For financial institutions, underwriting and understanding their customers is a highly visible and widely understood requirement. Every company should have a KYC (know your customer) and/or underwriting process for assuming financial risk.
Financial risk is not just providing financing to a customer; the potential for fines, duties or legal action or dependency on one customer for a substantial portion of sales are additional examples.
Operational and reputational risks can also have financial impacts. Clearly, greater financial risk requires better risk management and higher compensation.
The underwriting process should focus on a customer's capacity and willingness to meet financial obligations.
What are the customer's financial characteristics relating to cash flow (quality, sustainability and predictability), leverage, asset/collateral coverage, alternative sources of repayment, size, and competitiveness/flexibility? And what are the customer's qualitative characteristics relating to management, ownership, industry, strategy and reliability of information?
Accurate evaluation of the appropriateness of a specific service or product for any customer must be founded on a thorough understanding of each transaction's purpose and structure.
In addition, financial institutions in the trade business often provide support by financing or protecting their customers' customer's purchase of product through direct loans, confirmations of letters of credit, etc.
In such cases, it is important to know the answers to these questions:
|·||Is the customer's customer an existing relationship, and will the business relationship continue?|
|·||Is there anything unusual about this sale for the customer?|
|·||Does the purpose of the transaction make sense?|
|·||Most important, is the customer prepared to be engaged in a crisis event?|
Hopefully, the willingness to engage will also have some influence with the purchaser. Your customer's involvement will not eliminate the need for due diligence, but may help to focus it.