International trade finance: Tools and techniques -I

Trade finance, the key facilitator of trade, refers to the financing arrangement with the lenders based upon the commercial transaction related to the movement of goods, services and performances. Credit and credit insurance help to oil the wheels of trade by bridging the gap between varying expectations of importers and exporters when payment should be made. Trade finance includes such activities as lending, issuing letters of credit, factoring, export credit and insurance. Companies involved with trade finance include importers and exporters, banks and financiers, insurers and export credit agencies, as well as other service providers. Trade finance is of vital importance to the global economy, with the World Trade Organisation estimating that 80 to 90 per cent of global trade is reliant on this method of financing. There is a basic difference between the mode of international trade payment and the international trade financing. International trade finance is held upon the strength of the mode of international trade payment across borders. The international trade payment methods (tools for procuring/raising trade finance) are:
(1) Open account.
(2) Cash in advance
(3) Payment on the basis of the consignment.
(4) Bills for collection.
(5) Documentary credit.
(6) Bank Payment Obligation(BPO/ Electronic trade settlement)
OPEN ACCOUNT: An open account transaction means that the goods are shipped and delivered before payment is due, usually within 30 to 90 days. Obviously, this is the most advantageous option to the importer in cash flow and cost terms, but it is consequently the highest risk option for an exporter. Due to  intense competition for export markets, foreign buyers often press exporters for open account terms since the extension of credit by the seller to the buyer is more common abroad. Therefore, exporters who are reluctant to extend credit may face the possibility of the loss of the sale to their competitors. However, with the use of one or more of the appropriate trade finance techniques, such as export credit insurance, the exporter can offer open competitive account terms in the global market while substantially mitigating the risk of nonpayment by the foreign buyer.
FINANCING UNDER THE OPEN ACCOUNT : Open account terms may be offered in competitive markets with the use of one or more of the following trade finance techniques:
* Export Working Capital Financing,
* Government-Guaranteed Export Working Capital Programs,
* Export Credit Insurance,
* Export Factoring,
* Forfaiting.
EXPORT WORKING CAPITAL FINANCING: To extend open account terms in the global market, the exporter who lacks sufficient liquidity needs export working capital financing that covers the entire cash cycle from purchase of raw materials through the ultimate collection of the sales proceeds. Export working capital facilities can be provided to support export sales in the form of a loan or revolving line of credit.
* Funds may be used to acquire materials, labour, inventory, goods and services for export.
* A facility can support a single export transaction (transaction specific short-term loan) or multiple export transactions (revolving line of credit) on open account terms.
* The term of a transaction-specific loan is generally up to one year and a revolving line of credit may extend up to three years.
* A government guarantee may be needed to obtain a facility that can meet export needs.
* Risk mitigation may be needed to offer open account terms confidently in the global market.
GOVERNMENT ASSISTED TRADE FINANCING: For expediting local export, the government of the exporting country sometimes allocates special fund for the exporter which is disbursed through the commercial banks or specialised banks by which they can manage their supply chain towards the production of the factory and working capital requirements which enables them to be competitive in the international market. This type of financing is arranged for both the buyer and seller of the reporting country.
CASH-IN-ADVANCE: With this payment method, the exporter can avoid credit risk, since payment is received prior to the transfer of ownership of the goods. Wire transfers and credit cards are the most commonly used cash-in-advance options available to exporters. However, requiring payment in advance is the least attractive option for the buyer, as this method creates cash flow problems. Foreign buyers are also concerned that the goods may not be sent if payment is made in advance. Thus, exporters that insist on this method of payment as their sole method of doing business may find themselves losing out to competitors who may be willing to offer more attractive payment terms.
EXPORT CREDIT INSURANCE: Export credit insurance provides protection against commercial losses-default, insolvency, bankruptcy, and political losses-war, nationalization, currency inconvertibility, etc. It allows exporters to increase sales by offering liberal open account terms to new and existing customers. Insurance also provides security for banks providing working capital and financing exports.
Export Factoring: Factoring in international trade is the discounting of a short-term receivable (up to 180 days). The exporter transfers title to its short-term foreign accounts receivable to a factoring house for cash at a discount from the face value. It allows an exporter to ship on open account as the factor assumes the financial ability of the importer to pay and handles collections on the receivables. The factoring house usually works with consumer goods. A factor is a bank or a specialised financial firm that performs financing through the purchase of invoices or accounts receivable. Export factoring is offered under an agreement between the factor and exporter, in which the factor purchases the exporter's short-term foreign accounts receivable for cash at a discount from the face value, normally without recourse, and assumes the risk on the ability of the foreign buyer to pay, and handles collections on the receivables.
Factoring helps eliminate virtually all risks to the exporter with 100 per cent financing of contract value and allows offering open account in markets where the credit risk would otherwise be too high. It generally works with bills of exchange, promissory notes, or a letter of credit and normally requires the exporter to obtain a bank guarantee for the foreign buyer and financing can be arranged on a one-shot basis in any of the major currencies, usually on a fixed interest rate, but a floating rate option is also available.
FORFAITING: Forfaiting is a method of trade financing that allows the exporter to sell its medium-term receivables (180 days to 7 years) to the forfeiter at a discount without recourse basis, in exchange for cash. With this method, the forfaiter assumes all the risks, enabling the exporter to extend open account terms and incorporate the discount into the selling price. Forfaiters usually work with capital goods, commodities, and large projects. Similar to factoring, forfaiting virtually eliminates the risk of nonpayment, once the goods have been delivered to the foreign buyer in accordance with the terms of sale. However, unlike factors, forfaiters typically work with the exporter who sells capital goods, commodities, or large projects and needs to offer periods of credit from 180 days to up to seven years.
LETTERS OF CREDIT: Letters of credit (LCs) are among the most secure instruments available to international traders. An LC is a commitment by a bank on behalf of the buyer that payment will be made to the exporter provided that the terms and conditions have been met, as verified through the presentation of all required documents. The buyer pays its bank to render this service. An LC is useful when reliable credit information about a foreign buyer is difficult to obtain, but you are satisfied with the creditworthiness of your buyer's foreign bank. An LC also protects the buyer since no payment obligation arises until the goods have been shipped or delivered as promised. There are various types of letter of credit issued across the world-such as: Irrevocable letter of credit, transferable letter of credit, red clause letter of credit, standby letter of credit etc. as necessitated by the buyer and seller considering their thirst of financing. Raising finance by using letter of credit is very customary in the trade finance world and the common financing are:
* For the Exporter
* Back to Back Letter of credit for procurement of the raw materials opened at the strength of the Export LC. By taking bank finance through the BTB LC, an exporter takes breath in a very own manner until the export proceeds realized from the foreign buyers.
* Packing Credit
* Bill purchased/Discounting
* Export cash credit
* Overdraft
* For the importer:
* Buyers credit
* Suppliers credit (period offered by the suppliers to the buyer)
All of the above financing facilities create impacts on the cash and cash cycles of the buyer and the suppliers any way.
FACTORS TO BE CONSIDERED BEFORE ISSUING LETTER OF CREDIT: The credit must be an irrevocable one. Irrevocable documentary credit cannot be cancelled without the mutual agreement between the parties involved there in.
* Under the documentary credit, raising finance is guided by the Uniforms Customs and Practice for Documentary credit (UCPDC) 2007 version, ICC publication No.600 which is widely used in the documentary credit world. There are thirty nine articles with clear guidance on the nature of Transport documents, Insurance documents and the financing procedures by honour to the bills and negotiation by the lenders who are not the drawee of the bill. By the including the term "NEGOTIATION", the exporters bank has space to finance to the exporter under the documentary credit. No only that there is huge scope for the drawee bank to finance under their accepted bill which is very new and trade-friendly for both the buyer and seller.
RISK ISSUES TO BE CONSIDERED BEFORE FINANCING UNDER DOCUMENTARY CREDIT: Transport documents should be in negotiable nature and title to goods must be to the order of the issuing bank.(Chapter-07,Guidelines for Foreign Exchange Transaction VOL-I)
* Discourage import on CIF and CIP basis(Import Policy order 2015-2018)
* Freight Forwarders bill of lading should be avoided without submission of master bill of lading to ensure the name of the consignee.
* Documentary credit should be issued through SWIFT.
* Supplier's credit report is a must before issuance of documentary credit if the credit is more than $10,000.00.
* Draft must not be drawn on the applicant.
 The writer is Head of Offshore banking unit, Bank Asia Limited.
[email protected]