Factoring’s Protection Against Bad Debts vs Credit Insurance

As a former selling executive of international factoring and now member of the Legal Committee of FCI, I wanted to write this short article about the differences of factoring and credit insurance from marketing and legal points of view.

Roots of factoring go to thousands years ago as mentioned also in the Marketing and Sales Manual of FCI that I have referred while writing this article. The former factors or “commission merchants” (mercantile agents) used to serve the clients as follows:

·     They held stocks of goods (mainly textiles and clothing) for their European principals. 

·      They sold the goods in their own name on behalf of the principal. 

·      Often because of the “factor’s” better knowledge of local buyers, the principal allowed the “factor” to sell on credit terms, the “factor” raising his own invoice (rather than purchasing invoices as we do today). 

·      As they were responsible for selling on credit, the “factor” began to assume the “delcredere” risk. 

·     Finance was also provided to cover port charges, duty, etc. as well as to pay the principal.

After the improvement in communication systems, sellers began to find their own buyers but their need for collection and credit protection continued. They now use international factoring or credit insurance to cover their foreign debtors’ credit risk.

Being the largest factoring chain, FCI has two main activities and value propositions: 

1.     FCI facilitates and promotes International Factoring through a Correspondent Factoring platform. 

2.    FCI is the Global Industry Association for Open Account Receivables Finance 

·     FCI actively supports the growth of the Industry and works jointly with policy makers and stakeholders worldwide FCI promotes best industry practices through education

·     FCI publishes Information & Statistics about the Industry

·      FCI endorses financial stability, the prevention of financial crime and respect for regulatory compliance and conduct.

Therefore, FCI’s role by establishing global standards has always been very important to provide factoring customers with book keeping, collection functions and 100% protection against bad debts and to protect the export and import factor's rights in the global factoring industry.  

The Export factor provides credit cover on the foreign buyers backed through his correspondent in the import country. The Import factor, very often belonging to a banking group or a bank himself, has access to all necessary information from public sources, other banks and from his own database allowing him to evaluate the standing of a buyer. All customers are constantly supervised, direct experience is derived from the collection efforts, i.e. payment performance is monitored. 

In time, after the emergence of credit insurance industry, some export factors decided to leave the two - factor system to do direct international factoring and some continued to provide their clients a more expensive but better service using the information and collection expertise of their foreign correspondents (import factors) mainly located in the buyers’ countries. Recent developments show that also some of the import factors benefit from some advantages of credit insurance as risk sharing.

As factoring and credit insurance are two different institutions it is very normal that they have some differences. I will not go through all of them but will emphasize the most differentiating ones in terms of protection against bad debts:

·     Factoring is sale of the receivable from the shipment whereas the credit insurance is a standby coverage. Protection of credit insurance comes into force after the proof that the debtor is unable to pay while the factor’s start with the shipment. 

·     Factor has to pay the purchase price of the receivable whenever they receive it from the debtor or on the 90th day after the due date of the receivable, whereas the insurer starts investigating the collectability of the receivable after the failure of the debtor is proven and pays.

·     Factoring covers 100% of the receivable whereas credit insurance’s coverage is always below this level.

·     Factors may agree on flexible payment terms depending on the case, but credit insurance companies may have general maximum terms.

·     Import factors constantly verify and monitor the debtors’ existence and payment performance, as stated above, being the owner of the receivable, whereas the insurance companies may have no direct contact with the debtors until a problem occurs. 

Years ago, we had learned the following to diminish the seller risk as export factor. “If the seller knows better than the factors about the debtor, this means, either they do not need factoring or there will be a possible fraud.” Some of the arbitration cases and the requirement in the Legal circular 17:2 to advise the import factor about the relationship between the seller and the debtor, prove this possibility. 

Therefore, one of the main selling propositions of international factoring is the existence of import factors, their expertise and ability to monitor and supervise the debtors to protect the suppliers against bad debts.

Of course, the credit insurance industry is one of the major assistants of factoring system but it cannot protect the supplier’s rights as factoring does. This is always enough to justify the price difference between factoring commission and insurance premium. Import factors’ involvement in monitoring the risk position of the debtors  is the main reason for exporters to chose factoring to sleep better in comfort and with peace in mind. 

Yüce UYANIK,

January 2019