Evaluation of the cost-effectiveness of export-finance tools in a Russian commercial bank

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Trends and challenges of financing foreign trade in Russia

Geographic, climatic, demographic and other differences between the countries led to emergence of international trade, which eventually became the cause of international division of labor in the industrial era. Formation of the USSR, industrialization, collectivization and other dramatic events of the mid-20th century brought our country to a position of the world leader in industrial production, which resulted in changes in structure of imports and exports. Eventually, after 80th years economic experiments, Russia has become not only the largest importer of agricultural products and exporter of minerals, primarily oil and gas, but also an exporter of manufactured goods and weapons. (Logvinova, 2008).
Disintegration of USSR into 15 independent countries, the complete disintegration of the CMEA (The Council for Mutual Economic Assistance) and the adoption of a number of its countries as members of European Union has formed a completely new economic and geopolitical situation in which Russian economy is developing during the last 20 years.
Recession in the Russian economy of the late 20th century, which was initially triggered by a sharp fall in revenues from energy exports, has led to a decline in the investments in fixed assets of Russian companies. Currently, the wear and tear of fixed assets, primarily machinery is 80-90%. At the same time a large number of manufacturers of industrial equipment, vehicles, etc appeared abroad, and acquiring products became an import. It should be noted that the already lopsided economy of the USSR with a predominance of heavy industry and the almost complete absence of the service sector and weak sector of consumer goods production and trade, became even more crooked. There are virtually no whole industries in the modern Russian economy that existed in the Soviet Union; the need for products is replenished by imports. (Logvinova, 2008).
Among the major import commodity groups, I can mention transport and transportation equipment (74%), food products (6%), metal products (5%) and textile products (5%). Among exports the largest share is oil and gas (81 %), metal products (11%) and minerals (2 %). As can be seen from the analysis of the commodity structure of imports and exports in January -December 2013 (Table 1, 2) Russia practically financed imports of machinery, equipment and vehicles by revenues from oil and gas exports (Federal Customs Service, 2014).

History of ECA and the modern international system of export credit

First export credit program was created in Switzerland by the private insurance company Federal, in 1906. However, the official « date of birth » of export credit practices considered to be 1919, when the concept was taken up by the British Empire which established the first state system of assisting exporters (Export Credits Guarantee Department, ECGD). The British system became a benchmark and with more or less success was copied by other countries. The main motive of the British program was to create a tool to struggle with the crisis, unemployment and business recovery, destroyed in the First World War. Parallel with the program of export credit insurance British government launched a program of direct lending of commercial transactions (trade finance), by which exporters and buyers of British goods could get a six-year loan at a discounted rate. (Krauss, 2011).
Success of Swiss and British programs feat other countries to follow similar steps. Export credit insurance system appeared in Belgium (1921), Denmark (1922), the Netherlands (1923), Finland (1925), Germany (1926), Austria and Italy (1927), France and Spain (1928) and in Norway (1929) , etc.
The global economic crisis in 1929 led to an increase in state support for exports in this period. In 1934 – the U.S. Eximbank was established, and at the same time the U.S. government chose to provide export credits to exporters at concessional rates instead of insurance. The final chord in the establishment of national systems of export support was the establishment in 1934 of the Berne Union (International Union of Credit and Investment Insurers) with the goal of establishing cooperation between the national insurers, exchange of information on the purchasers, markets and harmonization of common terms and conditions of insurance. End of World War II and the recovery period, as in the case with the First World War, was a period of active revival of export support programs. In the late 1940s and early 1950s, export insurance agencies and export-import banks were recreated in Japan, Germany, Italy and Austria. (Krauss, 2011) Existing demand in developing economies to imports of basic industries from developed market economies has found its expression in the emergence of a financial product, which, in its general form, is called Export Finance, which was formed within the Organization for European Economic Co-operation (OEEC), which coordinated the American and Canadian aid to victims from the second World War, to the victims from European countries under the Marshall Plan in the framework of the so-called « European recovery Program » (European Recovery Program). In the later stages of its existence, it takes active measures to stimulate economic cooperation among member countries through trade liberalization and the creation of a system of multilateral settlements. Activities of the organization to restore convertibility led to the creation in 1950 of the European Payments Union and in the conclusion of the European Monetary Agreement in 1956. Within its framework, the Code of trade liberalization was adopted in 1950, which has significantly reduced quantitative restrictions on the trade between member countries. (Shreper, 1995).
When the Marshall aid was completed, western countries have come to the conclusion that the accumulated potential of OEEC is wise to continue to use in the future in order to search for solutions for common problems of the participating countries and in 1961 the OEEC was transformed into the Organization for Economic Co-operation and Development (OECD), which currently consists of 30 countries: Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Korea, Luxembourg, Mexico, Netherlands, New Zealand, Norway, Poland, Slovakia, Portugal, Spain, Sweden, Switzerland, Turkey, United Kingdom, United States.
Main motive of the development of Export Finance principles was the stimulation of national exports by overcoming the country, especially political risks, as the main obstacles to the provision of credit. In most countries, this role has been taken by the governments, forming special state institutions called Export Credit Agencies (ECAs). The primary role of such agencies was taking risks of exporters, conducting due diligence of foreign partners and providing guarantees or insurance coverage from the part of the exporter’s to domestic enterprises or financial institutions. (Krauss, 2011).
Export credit agencies (ECAs) is a govermnet tool which is supporting the country’s exports as well as strengthening the position of national economies on the foreign markets. The key specialization of (ECAs) throughout the history of their existence was supply of equipment and technology to the countries conducting an accelerated industrialization. From the outset, despite the differences, the meaning of the activities of all ECA is to issue guarantees or issue insurances to funding banks and taking on a number of specific commercial and political risks. Without (ECAs) with those risks an international lending is very difficult and in some cases is not even possible. (Broek, 2003).

Government regulation of export credit activities

International trade is one of the main components of the Russian economy. Export share is 25-30% of Russian GDP and consists of more than 60% of traditional commodities: energy, metals and products of their first conversion. (Federal Customs Service, 2013) At the present stage, the most important task of our country is a deep modernization of almost all enterprises in the basic industries and creation from scratch many new high-tech industries, which will be able to produce competitive products. Lack of production of modern industrial equipment in Russia often makes import the only way for enterprises to acquire such equipment. At the same time, lack of long-term credit resources in the Russian banking system and their high cost, in turn due to high inflation rate, posing use of international trade finance instruments outside of a competition. Consequently, the most important task of the government is the organization of financing, both imports and exports. (Utkin, 1998).
Government regulation of foreign trade activity in the Russian Federation is carried out in order to ensure favorable conditions for this type of activity, as well as to protect the economic and political interests of Russia.
The main regulatory document defining the basis for the government regulation of foreign trade activity – and in particular export transactions – is the Federal Law of 8 December 2003 № 164-FZ « On the Fundamentals of Government Regulation of Foreign Trade ». According to Article 3 of Law 164-FZ government regulation of foreign trade is based on the Constitution and other federal laws and other normative legal acts of the Russian Federation, as well as the generally recognized principles and norms of international law and international treaties of the Russian Federation. (Efimova, 2001).
Regulation of foreign trade in terms of goods is carried out by establishing export and import duties (customs tariff regulation) needed for the protection of the domestic market of the Russian Federation and to promote progressive structural changes in the economy. Those methods of regulation are called tariff methods. They are based on the Customs Code, the Law of the Russian Federation on May 21, 1993 № 5003-1 « On Customs Tariff » and other regulations, approved by the legislature. Customs Code is created in accordance with the customs policy of the government. Customs regulations define general tasks and functions of the customs authorities, the order of development, adoption and use of tariffs, conditions for exemption from the payment of fees, penalties for violation of customs regulations, and the grievance procedure. Customs formalities are the most effective methods of regulation of foreign trade among all other methods. (Efimova, 2001) Nowadays, there can be also identified seven main groups relating to non-tariff methods: price controlling, financial measures, quantitative methods of control, automatic licensing, monopolistic measures, technical barriers, and para-tariff methods (VAT and excises).
Modern integrated system of boosting sales of goods on the world market include economic incentives for exports, administrative measures to influence the export and use of moral incentives for exporters. Economic instruments – credit and financial instruments play major role in this system. (Utkin, 1998).
Loan funds are mainly used in two ways: by providing export credit on more favorable terms compared to the conditions prevailing in the domestic or international market, and insurance of export activities. (Vikremereitn, 1995).
The active role of the government in the provision of long-term and medium-term loans is explained because commercial banks are reluctant to finance investments associated with great risk. (Utkin, 1998).
Important financial instruments of boosting exports are tax breaks and subsidies. Such assistance substantially increases the competitiveness of goods and stimulate commercial and sometimes production activities. (Utkin, 1998).

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ECA risks

International trade, as well as international investments in the real sector of the economy lead to certain risks and have a need in financing and related financial services. ECA implement insurance/guarantee of exports and export credits, direct export credits and insurance of private investment abroad, providing consultancy services to exporters. The main purpose of the ECA – protection of exporters and investors, as well as financing banks from losses due to various kinds of risks associated with the implementation of export sales and promotion of products of national companies in foreign markets. (Afanasyev, 2005) While providing an insurance coverage should be provided in the particular terms and conditions, including the size of the insurance premium and the total risk limit, providing competitive insurance services compared to similar services leading by competitors, as well as the competitiveness of commercial offers by national companies under the terms of their participation in international transactions/ projects. Thus, the Export Credit involves two main types of risks – commercial and political. (Krugman P. , 2012).
Political risks in international trade, in reality have its own specifics, depending on their country of origin, so at the same time it is also called country risks. The classification of political risks is shown in the Figure 4 below this paragraph. (Eiteman, 2010) Political risk reflects the critical situation due to the actions of public authorities in the importing country (for example, cancellation of licenses, restrictions on export and import, confiscation of goods, prohibition of sales, etc.), which could negatively impact the international economic and trade relationships, delays in payments due to lack of the convertible currency, a moratorium on debt service, as well as other measures leading to the loss of ownership or property income. In other words, the country risk is a failure to pay the debts caused by the insolvency, which was the result of errors in the government’s management, but if the insolvency was caused by mismanagement at the firm level – it is considered a commercial risk. Civil riots, armed conflicts, acts of terrorism also types of risks that can be identified as country/political risks. (Eiteman, 2010).

Methodology of Export Finance structuring in Russian Federation

In trade finance private sector is represented by commercial banks, suppliers, customers, private insurers, reinsurers, non-bank financial institutions and capital markets, etc., and the main state support agents are represented by export credit agencies (ECAs) and international banks of development (EBRD, IFC and others) (Yescombe, 2008). In the traditional system of export financing, commercial banks play a central role, not only to make payments from the importer to the exporter, but also by providing lending, often secured only by the rights on financed goods. In this framework, banks have certain risks, while ECA are officially involved only when the risk of default for the private financial sector is disproportionately high. Market participants in the Russian export financing are classified in the Table 1 below. (Vikremereitn, 1995).

Main characteristics of long-term financing covered by ECA

Currently there are three models of institutional organization of the system of export support: insurance; guarantee and/or funding and mixed system. A mixed model became the most widespread nowadays, because it combines insurance and financing at the same time, both for individual transactions and in the portfolio as a whole. All three legal forms of ECA come from these models (Aksenov, 2012):
– State government departments. State support for exports is available in the form of special export credit programs through central banks or ministries of finance or industry.
– State Export-Import banks or International banks of development, such as EBRD, IFC, etc.
– Insurance companies that have an exclusive agreements with the state. As an example, Coface in France, Euler Hermes in Germany and Atradius in the Netherlands.
Classical European model focuses on insurance coverage of export operations. American, by contrast, involves primarily the guarantee and credit support (US EximBank, CCC, OPIC). The main functions of Export Credit Agencies, regardless of the legal form and the particular form of provision (guarantee or insurance) are (Aksenov, 2012):
1. Short-term insurance (maturity up to 2 years) of export credits from commercial and political risk. Insured is Exporter (supplier) of goods (works, services), or the exporter’s bank extending credit to a foreign buyer – importer.
2. Long-term insurance (with maturities from 2 to 15 years) of export credits from commercial and political risk in terms of the OECD Consensus. Insured is Exporter (supplier) of goods (works, services), or the exporter’s bank extending credit to a foreign buyer – Importer.
3. Insurance of foreign investments, related to export industries and technologies, from the risk of loss of income from investments abroad because of obstruction of their transfer to the exporting country, as well as gratuitous alienation of investments due to political reasons. Investor is insured. All banks financing international trade work exclusively with documentary credits: UCP 500 or regulated UCP 600, documentary collection, regulated URC 522, as well as in accordance with international rules of export credits with state support, better known as the OECD Consensus (Balabanov, 2007). In accordance with the Rules of the OECD loans are provided with maturities from 2 to 7 years, the size of the loan – up to 85 % of the export contract, the interest rate – based on floating interest rates (LIBOR, EURIBOR, etc.) , the insured person is the exporter’s bank, the first payment is at least 15 % of the contract value, contract is paid as a separate payment order or letter of credit opened by the borrower, funding is available in EUR or USD, minimum loan amount of EUR 250 000 (or the equivalent amount in USD), interest is paid once in a six months on the outstanding loan amount, repayment of the loan is done by equal semi-annual fractions. In some cases, there is the possibility of short-term financing of 15% of advance payment by issuing a documentary credit with deferred payment for the importer’s bank. (Balabanov, 2007)

Table of contents :

1 Introduction
1.1 Background
1.2 Problem discussion
1.3 Purpose
1.4 Delimitation
1.5 Perspective
1.6 Definitions
1.7 Disposition
2 Frame of reference
2.1 Theoretical fundamentals of Export Financing
2.1.1 Trends and challenges of financing foreign trade in Russia
2.1.2 History of ECA and the modern international system of export credit
2.1.4 ECA risks
2.1.5 Theoretical basis of Export Financing
2.2 Methodology of Export Finance structuring in Russian Federation
2.2.1 Participants of Export Finance
2.2.2 Main characteristics of long-term financing covered by ECA
2.2.3 Typical models and structures of Export Financing
2.3.4 Benefits of Export Financing
2.3.5 Due Diligence of Export Finance transactions
3 The Methodology
3.1 Methodological considerations
3.2 Data collection analysis
3.2.1 Primary data
3.2.2 Secondary data
3.2.3 Sampling and selection of respondents
3.3 Conducting the interviews
3.4 Approach
3.5 Quality of investigation
3.5.1 Reliability
3.5.2 Validity
4 Empirical findings
4.1 Evaluation of the cost-effectiveness of export-finance tools in a Russian commercial bank
4.2.1 Interview with an advisor to the Chairman of the Managing Board of Gazprombank Mikhail Kuznetsov
4.2.2 Interview with a financial consultant Alexander Ageev.
4.2.3 Interview with Respondent 1, CEO of the constructing company
5 Analysis
5.1 Evaluation of the cost-effectiveness of export-finance tools
5.2 Interview analysis
6 Conclusions
7 Bibliography 

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