate smoother transactions and reduce trade barriers.
4. Reporting claims without IT support: The claim reporting process can be simple with adequate IT support. Investing in IT solutions that enhance reporting capabilities is vital for timely and accurate claims processing.

The collaboration between Eximbank funding and factoring services provides a replicable model that can optimise the benefits of trade finance. By addressing the challenges and leveraging the strengths of both entities, this business model can significantly enhance the efficiency and reach of trade finance, supporting the growth and sustainability of export-oriented businesses.

The future of factoring and credit insurance

The symbiotic relationship between factoring and credit insurance is a testament to the power of integrated financial solutions. By combining the strengths of both services, businesses can enjoy enhanced security, improved financing terms, and greater market opportunities. As the financial landscape continues to evolve alongside continual growth in open account trade, the collaboration between factoring and credit insurance will doubtless play a pivotal role in driving global trade and economic growth.