10.5.6-RISK AND THE RELATION TO TRADE CREDIT-MONITORING
Monitoring of a borrower's entire operation is vital to avoid the chance that certain transactions are kept hidden - an 'audit trail' needs to be established. Even so, it can still be difficult for a bank to determine whether a client is entirely truthful with them, for example when it comes to forward transactions. Other than the exchange of contracts, a forward PTBF sale or purchase for completion six months ahead need not immediately generate visible action or disclosure, and could therefore be kept secret. But differential volatility has proved to be a risk factor in itself. Unless a deal is back-to-back (the differential on both the purchase and the sale has been fixed), the company's position contains an unknown price risk. This is another reason also why banks dislike financing unsold stocks.
Similarly it is not always easy for banks to determine whether someone is speculating. The 1990s saw spectacular collapses of loss-making speculative operations in a number of commodities, usually because at least some of 'the book' was hidden from both top management and the banks. Loss-making deals were kept secret and were rolled over until the loss became too high to manage. But there have also been instances where rogue traders declared insolvency while keeping profitable transactions hidden. Most banks will therefore regularly audit the borrower's procedures and administration, including retrospectively checking adherence to position limits and contract disclosure. This may be done as often as once a month.
Banks also watch for gradual changes in client behaviour. They will, of course, also control as much as possible the use of loan finance, for example by making payment direct to authorized suppliers and by using collateral managers. See 10.10 on collateral management.
In some producing countries local commercial banks have had bad experiences with lending to agriculture and commodity trading in the past. Admittedly this has sometimes been due to government interference. Nevertheless it has caused many local banks to cease such lending altogether, and others are now extra careful 'because soft commodity financing is dangerous and requires intimate knowledge of the trade'.
The degree to which a bank follows the borrower's operation will vary from case to case. It is not unusual for a bank to price or 'quantify' its risk on a particular borrower on a daily basis.
to understand that unsold stocks will be valued at the purchase price or at market value, whichever is the lower. Stocks held against forward contracts that are to be shipped at some later stage, may also be valued on the same basis because they do not constitute receivables.
This is because if shipment is subsequently frustrated then it is likely that neither the exporter nor the bank will be able to realize the sales value of the original contract and the goods may have to be disposed of at the then ruling market price.
Cumbersome as all this may seem, the bank is a direct partner in the risk the business entails and as such is entitled to all relevant information. As with buyers, so too with banks: the early and frank disclosure of unexpected events usually leads to solutions being found. Good relationships and optimal support in banking are based on openness. If a bank rules out a particular buyer perhaps the exporter should be grateful rather than annoyed, as the real message being conveyed is 'watch out!'
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