'Bad credit is the most serious and immediate risk'

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: With the breakdown of major financial institutions in the recent past, the importance one must lay on on bad debts, and more importantly, bad credit, has only been highlighted. P Umesh, vice-president & head-south zone, Howden India advocates the cause of credit insurance in these tough times. Excerpts:

How can receivables be realised in case of bad credit?

The melt down of the likes of Lehman Brothers and AIG was hard to believe. The myth that things could never go wrong in such Wall Street companies exploded, reminding everyone about the fragile environment we live in. Coming on the heels of the sub prime lending crisis, the failure of iconic companies is adding to the woes of the global credit crisis. All those who have rendered services or supplied products to the failed companies are encountering huge problems in realising their receivables.

When the buyers of products or services default in payment, the provider is left with nothing except earned and unreceived funds. This not only causes a financial loss to the provider, but also disrupts the operating cycle and leads to confusion in the prediction of cash flows. According to a recent survey, bad credit has unseated terrorism as the most serious and immediate risk, and this in turn, threatens the economy. It is time business organisations seriously looked at this risk. Due diligence and being choosy about customers can lessen the risk of bad debts, not eliminate the risk totally. While factoring, receivables securitisation, bank financing through irrevocable L/C and credit default swaps are some answers to this problem, credit insurance is clearly the simplest and the most well accepted solution.

What is credit insurance?

A credit insurance policy provides indemnity to a seller of products or a provider of services, in case of non-payment by his client, who maybe in the same country (domestic risk) as the supplier or in a different country (export risk). The insurance covers non-payment as a result of insolvency of the buyer or non-payment after an agreed number of months after the due date (protracted default). Typically, non-payment problems may arise due to commercial risks like insolvency of the client, protracted default or a, wrong repudiation of the contract by the client, after the seller has incurred the expenses for the services.