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Consequences of the weakening economy for the design of credit lines in industry and trade

What are the impacts on companies and what are the possible solutions? Find out more in SCHUMANN Insights.
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19.08.2022, Prof. Dr. Matthias Schumann

What consequences does the weakening of the economy have for the design of credit lines in industry and trade?

Rising energy prices, inflation, shortages of materials and a lack of labor with the beginnings of a wage-price spiral are leading to weakening expectations for the future in various sectors, and in some cases, there is talk of recessionary risks for the economy.

What consequences does this have for the business of one's own company, existing credit lines, supplier, and customer credits?

Possible effects for companies

From the point of view of the lending banks, a gloomy or negative business outlook leads to poorer future expectations for the company. In the case of loans granted, this increases the risk that such a loan may also lead to difficulties for the company concerned when it comes to servicing. As a result, the rating of the respective company is reduced due to the weaker future expectations. A poorer rating then leads either to the credit lines used becoming more expensive, to more interest having to be paid, or to the credit lines being reduced to limit the risk. Higher interest rates are already taking hold because of central banks raising interest rates to combat inflation.

How can companies act?

How can companies respond now without jeopardizing their own business?

In this situation, it makes sense to focus on risk sharing. There are several ways to do this, depending on the situation.

Usually, a company not only has an overdraft facility at its disposal, but also investment loans and guarantees.

If you want to relieve the pressure on your bank credit lines, you can use surety bonds instead of bank guarantees. This relieves the banks' credit lines and may also be more favorable in terms of conditions overall due to risk sharing.

Solutions for B2B companies

In B2B business, when their own credit lines are cut by financial service providers, companies are more likely to take advantage of supplier credit. Discounts are no longer paid, payment terms become longer. This also increases the risk for the lending suppliers. In this situation, it may be appropriate to reduce one's own risks in the accounts receivable portfolio by taking out trade credit insurance. This costs money, but also means that the secured receivables can be used as collateral in credit transactions with banks, thus increasing the scope for credit. Now, it may be noted that trade credit insurance will tend to reduce credit limits as risks increase. However, lessons have been learned from the financial crisis of 2007 /2008 and this is done in a very differentiated manner. If such reductions occur, then this is also a signal for caution on the part of the supplying company that the customer could run into financial problems in the future. In the meantime, there are also products in the industry that can be used in the sense of risk sharing with reduced limits. So-called top-up policies can be an appropriate tool for individual companies if they are dependent on continuing to provide customer cover at the usual level.

Opportunities for foreign trade and investment business

In foreign trade, when appropriate transactions are made to maintain export business, the respective states will expand the opportunities to secure business with government guarantees. This can also be used. The corresponding fees would have to be priced into the transactions or reduce the margins. In Germany, the Hermes guarantees are worth mentioning here.

Investment business, with the loans that often accompany it, will also change in parts. We already have a shift in many parts of the economy from purchase to rental business. This relieves liquidity and leads to continuous expenditure, in some cases with usage-based cash flows. Putting this in a broader context, this means that leasing transactions will tend to increase.

Options for longer payment terms

Finally, I want to come back to longer payment terms or longer utilization of payment terms. If a company is restricted in its own activities by having to wait longer for its customer payments, it may also make sense to consider factoring in order to have a faster inflow of liquidity. Risk assessments could also be additionally integrated or relocated in this way.

This provides a whole portfolio of alternative courses of action on how to respond to a clouding of the economic environment from the point of view of credit management in industry and commerce. This can help to at least mitigate the effects of such a situation.

About the Author
Prof. Dr. Matthias Schumann

Since 1991, Prof. Dr. Matthias Schumann has held a professorship in Business Administration and Information Systems (Chair of Application Systems and E-Business) at the University of Göttingen. He also heads the joint computing center of the Faculty of Economics and the Faculty of Social Sciences. He is a shareholder of Prof. Schumann GmbH.

Prof. Schumann's research interests include information systems at financial service providers and systems for credit management, as well as issues related to knowledge and education management. Prof. Schumann has a wide range of experience in consulting companies, extensive lecturing activities and more than 350 publications.

University of Göttingen

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