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  • QA 221
    Question:
    Will reducing availability of credit insurance affect the coffee trade?
    Background:
    Major credit insurers are reducing credit insurance limits or even cancelling cover altogether. This comes in the face of demands from commodity processors and others for extended payment terms. In your view, how will a general reduction in credit insurance facilities impact on the way coffee and other commodities are traded?
    Asked by:
    Academia/Press - United Kingdom
    Answer:

    It may but, mostly for smaller operators…

    First some background…

    Credit insurance is provided by specialised companies that assess the credit risk posed by an importer's individual clients. Especially smaller companies cannot afford the risk that a client fails to pay for goods delivered whereas their own banking facilities may well be dependent on having adequate credit insurance in place. The credit insurer in turn places limits on the amount of credit that can be insured for each client but, as has been happening, such limits can suddenly be sharply reduced or even withdrawn altogether. In such a situation, smaller importers/wholesalers, who rely on the security of the insurance, may have to either stop supplying altogether or demand cash upfront. *

    Usually, credit insurers require an importer to take out cover for all his clients - in other words: all or none. Whether to insure or not will depend on the type of business that is conducted and the premium required. If the great majority of clients are top roasting companies then the cost may not be warranted, or simply becomes too high. Cost would appear to be one reason why the use of credit insurance is not widespread in the United States coffee market although it is used in the specialty segment. In Europe it is however fairly widely used, but mostly amongst smaller companies that do not normally sell (regularly) to the majors. The cost is relatively modest whereas for many importers/traders the willingness of a credit insurer to cover a (potential) client is a good indication of that client's financial standing. This is particularly important now that many smaller roasters demand extended credit terms.

    Why is the availability (or absence) of credit insurance important?

    Here one has to differentiate between the two value chains. Coffee is mostly retailed through two separate market segments: supermarket chains and individual outlets as coffee shops etc.  Furthermore, especially for smaller operators bank finance and credit risk are irrevocably linked with most funding being conditional on having adequate credit risk insurance in place.

    Supermarket chains are mostly serviced by the major roasting companies who in turn rely largely on trade houses for their green coffee supplies. In recent times the tendency on the part of supermarket chains to demand ever more credit from suppliers has notably intensified. This in turn means similar demands from major roasters. For example, instead of buying on the basis of 'cash against documents on first presentation', some of the majors now buy green coffee on the basis of 'payment on arrival', thus shifting a substantial financing burden on to their suppliers. Whilst accepting that major roasters present little or no credit risk, this shift still obliges potential suppliers to find the additional funding this necessitates. Major operators will find this easier than will their smaller counterparts, some of who may be unable to compete because they cannot raise the extended finance. **

    Smaller roasters and coffee shops (particularly specialty) are largely serviced by importers/traders and wholesalers. The provision of credit has always been an accepted way of doing business in this segment. This is particularly so in the specialty business where most small roasters expect to receive 30 or more days of credit from the date of delivery. However, as the economic climate has worsened so has the availability of finance - even medium sized roasters are looking to their suppliers for additional credit by way of later payment, also because their own clients are seeking extended credit terms. Again, larger trade houses may deal with this more easily, for example by channelling their specialty and smaller client business through separate companies that can afford to take out cover for all their clients.

    For smaller operators selling on credit is not possible without credit insurance, whereby the insurance company insures the risk that a buyer will not pay for goods received. This is central to the functioning of almost every retail supply chain, so also for coffee. Without access to adequate credit insurance many smaller importers/wholesalers will be unable to trade as freely as before. And there is every indication that because of current poor loss experiences credit insurers may continue reducing their risk exposure, sometimes by cancelling individual company coverage altogether! Therefore, irrespective of the availability of bank finance an importer may have to retreat from certain types of business and/or clients. ***

    If current economic trends continue then we would suggest that reduced activity by smaller players in the green coffee trade could impact on their counterparts in producing countries. Smaller exporters, especially stand-alone operations, are already at a disadvantage when attempting to compete with the large multi-national trade houses. If their particular market segment now also shrinks because the financial capacity of their counterparts is diminishing, then in time this may mean still greater concentration in the coffee industry.  Alternatively the higher cost of doing business will be passed back to origin…

    In producing countries this is potentially bad news for a) the specialty industry, particularly newer suppliers, and b) those exporting/trading non-standard grades or lower qualities that mostly find their market amongst the smaller roasters. Any backwards shift of the burden to finance mainstream supplies (supermarket chain to roaster, roaster to supplier) is also likely to translate in higher costs for producing countries.

    *   It is important not to confuse credit insurance with credit lines. The first refers to insuring the risk a buyer does not pay for goods received - the second refers to the amount of credit (or overdraft facility) a commercial bank is prepared to provide to an importer or trader.

    ** See topic 04.02.07 for a review of payment conditions. See chapter 10 'Risk and the relation to trade credit' for more on risk issues generally.

    *** It is important to note that credit insurers of course do not reduce or cancel individual client limits without reason. General reductions may be linked to a deteriorating economic climate in the sector concerned whereas individual reductions may be because of information received or obtained. For example for privately held companies from annual accounts lodged with Chambers of Commerce or similar such institutions.

    Posted 21 May 2009

    Related chapter(s):
    Related Q & A:
    Q&A 018, 035