Losing Sleep Over the Sovereign Debt Situations in Europe and the USA?

By Ron Doyle

Are trade credit risk concerns keeping you awake? Are you feeling the stress from the sovereign debt situations around the globe? Well… you should be! 

Below are four ways in which debt crises can impact the creditworthiness of commercial buyers:

1. Bank liquidity is critical to the normal operational financing of companies. If bank liquidity tightens, the availability of financing becomes more restrictive, and if it is available, it becomes more expensive. In Europe the level of unsecured interbank lending has basically ground to a halt, according to David Oakley, correspondent for Capital Markets, in his July 3, 2011 FT.com article. 

Oakley indicates that unsecured lending has now been replaced by collateralized loans between banks. The problem with this option is much of the collateral is Sovereign Debt and its collateral value is dependent upon the debt maintaining an investment grade rating. For exactly this reason, European governments are very sensitive to downgrades in ratings by U.S. rating agencies. If much of the debt of the PIIGS (Portugal, Ireland, Italy, Greece and Spain) is downgraded or one of these countries defaults, there could be a severe liquidity crisis in Europe leading to another recession. Weaker companies will have difficulty refinancing their debt as credit quality becomes the determining factor. European banks are also facing another stress test this year with Basel III capital and reserve requirements.

2. The political problems surrounding the increase of the U.S. debt ceiling, which are unresolved at the time of writing, could result in the country’s default on its debt coming due in August and restricting its ability to refinance. If this situation were to occur or if the U.S. debt is downgraded, again the world financial structure will be thrown into turmoil and the availability of capital will become very tight. Trade flows will definitely be reduced and the creditworthiness of many banks will be affected as their liquidity will be reduced. Even transactions on secure terms will face greater risk, if banks default.

3. Most North American and European governments, at federal, state and municipal levels, are facing budget deficits, and to address the problem, they only appear to be willing to look at cuts to expenditures. Almost all governments are unwilling to raise taxes. Some are even continuing to reduce taxes. With these economies facing either slow growth or actual recession, government revenue growth will be limited and the cost of financing their debt will increase. Therefore, rather than merely ending stimulus programs, governments are actually doing the reverse, which will increase unemployment and decrease consumer confidence.

4. If the European debt crisis escalates to the point where some countries have to leave the Euro and revert to their old currencies, importers in those countries will be devastated. This is a possibility because the only two tools that governments have at their disposal to regulate their economies are fiscal (tax) and monetary policy. Some of the troubled European countries may have to regain control of their monetary policy as the only way out of crisis.

Chief Financial Officers (CFOs) around the world must seriously evaluate three items:

  • The escalation in credit and political risk to their domestic receivables,
  • Their foreign cash flows from export sales or foreign held assets and
  • The actual risk of political action impacting the foreign held assets.

After assessing the risks, CFOs must then decide to either hold all of the risk or to transfer part of the risk in order to avoid a catastrophic loss.

(Ron Doyle is a founder of Millennium CreditRisk Management – credit and political risk insurance specialists – www.mcm.ca. ICBA is the world’s largest team of independently-owned, specialist trade credit insurance brokerages. Partners combine local service with global coordination to provide credit and political risk insurance solutions for multinational companies.)