By Ron Doyle

What does “contagion” mean in the context of trade credit insurance, the global economy and credit risk? Contagion is defined as a tendency to spread – as in the spreading of a harmful idea or practice.

The world financial news each day has many stories about different sectors of the economy: banking, mining, manufacturing, etc. When reading these items, it is often difficult to see how, or if, the problems in one geographic area or industrial sector will affect a seemingly unrelated company in another region.

In the recent recession, many Canadian exporters experienced payment defaults related to goods sold to Mexican buyers. In these cases, buyers were deemed to be creditworthy when the sales were made, but when the payments were due, they were unable to meet their commitments.

 This scenario is a good example of contagion:

1. A number of Mexican banks speculated on the value of the U.S. dollar and lost material amounts.
2. The losses caused the Mexican banks to tighten the credit markets.
3. Importers found their lines of credit reduced, causing cash flow problems.
4. At the same time, the Mexican peso suffered a major devaluation against the U.S. dollars making it harder for importers to meet their U.S. dollar obligations.
5. The North American and European economies crashed into recession, primarily due to bank problems related to asset-backed securities.
6. Global inter-bank lending virtually dried up.
7. Consequently, the exporters weren’t paid because banks around the world had toxic assets on their Balance Sheets.

The frightening aspect of the foregoing example is that it didn’t develop over years, but over a few months – during the time an order was accepted until the time the payment was defaulted. If Mexico were a major export market for a company, these defaults were catastrophic. If the companies had not purchased trade credit insurance, they would have failed.

(Ron Doyle is a founder of Millennium Credit Risk Management – credit and political risk insurance specialists – www.mcm.ca. ICBA is the world’s largest team of independently-owned, specialist trade credit insurance brokerages. Partners combine local service with global coordination to provide credit and political risk insurance solutions for multinational companies.)