Foreign Exchange -- Money The following question was presented to members of an international credit group. It addresses a timely issue, given the current crises in financial markets. Although the group is not affiliated with ABC-Amega, both responders were kind enough to let us share their comments with our subscribers.

Q. Accountant of a Zinc and Alloy Company: We have an established distributor in [South] Korea who is being hit hard by exchange rate changes. The exchange from USD to Korean Won [KRW] has gone from 950 to 1,320 over the past year. [Per Oanda The Currency Site: on 10/28/07, 1 USD = KRW 910.26, and on 10/28/08, 1 USD = KRW 1,426.74.]

The customer is now past due by 30 days (terms ½ CIA ½ 30 days from delivery) and would like to place a new order. He set his prices to his customers based on the better exchange rate, and if he were to pay us now as we would like, he would lose money and thus we would lose business. What are our options on this? Does anyone have any creative financing that could benefit both parties? [CIA=cash in advance]

Answer [Edward D. Curren]: This is a classic example of “Lehman’s Law” of FX (Foreign Exchange) risk: “If one or more participants in a transaction denominate their financial records in a currency other than that of the transaction, there is an FX risk – the question becomes who is going to manage that risk.”

Just because you sell in US dollars does not relieve you of the intrinsic FX risk. It becomes a business decision whether it is better for your company to demand the money now and lose future sales or accept the cost of money for the time of the delay and offset it with future business. Of course, you always risk no payment at all.

Regardless of your decision in this situation, you need to develop a policy on who is going to manage the FX risk – you or your customer. The simplest way is to sell on an L/C (letter of credit) in US dollars, but this is a poor way to increase export sales. I suggest that, if you have a reasonably educated treasurer, you may want to make a visit with your treasurer to your banker and see what FX futures options the bank may be willing to provide and what the costs would be. I am assuming that you do not currently have anyone within the company that is responsible for FX hedging.

Edward D. Curren
Manager Group Credit Department
B&W Power Generation Group, Inc.

Answer [Bank VP]: Ed makes some very insightful points. I thought it might help to forward an excerpt of a letter I received last week from my Korea Bank Manager. It helped me better understand the current market condition and overall bank health in Korea, which has a direct impact on your customers.

"As fears of a global recession grow, combined with the liquidity and financial crisis in the USA, stock markets around the world have plummeted. Korea, like many other markets, has been no exception although the fall in the Korean stock market and the drop in the Won’s value has been pronounced. Since the beginning of the year, the Won’s value relative to the dollar has declined significantly more than most other currencies. Korea’s stock market has also experienced precipitous declines, with the KOSPI falling 9.4% yesterday. The volatility in the market resulted in trading actually being halted for a brief five minute period during yesterday’s trading. However, Korea was not alone in experiencing dramatic falls in equity prices yesterday with Japan’s NIKKEI dropping 11.4%, Australia’s All Ordinaries Index falling 6.66%, Hong Kong’s Hang Seng Index declining 4.8% and Singapore’s Straits Times Index dropping 5.25%.

“Recently, Moody down-graded the outlook for Korea’s banks. This was followed yesterday by Standard & Poor which changed its outlook for Korean banks from positive to negative. However, there has been no change in Standard & Poor’s ratings for individual banks, which range from A to A-. Standard & Poor’s primary concern was the funding challenge faced by the banks. With aggregate loans at about 125% of deposits, Korea’s banks are dependent on external funding. With the international capital markets experiencing extreme liquidity constraints, obtaining external funding is a challenge for the Korean banks. In addition, the funding that is available comes with significantly higher pricing, adversely affecting the profitability of the Korean banks.

“The Korean government has acted to address the liquidity challenges faced by its banks. Already, the Korean government has injected $10 billion into the Swap markets, with Korea’s EXIM Bank adding a further $5 billion directly into the country’s banking system. In addition, Korea’s Strategy and Finance Minister announced publicly that the government would provide 100% support for any funding needs faced by the country’s banks in order to prevent any of them from defaulting. An additional $10 billion injection into the banking sector is also expected from Korea’s EXIM Bank. At the same time, the Korean government is developing a comprehensive plan that includes a guaranty on inter-bank lending to further assist the banks’ funding needs.

“Recently, there has been a trend where exporters to Korea are switching from sight L/C’s to usance L/C’s. This is placing pressure on availability since the quick turn-over of sight transactions is being replaced by transactions carrying tenors of 90 to 180 days, resulting in more “overlapping” of exposures as each transaction is kept on the books for a longer period of time.

“Historically, the safest type of international lending has been trade related since countries in a crisis need to encourage trade to recover and eventually prosper. The Korean government would not want the import of food, raw materials, etc. to be jeopardized and would likely support the banks in any way it can to support such activity.”

I've personally seen a sizeable increase in usance [deferred payment] LC's [letters of credit] as a way to "finance" the sale and mitigate the risk of nonpayment. From the buyer’s perspective, you are giving them more favorable payment terms (you could sell under LC payable 45-90 days sight, which would be much better than CIA and 30 days after delivery) and, on the seller's side, you can discount the drafts instead of waiting for maturity or worrying about when/if the buyer will pay the final 50%.

Vice President
a US bank with a presence
in South Korea

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