Group Members - No.

16
Daljit Arora 03
Khushboo Damani 21
Ronak Desai 26
Rohit Dutt 28
Amisha Khanna
Jitendra Relan 79
 CONTENT

• Introduction to International Trade

• Methods of Payment

• Pre-Shipment Finance

• Post-Shipment Finance

• Letter of Credit

• Open Account

• Documentary Collections

• Factoring

• Top Trading Nations

• Risk in International Trade

• Countertrade
I NTERNATIONAL TRADE

International trade is exchange of capital, goods, and services across international

borders or territories.[1]. In most countries, it represents a significant share of gross domestic
product (GDP). While international trade has been present throughout much of history
(see Silk Road, Amber Road), its economic, social, and political importance has been on the
rise in recent centuries.

Industrialization, advanced transportation, globalization, multinational corporations,

and outsourcing are all having a major impact on the international trade system. Increasing
international trade is crucial to the continuance of globalization. Without international trade,
nations would be limited to the goods and services produced within their own borders.

International trade is in principle not different from domestic trade as the motivation and the
behaviour of parties involved in a trade do not change fundamentally regardless of whether
trade is across a border or not. The main difference is that international trade is typically
more costly than domestic trade. The reason is that a border typically imposes additional
costs such as tariffs, time costs due to border delays and costs associated with country
differences such as language, the legal system or culture.

Another difference between domestic and international trade is that factors of

production such as capital and labour are typically more mobile within a country than across
countries. Thus international trade is mostly restricted to trade in goods and services, and
only to a lesser extent to trade in capital, labour or other factors of production. Then trade in
goods and services can serve as a substitute for trade in factors of production. Instead of
importing a factor of production, a country can import goods that make intensive use of the
factor of production and are thus embodying the respective factor. An example is the import
of labour-intensive goods by the United States from China. Instead of importing Chinese
labour the United States is importing goods from China that were produced with Chinese
labour.

International trade is also a branch of economics, which, together with international finance,
forms the larger branch of international economics.
T RADE FINANCE

Trade finance is related to international trade.

While a seller (the exporter) can require the purchaser (an importer) to prepay for
goods shipped, the purchaser (importer) may wish to reduce risk by requiring the seller to
document the goods that have been shipped. Banks may assist by providing various forms of
support. For example, the importer's bank may provide a letter of credit to the exporter (or the
exporter's bank) providing for payment upon presentation of certain documents, such as
a bill of lading. The exporter's bank may make a loan (by advancing funds) to the exporter on
the basis of the export contract.

Other forms of trade finance can include trade credit insurance, export factoring, forfaiting and
others. In many countries, trade finance is often supported by quasi-government entities
known as export credit agencies that work with commercial banks and other financial
institutions.

In short, trade finance means money lent to exporters or importers.

DEFINITION

Trade Finance is the science that describes the management of money, banking, credit,
investments and assets for international trade transactions.

International Trade

Flow of Commodity Flow of Productive Factors

TRADE RELATIONSHIP

Trade financing shares a number of common characteristics with the traditional value chain
activities conducted by all firms. All companies must search out suppliers for the many
goods and services required as inputs to their own goods production or service provision
processes. Issues to consider in this process include the capability of suppliers to produce
the product to adequate specifications, deliver said products in a timely fashion, and to work
in conjunction on product enhancements and continuous process improvement. All of the
above must also be at an acceptable price and payment terms.
The nature of the relationship between the exporter and the importer is critical to
understanding the methods for import-export financing utilized in industry. There are three
categories of relationships (see next exhibit):

– Unaffiliated unknown
– Unaffiliated known
– Affiliated (sometimes referred to as intrafirm trade)

The composition of global trade has changed dramatically over the past few decades,
moving from transactions between unaffiliated parties to affiliated transactions.

ADVANTAGES AND DISADVANTAGES

Advantages

• Market expansion
• Economies of scale
• Surplus not wasted
• BOP
• Global productivity
• Socio economic setup of country

Disadvantages

• Annihilation of infant industry

• Exchange rate fluctuation
• Unequal distribution of wealth

EXIM BANKS

Exim Bank is managed by a Board of Directors, which has representatives from the
Government, Reserve Bank of India, Export Credit Guarantee Corporation of India (ECGC),
a financial institution, public sector banks, and the business community.

The Bank's functions are segmented into several operating groups including:

Corporate Banking Group which ABN, MN handles a variety of financing programmes for
Export Oriented Units (EOUs), Importers, and overseas investment by Indian companies.
Project Finance / Trade Finance Group handles the entire range of export credit services
such as supplier's credit, pre-shipment credit, buyer's credit, finance for export of projects &
consultancy services, guarantees, forfaiting etc.

Lines of Credit Group Lines of Credit (LOC) is a financing mechanism and export
transactions in the agricultural sector for financing. Small and Medium Enterprises Group to
the specific financing requirements of export oriented SMEs. The group handles credit
proposals from SMEs under various lending programmes of the Bank.

Export Services Group offers variety of advisory and value-added information services
aimed at investment promotion Fee based Export Marketing Services Bank offers assistance
to prorate Affairs.
METHODS FOR INTERNATIONAL TRADE FINANCE

According to stage of financing:

• Pre-shipment finance

• Post-shipment finance

Instruments/methods of financing:

• Letter of credit

• Open account

• Factoring

• Document collections

PRE-SHIPMENT FINANCE :

Definition:

“Financial assistance extended to the exporter from the date of receipt

of the export order till the date of shipment is known as pre-shipment
credit”.

Such finance is extended to an exporter for the purpose of procuring raw materials,
processing, packing, transporting, warehousing of goods meant for exports. Maximum
period of 180 days Exporter can obtain 90% of the FOB value of the order or 75% of the CIF
value of the order.

This is extended to the customers for procuring goods, purchase of raw materials,
processing them and converting them into finished goods for the purpose of exports The
type of limit depends upon the nature of production and procurement system concerning the
commodity to be exported. Clean Export Packing Credit (EPC) can be granted when first
class clients have to give advance payment to the suppliers.

The clean advance is converted to EPC hypothecation/ pledge or secured shipping loan
depending upon the nature of the commodity. Packing credit hypothecation is extended
where raw materials, work-in-process and finished goods meant for exports are available as
security. The processing/ manufacturing may be undertaken by the exporter himself or
through sub-contractors as captive units.

Sometimes exporters have to obtain the raw materials in bunched lots or the material
procured may be sizeable in nature. In such cases packing credit loan can be granted in the
form of pledge. Once the goods are ready for shipment and the exporter/ supplier has
handed over the goods to the transporter/ clearing and forwarding agents for effecting the
shipment, the advance can be granted as secured shipping loan.
Pre-shipment advance is usually granted up to a maximum of 180 days or expiry of relative
LC or order, whichever is earlier. In some cases EPC can go up to 360 days. Pre-shipment
Credit can be in Indian Rupees or in Foreign Currency. This facility was given as exporters
complained that interest in India was high.

All pre-shipment finance is self-liquidating in nature from post-shipment finance. If pre-

shipment advances are not adjusted by submission of export documents, the advances will
cease to qualify for concessional rate of interest ability. Ordinarily, each packing credit
sanctioned should be maintained as a separate account for the purpose of monitoring of
sanction and end-use of funds.

IMPORTANCE OF PRE-SHIPMENT FINANCE

o Purchase raw material, and other inputs

o Assemble the goods in the case of merchant exporters.

o Store the goods in suitable warehouses till the goods are shipped.

o Packing, marking and labeling of goods.

o Pre-shipment inspection charges.

o Purchase of heavy machinery and other capital goods

o Consultancy services.

o Export documentation expenses.

Post-shipment finance means any credit provided by a bank to an exporter from the date of
extending the credit after shipment of goods to the date of realization of sale proceeds.

Post-shipment advance mainly take the form of –

(i) Export bills purchased/ discounted/ negotiated

(ii) Advances against bills for collection
(iii) Advances against duty drawback receivable from Government

Export Credit in Foreign Currency

With a view to making credit available to exporters at internationally competitive rates, Ads
have been permitted to extend pre-shipment credit in foreign currency (PCFC) to exporters
for domestic and imported inputs of exported goods at LIBOR related rates of interest.

The facility may be extended in one of the convertible currencies, viz. US Dollars, Pound
Sterling, Japanese Yen, Euro, etc.
POST-SHIPMENT FINANCE :

Definition:

“Post Shipment Finance is a kind of loan provided by a financial

institution to an exporter or seller against a shipment that has already
been made.”

Export finance is granted from the date of extending the credit after shipment of the goods to
the realization date of the exporter proceeds. Exporters don’t wait for the importer to deposit
the funds.

FEATURES:

Purpose of Finance
Post shipment finance is meant to finance export sales receivable after the date of shipment
of goods to the date of realization of exports proceeds. In cases of deemed exports, it is
extended to finance receivable against supplies made to designated agencies.

Basis of Finance
Post shipment finances is provided against evidence of shipment of goods or supplies made
to the importer or seller or any other designated agency.

Types of Finance
Post shipment finance can be secured or unsecured. Since the finance is extended against
evidence of export shipment and bank obtains the documents of title of goods, the finance is
normally self liquidating.

Quantum of Finance
As a quantum of finance, post shipment finance can be extended up to 100% of the invoice
value of goods. In special cases, where the domestic value of the goods increases the value
of the exporter order, finance for a price difference can also be extended and the price
difference is covered by the government.

Period of Finance
Post shipment finance can be off short terms or long term, depending on the payment terms
offered by the exporter to the overseas importer. In case of cash exports, the maximum
period allowed for realization of exports proceeds is six months from the date of shipment.
Concessive rate of interest is available for a highest period of 180 days, opening from the
date of surrender of documents. Usually, the documents need to be submitted within 21days
from the date of shipment.

TYPES OF POST SHIPMENT FINANCE :

1. Export Bills Purchased/ Discounted.(DP & DA Bills)

Export bills (Non L/C Bills) is used in terms of sale contract/ order may be discounted or
purchased by the banks. It is used in indisputable international trade transactions and the
proper limit has to be sanctioned to the exporter for purchase of export bill facility.

2. Export Bills Negotiated (Bill under L/C)

The risk of payment is less under the LC, as the issuing bank makes sure the payment. The
risk is further reduced, if a bank guarantees the payments by confirming the LC. Because of
the inborn security available in this method, banks often become ready to extend the finance
against bills under LC.

3. Advance Against Export Bills Sent on Collection Basis

Bills can only be sent on collection basis, if the bills drawn under LC have some
discrepancies. Sometimes exporter requests the bill to be sent on the collection basis,
anticipating the strengthening of foreign currency.

Banks may allow advance against these collection bills to an exporter with a concessional
rates of interest depending upon the transit period in case of DP Bills and transit period plus
usance period in case of usance bill. he transit period is from the date of acceptance of the
export documents at the banks branch for collection and not from the date of advance.

4. Advance Against Export on Consignments Basis

Bank may choose to finance when the goods are exported on consignment basis at the risk
of the exporter for sale and eventual payment of sale proceeds to him by the consignee.
However, in this case bank instructs the overseas bank to deliver the document only against
trust receipt/undertaking to deliver the sale proceeds by specified date, which should be
within the prescribed date even if according to the practice in certain trades a bill for part of
the estimated value is drawn in advance against the exports. In case of export through
approved Indian owned warehouses abroad the times limit for realization is 15 months.

5. Advance against Undrawn Balance

It is a very common practice in export to leave small part undrawn for payment after
adjustment due to difference in rates, weight, quality etc. Banks do finance against the
undrawn balance, if undrawn balance is in conformity with the normal level of balance left
undrawn in the particular line of export, subject to a maximum of 10 percent of the export
value. An undertaking is also obtained from the exporter that he will, within 6 months from
due date of payment or the date of shipment of the goods, whichever is earlier surrender
balance proceeds of the shipment.

6. Advance Against Claims of Duty Drawback

Duty Drawback is a type of discount given to the exporter in his own country. This discount is
given only, if the inhouse cost of production is higher in relation to international price. This
type of financial support helps the exporter to fight successfully in the international
markets.In such a situation, banks grants advances to exporters at lower rate of interest for
a maximum period of 90 days. These are granted only if other types of export finance are
also extended to the exporter by the same bank.
After the shipment, the exporters lodge their claims, supported by the relevant documents to
the relevant government authorities. These claims are processed and eligible amount is
disbursed after making sure that the bank is authorized to receive the claim amount directly
from the concerned government authorities.

LETTER OF CREDIT :

Definition:
“A formal document issued by a bank on behalf of customer, stating the
conditions under which the bank will honour the commitment of the
customer.”
The letter of credit is also known as banker’s commercial credit or documentary letter of
credit. L/C used in domestic trade are called inland L/C’s.

The essence of the L/C is the promise of the issuing bank to pay against specified
documents, which must accompany any draft drawn against the credit. To constitute a true
L/C transaction, all of the following five elements must be present with respect to the issuing
bank:

– Must receive a fee or other valid business consideration for issuing the L/C
– The L/C must contain a specified expiration date or definite maturity
– The bank’s commitment must have a stated maximum amount of money
– The bank’s obligation to pay must arise only on the presentation of specific documents
– The bank’s customer must have an unqualified obligation to reimburse the bank on the
same condition as the bank has paid.

Commercial letters of credit are also classified:

– Irrevocable versus revocable

– Confirmed versus unconfirmed
• The primary advantage of an L/C is that it reduces risk
– the exporter can sell against a bank’s promise to pay rather than against the promise of a
commercial firm.

The major advantage of an L/C to an importer is that the importer need not pay out funds
until the documents have arrived at the bank that issued the L/C and after all conditions
stated in the credit have been fulfilled.

PARTIES TO A LETTER OF CREDIT :

Importer is called the opener of the L/C on whose behalf the credit is opened by his bank.
Issuing bank: the importer’s bank which issues the credit.

Beneficiary: The exporter in whose favour the L/C is opened.

Advising Bank: The bank located in exporter’s country & correspondent bank of the L/C
issuing bank or its own branch who advises the credit to the beneficiary or his bank
Negotiating: The L/C will mention the name of the bank authorized to handle & negotiate
the documents drawn under the L/C & pay to the exporter & claim the reimbursement from
issuing bank. Sometimes the L/C may be freely negotiable & the exporter’s bank may also
negotiate the documents.
Issuing Bank: The relationship between the importer and the issuing bank is governed by
the terms of the application and agreement for the letter of credit (L/C).
LETTER OF CREDIT – THE PROCESS:

TYPES OF LETTER OF CREDIT:

1. Irrevocable: It is the one that cannot be revoked, cancelled or modified w/o the express
consent of all the concerned parties to that credit.

2.Revocable: It may be altered at the will of any party

3. Negotiation: assures anyone who negotiates drafts under it that they will be honored by
the opening bank provided they comply with all the terms.

4. Confirmed credit has added strength of another bank of repute who adds its confirmation
to pay even if the L/C opening bank does not pay. When the opening bank is of undoubted
reputation & financial strength, a confirmation by other bank is not necessary & hence is
called unconfirmed credit.

5. In case of repeat shipments b/w the same buyer & seller then a revolving credit is used.

6. Another vehicle under which the beneficiary of a L/C can take advantage of the credit
worthiness of the importer is the back to back credit.

7. This instrument is similar to a normal L/C except that it contains a clause ( originally
typed/printed in red) authorizing the negotiating bank to make clean advance to the exporter.
This enables the exporter to avail advance for purchasing, processing raw material meant
for exports. Here , the importer is giving the unsecured loan to exporter for buying necessary
merchandise.

8. A transferable L/C is one under which the beneficiary has the right to instruct the paying
or advising bank to make the credit available to one or more other beneficiaries
9. A traveler’s L/C provides funds for business people & others who travel abroad for
relatively long periods of time.

OPEN ACCOUNT:

Definition:
“Open Account is a form of trade whereby sales are made to the buyer
without entering into any formal contract. The system works on
complete trust between buyer & seller.”

An open account transaction means that the goods are shipped and delivered before
payment is due, usually in 30 to 90 days.

Open Account is the most advantageous option to the importer in cash flow and cost terms.
It is consequently the highest risk option for an exporter.

Exporters may also wish to seek export working capital financing to ensure that they have
access to financing for both the production for export and for any credit while waiting to be
paid.

Due to the 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
non-payment by the foreign buyer.

Open account terms may be offered in competitive markets with the use of one or more of
the following trade finance techniques:

1. Export Working Capital Financing

2. Export Credit Insurance
3. Export Factoring
4. Forfaiting

Pros: This method of payment will definitely enhance export competitiveness, but exporters
should thoroughly examine the political, economic, and commercial risks, as well as cultural
influences to ensure that payment will be received in full and on time. Open account terms
may help win customers in competitive markets

Cons: Exporter faces significant risk as the buyer could default on payment obligation after
shipment of the goods. Risk mitigation measures that is using one & more appropriate trade
finance techniques so as to mitigate the risk of non-payment can add to additional costs
DOCUMENTARY COLLECTIONS :

Definition:
“A documentary collection is a transaction whereby the exporter
entrusts the collection of a payment to the remitting bank (exporter’s
bank), which sends documents to a collecting bank (importer’s bank),
along with instructions for payment. Funds are received from the
importer and remitted to the exporter through the banks involved in the
collection in exchange for those documents.”

Documents should be consistent with each other and complete. Conform with the terms of
the credit. Comply with the provisions of UCP. Banks must examine all documents stipulated
in the Credit with reasonable care. Each bank will have a reasonable time not exceeding
seven banking days following the day of receipt to examine the documents (Article 13b).
Concept of discrepant documents (Article 14).

Documentary collections involve the use of a draft that requires the importer to pay the face
amount either on sight (document against payment—D/P) or on a specified date in the future
(document against acceptance—D/A).

Importer can collect documents by following payment terms:

A. Document against acceptance (D/A): Importer pays the face amount on a specified
date in the future. Transfer of title of goods and documents is done on receipt of
payment.

B. Document against payment (D/P): Importer pays the face amount on sight of goods.
Transfer of title of goods and documents is done immediately.

Advantages & Disadvantages:

The draft lists instructions that specify the documents required for the transfer of title to the
goods. Although banks do act as facilitators for their clients under collections, documentary
collections offer no verification process and limited recourse in the event of non-payment.
Drafts are generally less expensive than letters of credit.

Ask beneficiaries to make corrections. Accept minor discrepancies and pay under reserve.
Obtain indemnity from seller. Telex/fax details of discrepancies to the issuing bank and
request permission to pay. Send the documents on collection

A trade transaction could conceivably be handled in many ways. The transaction that would
best illustrate the interactions of the various documents would be an export financed under a
documentary commercial letter of credit, requiring an order bill of lading, with the exporter
collecting via a time draft accepted by the importer’s bank.
FACTORING :

Definition:
“Financial transaction whereby a business sells its accounts receivable
to a third party called a factor (financial institution) at a discount in
exchange for immediate money with which to finance continued
business.”

Factoring is a financial transaction whereby a business sells its accounts receivable (i.e.,
invoices) to a third party (called a factor) at a discount in exchange for immediate money
with which to finance continued business.

Factoring is a financial option for the management of receivables. In simple definition it is the
conversion of credit sales into cash. In factoring, a financial institution (factor) buys the
accounts receivable of a company (Client) and pays up to 80%(rarely up to 90%) of the
amount immediately on agreement. Factoring company pays the remaining amount
(Balance 20%-finance cost operating cost) to the client when the customer pays the debt.

Factoring differs from a bank loan in three main ways. First, the emphasis is on the value of
the receivables (essentially a financial asset)[1], not the firm’s credit worthiness. Secondly,
factoring is not a loan – it is the purchase of a financial asset (the receivable). Finally, a bank
loan involves two parties whereas factoring involves three.

The three parties directly involved are: the one who sells the receivable, the debtor, and the
factor. The receivable is essentially a financial asset associated with the debtor’s Liability to
pay money owed to the seller (usually for work performed or goods sold).

Disclosed factoring is the arrangement under which the exporter enters into a factoring
agreement with the financial house and assigns the benefit of the debts created by the sale
transaction to them. The importer is then notified and effects payment to the factor.
The arrangement is usually on a non-recourse basis. This means that the factor cannot
claim the assigned funds from the exporter if the importer fails to pay, in other words, he
assumes the credit risk in the transaction. Those debts that are not approved by the factor
are assigned on a recourse basis, so he can claim against the exporter in case of any
default of the importer.

Recourse factoring is more accurately described as invoice discounting. Factoring

arrangements are usually made on a whole turnover basis. This arrangement connotes an
obligation of the exporter to offer all his receivables to the factor who receives a commission.

Undisclosed factoring, which is usually undertaken on a recourse basis, does not involve the
importer. The agreement is made between the factor and the exporter and the importer
remains bound to pay as agreed under the sales contract. In receipt of payment, the
exporter holds the funds in a separate bank account as trustee for the factor.

TWO FACTORS SYSTEMS:

This entails the use of two factors, one in each country, dealing with the exporter and the
importer respectively. The export factor on obtaining the information from the exporter on the
type of his business and the proposed transaction will contact the import factor designated
by the importer and agree the terms of the deal. The importer advances funds to the import
factor who then transmits them to the export factor, minus his charges. In the two factor
system the import factor and the importer do not come into direct contact.

The system involves three agreements, one between the exporter and the importer, one
between the export factor and the exporter and one between the factors themselves. It is
important to bear in mind that the import factor’s obligations are to the export factor alone
and they include determining the importer’s credit rating and the actual collection of the
debts. The import factor assumes the credit risk in relation to approved debts and is
responsible for the transfer of funds to the export factor. On the other hand, the export factor
is responsible to the import factor for the acceptance of any recourse.

DIRECT IMPORT AND EXPORT FACTORING:

Direct import factoring connotes the situation where the exporter assigns debts to a factor in
the country of the debtor. This is usually the case where there is a substantial volume of
exports to a specific country. This solution is a cheap and time efficient method of debt
collection but it does not serve the aim of providing finance to the exporter. The factor
provides a debt collection service and does not enquire into the creditworthiness of the
importer. Prepayments are not possible because that would expose the factor to high risks.

Direct export factoring on the other hand, does operate as an alternative to the two factor
system. In this situation, the factor is appointed in the exporter’s own country and deals with
all the aspects of the factoring arrangement including the provision of financing and the
assessment of the financial position of the importer. This system is inexpensive and
facilitates the communication between the exporter and the factor. However, all the
advantages of the two factor system relating to the import factor’s proximity to the importer
and his jurisdiction can be listed here as disadvantages. Communication problems with the
debtor, credit risks and the occurrence of disputes are the most important problems.

Back to back factoring is an arrangement most suitable for debts owed by the exclusive
distributors of products to their suppliers. The structure of the agreements is similar to the
ones already considered with one material difference. The exporter enters into a factoring
agreement with the export factor who contracts with the import factor in the usual way. The
difference lies in the existence of a separate factoring agreement between the import factor
and the distributor. Included in that arrangement is a right to set off credits arising from the
domestic sales of the distributor with his debts to the supplier.
TOP TRADING NATIONS :
INTERNATIONAL TRADE RISK :

The following exhibit illustrates the sequence of events in a single export transaction.
From a financial management perspective, the two primary risks associated with an
international trade transaction are currency risk (currency denomination of payment) and risk
of noncompeting (timely and complete payment).

The risk of default on the part of the importer is present as soon as the financing period
begins. Companies doing business across international borders face many of the same risks as
would normally be evident in strictly domestic transactions. For example,

 Buyer insolvency (purchaser cannot pay);

 Non-acceptance (buyer rejects goods as different from the agreed upon specifications);
 Credit risk (allowing the buyer to take possession of goods prior to payment);
 Regulatory risk (e.g., a change in rules that prevents the transaction);
 Intervention (governmental action to prevent a transaction being completed);
 Political risk (change in leadership interfering with transactions or prices); and
 War and other uncontrollable events.

In addition, international trade also faces the risk of unfavorable exchange rate movements (and, the
potential benefit of favorable movements).

COUNTERTRADE :

The word countertrade refers to a variety of international trade arrangements in which goods
and services are exported by a manufacturer with compensation linked to that manufacturer
accepting imports of other goods and services.

In other words, an export sale is tied by contract to an import. The countertrade may take
place at the same time as the original export, in which case credit is not an issue; or the
countertrade may take place later, in which case financing becomes important.