Factoring and credit insurance: A partnership for financial resilience
Read the full whitepaper, published and produced in partnership with Trade Finance Global (TFG) and FCI here.
Credit insurance and factoring are crucial financial tools that provide businesses with the stability to navigate uncertain markets. These tools help mitigate risks and enhance liquidity, especially in international trade, where macroeconomic volatility and complex environments are common.
At FCI’s 56th Annual Meeting in Seoul, a panel of experts discussed the intricate relationship between credit insurance and factoring. The panel included:
Moderated by Deepesh Patel , Editorial Director, Trade Finance Global (TFG) .
1 Exploring the symbiotic relationship between factoring and credit insurance
Credit insurance and factoring are two financial tools that work in tandem to mitigate risks and enhance business liquidity. Their symbiotic relationship is crucial in providing businesses with the stability needed to navigate the uncertainties of international trade.
1.1 Understanding factoring and credit insurance
According to FCI, “International factoring is the process of purchasing an invoice from an exporter in one country and collecting it later from their buyer/importer located in another country. The exporter receives payment upfront from the factor by way of a discount against the invoice, and the source of repayment comes from the proceeds paid by the buyer/importer at the due date of the invoice.”
International factoring is the process of purchasing an invoice from an exporter in one country and collecting it later from their buyer/importer located in another country. The exporter receives payment upfront from the factor by way of a discount against the invoice, and the source of repayment comes from the proceeds paid by the buyer/importer at the due date of the invoice.
Credit insurance, on the other hand, protects businesses against the risk of non-payment by buyers. It covers the receivables, ensuring that even if a buyer defaults, the business will still receive payment, either partially or fully.
This insurance is particularly valuable in international trade, where the risk of default can be higher due to volatile economic conditions, political risks, and other factors.
For businesses, credit insurance both mitigates risk and enhances liquidity. By converting receivables into immediate cash, companies can improve their cash flow and financial stability. This is particularly important for businesses with limited payment records or those operating in international markets.
Credit insurance gives prospective traders the confidence to engage with new buyers and enter new markets, knowing they are protected against potential losses.
1.2 How they complement each other
The relationship between credit insurance and factoring is symbiotic because they complement each other in several ways. These include:
"Credit insurance provides a safety net by protecting companies against the risk of non-payment, making the factoring process more secure and appealing."
The panellists highlighted these benefits during the FCI’s 56th Annual Meeting in Seoul. Aboo said, “Credit insurance provides a safety net by protecting companies against the risk of non-payment, making the factoring process more secure and appealing.”
1.3 Practical applications
In practice, the relationship between factoring and credit insurance involves close cooperation between factors and insurers. Factors rely on insurers' data and insights to assess the risk of receivables, and insurers, in turn, benefit from the business generated through factoring.
In Poland, for example, 50% of factoring agreements are covered by credit insurance, though overall penetration rate of trade credit insurance is relatively low. Szcześniak said, “Credit insurance is a very important partner in our business, especially in international markets where we have limited access to foreign lawyers and financial data.”
2. Challenges in the current market
Despite the clear benefits, integrating credit insurance and factoring presents several challenges. These include poor information flow, cumbersome onboarding processes, and high premiums.
2.1 Information flow and decision-making delays
Effective information flow is fundamental for credit insurance and factoring. Credit insurers need accurate and timely data to assess the creditworthiness of buyers while factoring companies rely on this information to make informed decisions about purchasing receivables.
One of the significant issues facing the current market is the poor flow of information—often using antiquated methods—between insurers and factors. Shonhard said, “Cooperation between insurance companies and factoring companies usually involves exchanging information through email, which leads to delays.”
When factoring companies send proposals to insurers for granting limits, they often have to wait several days for a response. In a modern business environment, delays can be detrimental, especially for businesses that require quick access to funds.
The delay in decision-making is further compounded by the lack of real-time data exchange systems. Without real-time information, insurers and factors cannot make quick decisions, which are critical in maintaining a competitive edge. Szcześniak noted, "Our customers are not patient, and the competition is aggressive. The time we deliver the decision as to the limit is really critical."
This impatience is not unwarranted, as businesses need timely financial support to manage their operations, seize opportunities, and mitigate risks.
2.2 Cumbersome onboarding
Obtaining credit insurance can be cumbersome and time-consuming, which, in some instances, discourages businesses from pursuing it altogether.
Szcześniak said, “The onboarding process for obtaining credit insurance is often cumbersome, with businesses having to provide extensive documentation.”
Businesses and factoring companies must follow extensive procedures and provide significant documentation, financial information, credit histories, and other relevant data, which creates a substantial administrative burden and slows down the entire process.
Smaller businesses, which might not have dedicated teams to handle intricate paperwork, often find themselves overwhelmed by the demands of the onboarding process. This extensive documentation and thorough assessment require considerable time and effort and can strain the limited resources of smaller firms, making the process seem insurmountable.
“The onboarding process for obtaining credit insurance is often cumbersome, with businesses having to provide extensive documentation.”
2.3 High premiums
High credit insurance premiums pose a challenge in some markets and for some customers, creating a barrier for new entrants.
In many emerging markets, economic instability and higher perceived risks lead insurers to charge more to cover potential losses. Aboo noted, “In markets like India… the cost of credit insurance can be prohibitive, limiting its availability in regions where it is most needed.”
This makes it difficult for businesses in these areas to afford the necessary coverage, limiting their ability to engage in international trade and expand their operations. Shonhard added, “In emerging markets, the risk of economic instability makes insurers cautious about extending coverage, which limits the availability of credit insurance.”
Regulatory factors add another layer of complexity. In some regions, stringent regulations and the need for comprehensive compliance may drive up the cost of offering insurance, which is then passed on to businesses through higher premiums.
Additionally, insufficient information about buyers' creditworthiness increases insurers' risk. When there is limited access to reliable data, insurers must account for this uncertainty by raising premiums to protect against potential defaults. This can be detrimental for startups or businesses that have historically operated through the informal economy and, therefore, lack formal data trails.
3. Technological advancements as enablers
Technological advancements offer promising solutions to many challenges the credit insurance and factoring industries face. Automation and digitisation can enhance efficiency and streamline processes, while centralised data repositories can help with risk assessments.
3.1 Automation and digitisation
Automation and digitalisation will have a major impact on credit insurance and factoring. By integrating technologies such as application programming interfaces (APIs) and artificial intelligence (AI), these industries can streamline processes, reduce delays, and improve decision-making.
APIs enable real-time data exchange between insurers and factoring companies, leading to quicker and more accurate decisions. This reduces the reliance on manual processes and mitigates the delays associated with traditional methods like email exchanges.
Shonhard said, “AI and machine learning can enhance the underwriting process by providing deeper insights into buyer behaviour and creditworthiness.” These technologies can analyse vast amounts of data quickly and accurately, identifying patterns and risks that human analysts might miss.
Overall, automation and digitalisation can drive greater adoption of credit insurance and factoring by creating a more transparent, efficient, and informed market environment. Aboo said, “They can significantly improve the efficiency of credit insurance and factoring.”
Blockchain technology is also gaining traction as a tool for enhancing transparency and security in trade finance transactions. By providing an immutable and decentralised ledger of transactions, blockchain can help meet regulatory requirements for transparency and traceability. It also reduces the risk of fraud and errors, which are critical concerns for regulators and industry participants.
"AI and machine learning can enhance the underwriting process by providing deeper insights into buyer behaviour and creditworthiness."
3.2 Centralised data repositories and collateral registries
Centralised data repositories and collateral registries are other means of improving transparency and trust in the market.
Centralised data repositories serve as comprehensive databases that consolidate financial and credit information about buyers. These repositories gather data from various sources, including banks, credit insurers, and other financial institutions, to create a unified platform of reliable and up-to-date information.
Recommended by LinkedIn
Collateral registries are public databases that record security interests in movable assets, such as receivables, inventory, and equipment. Once established, they can provide comprehensive information about buyers' credit histories and payment behaviours, allowing for better risk assessment and more informed decisions.
These closely related tools are particularly beneficial in emerging markets, where access to reliable data is often limited. Leszczynski said, “Centralised data repositories and collateral registries can play a crucial role in improving transparency and trust in the market.”
If further collateral registries can be developed, especially in emerging markets, it could be a key step to enable trade credit insurers to engage further in factoring and trade finance.
4 Case study: Germany
Germany represents a mature cooperation with credit insurance and factoring, with 95% of factoring covered by insurance. The widespread use of these financial tools in Germany provides valuable insights into best practices and successful integration strategies.
4.1 Implementation and benefits
In Germany, the integration of credit insurance with factoring has been driven by a strong focus on risk management and financial stability. German businesses, particularly large corporations, extensively use credit insurance to mitigate non-payment risk and enhance their financial security.
A favourable regulatory environment and the availability of tailored insurance solutions have also supported the high penetration rate of credit insurance in Germany. These factors have made it easier for businesses to access credit insurance and incorporate it into their factoring agreements.
4.2 Challenges and solutions
Despite the high penetration rate, German businesses face challenges related to the complexity of managing large volumes of receivables and the need for efficient data exchange. To address these challenges, German financial institutions have invested heavily in technology.
For example, using centralised data repositories and advanced data analytics has enabled German businesses to manage their receivables more effectively and make informed decisions. These technologies have also improved transparency and trust in the market, making it easier for businesses to engage in international trade.
4.3 Lessons learned
The experiences in Germany highlight several key lessons for the integration of credit insurance and factoring:
5 The impact of regulatory changes
The future of factoring and credit insurance is closely intertwined with regulatory changes poised to change the industry. As these financial tools become more integral to global trade and finance, regulatory frameworks will continue to evolve, impacting how businesses and financial institutions operate.
5.1 Basel III and IV regulations
One of the most influential regulatory changes affecting factoring and credit insurance is the implementation of Basel III regulations. These international banking regulations aim to strengthen bank capital requirements by increasing liquidity and decreasing leverage. For factoring and credit insurance, these regulations bring both challenges and opportunities.
Read more about Basel III here, particularly around its’ US implementation (US).
Under Basel III and IV, banks must hold more capital against their assets, including receivables and trade finance instruments, which has implications for the availability and cost of credit. Factoring companies, which rely on purchasing receivables from businesses, will need to navigate these stricter capital requirements.
Credit insurance can play a crucial role here by mitigating the perceived risk associated with receivables, potentially allowing banks and factors to maintain or even increase their financing levels despite higher capital requirements. Aboo said, “Our [policy] wordings need to be consistently adjusted as the Basel III regulations change to make sure that we keep up from an internal capital relief point of view.”
“Our [policy] wordings need to be consistently adjusted as the Basel III regulations change to make sure that we keep up from an internal capital relief point of view.”
5.2 Enhanced risk management standards
Regulatory changes are also driving enhanced risk management standards. Financial institutions are increasingly required to adopt robust risk assessment and mitigation strategies. For the factoring industry, this means incorporating more comprehensive due diligence processes and leveraging advanced analytical tools to assess the creditworthiness of clients.
Credit insurers are similarly affected. To comply with regulatory expectations, they must provide more detailed and transparent risk assessments. This trend is pushing the industry towards greater technology integration, such as AI and machine learning, to enhance the accuracy and efficiency of risk evaluations.
5.3 Impact on emerging markets
Regulatory changes will have a pronounced impact on emerging markets, where the adoption of factoring and credit insurance is still growing. In many developing economies, regulatory frameworks are less mature, posing both challenges and opportunities.
On one hand, the lack of stringent regulations can create a more flexible environment for innovation and growth. On the other hand, the absence of robust regulatory oversight can lead to higher risks and lower investor confidence.
Multilateral banks and development agencies are working to address these challenges by advocating for regulatory reforms that support the growth of factoring and credit insurance. Shonhard said, “Leveraging the support of multilateral banks and development agencies can help grow credit insurance and factoring in emerging markets.” These organisations can provide the necessary infrastructure and financial support to encourage adoption.
Initiatives such as establishing collateral registries and payment repositories aim to enhance transparency and reduce risks in these markets. These efforts are crucial for creating a stable and attractive environment for factoring and credit insurance to thrive in emerging markets.
6 Next steps: Building a resilient financial ecosystem
Integrating credit insurance and factoring can enhance financial resilience and stability in global trade. This partnership mitigates risks, improves liquidity, and enables businesses to navigate complex international markets confidently.
To drive greater adoption of credit insurance and factoring, stakeholders must implement strategic initiatives that foster cooperation, education, and innovation.
6.1 Collaboration
While significant progress has been made in developing and adopting new technologies within the factoring and credit insurance industries, more collaboration is needed to create a successful environment.
Szcześniak said, “Better cooperation and communication between financial institutions, insurers, and technology providers are essential for improving market penetration and efficiency.”
By working together, stakeholders can develop integrated solutions that streamline processes and reduce friction in the customer journey, creating a more resilient and dynamic financial ecosystem that supports businesses in every corner of the world.
“Better cooperation and communication between financial institutions, insurers, and technology providers are essential for improving market penetration and efficiency.”
6.2 Education
Education about the benefits of factoring and credit insurance will encourage businesses to engage more with these financial tools. Szcześniak said, “Many businesses are unaware of the benefits of credit insurance and factoring. Educational campaigns and outreach programs are essential to inform businesses about how these tools can enhance their financial stability and growth prospects.”
Enhanced awareness can drive adoption, ensure better risk management, and facilitate smoother operations. By educating stakeholders about how credit insurance and factoring work and the value they bring, the industry can overcome misconceptions, build trust, and expand its reach, especially in emerging markets.
6.3 Innovation
The credit insurance and factoring industry must continue to innovate and adapt to evolving market conditions and technological advancements. Aboo said, “Fostering innovation and flexibility in insurance policies can address the specific needs of different markets. Insurers should consider offering customised solutions that cater to the unique risks and requirements of various sectors and regions.”
Technological advancements such as automation, AI, and blockchain can streamline processes, enable real-time data exchange, and provide deeper insights into creditworthiness. By fostering innovation, the industry can adapt to changing market dynamics, meet evolving customer demands, and expand its reach in developed and emerging markets.
7 Conclusion
Integrating credit insurance and factoring is more than a financial strategy; it is a pathway to building a resilient and dynamic financial ecosystem.
By addressing existing challenges, leveraging technological advancements, and implementing strategic initiatives, stakeholders can support businesses in every corner of the world and promote economic stability.
By supporting businesses in managing risks and improving liquidity, these financial tools are crucial in promoting global trade and economic stability. Through these efforts, credit insurance and factoring will enhance financial resilience and contribute to the broader goal of sustainable economic development.
Integrating credit insurance and factoring will require cooperation, education, and innovation. By embracing these elements, stakeholders can unlock the full potential of these financial tools and create a more robust and resilient global trade environment for decades to come.
Read the full whitepaper, published and produced in partnership with Trade Finance Global (TFG) and FCI here.
Financial Controller ( Senior Accountant) at Premier Info Assists Private Limited
1moVery informative
Branch Manager at Hibret Bank
1moVery informative
Senior Consultant in Banking, Finance & Regulatory Frameworks, ESG
1moYes there are string correlations.
Trade Credit Insurance Expert/Director/Underwriting/Broking
1moInsightful