## **Factoring From A Global Perspective**

commercial law, then more trade credit will be used by less creditworthy companies (Frank and Maksimovic 2003)<sup>19</sup> . This argument is consistent with the empirical findings of Chan and others (2001). ( See Petersen and Rajan 1997 for a more complete summary of theories of trade credit.) But there are reasons to suspect that these distinguishing features of trade credit may be limited. For example, in countries with well-developed information exchanges (private commercial credit bureaus or public credit registries), an established factoring industry, or a well-developed credit insurance industry, it is not clear that trade creditors would have an advantage in terms of access to credit information, given the economies of scale in information that these other institutions enjoy. In fact, when trade creditors are SMEs, the opposite would seem to be true.

In addition, arguments based on trade creditors having an advantage in understanding their customers’ business turn on whether the suppliers sell to industries closely related to their own and on the extent to which they sell to a wide variety of industries (which would dilute their industry-specific knowledge). Moreover, arguments based on trade creditors having a superior ability to repossess and liquidate inventory may be problematic in countries where access to bankruptcy estates is limited (as in the United States) or bankruptcy efficiency is weak (as in Italy).<sup>20</sup> Finally, the existence of a significant credit insurance industry (see below) and the global pervasiveness of factoring cast doubt on the superior information advantage enjoyed by trade creditors. If this advantage existed, then vendors would not outsource their credit function to factors or credit insurers. Given all these issues, and the lack of empirical cross-country analysis that addresses them, it is not clear that trade credit is a separate lending technology.

# **Credit insurance**

Credit insurance involves indemnifying accounts receivable against default. Financial institutions that sell credit insurance to SMEs assume the risk associated with the possibility that some of the firms’ invoices may be uncollectible. Credit insurance does not involve credit extension and so cannot be considered a lending technology. But it is closely related to factoring. Like factoring, credit insurance involves the outsourcing of the credit functions. Like the factor, the credit insurer assumes the risk associated with default (normally up to 80– 90%, versus factoring at 100%).

Credit insurance can be purchased by companies that sell to SMEs and by SMEs that sell to other companies (SMEs or large enterprises). In some ways credit insurers compete directly with factors. If a traditional lender (that is, a lender using financial statement or relationship technologies) buys credit insurance on the receivables that it takes as collateral, this is essentially synthetic factoring. Alternatively, an SME could purchase credit insurance on its receivables, enhancing the strength of its balance sheet to make it eligible for a financial statement loan. Finally, a company that primarily seeks to outsource the indemnification of credit risk, but not the financing function, might purchase credit insurance instead of factoring.

Credit insurance is also used to complement factoring. Factors uncomfortable with their exposure on some portion of receivables—say, when exposure on specific accounts or groups of accounts becomes too large—may buy credit insurance to manage this risk. This would be an internal decision

> 19 The general applicability of the Frank and Maksimovic (2003) model might be somewhat limited. Many countries do not give significant collateral priority to trade creditors. For instance, U.S. trade creditors generally do not have a collateral interest in the products they have sold unless they file a purchase-money security interest. This is not common in most trade relationships because the inventory has to be specifically identified (and identifiable) and filed with every invoice.

> 20 In addition, in some countries liquidation of assets such as inventory and equipment has become significantly more efficient in the past decade. Large liquidators have substantial databases on asset values, and Internet liquidation auctions appear to have changed liquidation from a local to a national market (Udell forthcoming). So, even if trade creditors enjoyed an advantage in liquidation in the past, this advantage has diminished recently.

**12**

**THE WORLD BANK**