Trade Finance

Amit Dubal(100)
Ajay George(103)
Zeeshan Mardani(119)
Varsha Sharma(144)
Anantvir Sikand(146)
Aditi Thapar(149)
What is Trade Finance??

The science that describes the

management of money, banking,
credit, investments and assets for
international trade transactions.
Types of Trade Settlement
Open Account: Long experience of trading
between buyer and seller
Advance Payment
Documentary D/P Collection
Documentary D/A Collection
Documentary Letters of Credit
Factoring
Forfaiting
In an open account trading scenario, the buyer has a
much greater leverage than the seller.
Under open account trade, the entire risk in the
transaction is borne by the seller since the payment is
made by the buyer only after the latter has taken
possession of the goods. Seller's risk is therefore of
non-payment or delayed payment.
Risk mitigants for the seller will be an established track
record with the buyer, mutual dependence between the
buyer and the seller or alternative structures built into
the transaction such as avalisation, export factoring, etc
Open Account transaction flow :
 This trade payment method is prevalent for transactions
where the seller has a much higher bargaining power than the
buyer. Such payment method may also be employed where
the buyer may not have the ability to open letters of credit
(formally called Documentary Credits) through their bank/s.
 It is also possible that the buyer is a cash rich company and
therefore wants to avail a cash discount from the seller.
 Obviously, the inherent risk in the transaction is borne by the
buyer which involves performance risk on the exporter as
well as country risk where cross-border trade in involved.
 Risk mitigants for the buyer could be an established
relationship with the seller, or any mutual dependence
between the buyer & the seller. Bank Guarantee from the
seller covering the performance risk could also provide
comfort to the buyer.
Advance Payment transaction flow:
 Importer can collect documents by following payment terms:

 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.

 Document against Payment (D/P)

Importer pays the face amount on sight of goods
Transfer of title of goods and documents is done immediately..
Collections transaction flow :
 DCs, more commonly known as letters of credit are a widely used
method to effect payments in domestic and international trade.
 A written undertaking is issued by a bank (usually referred to as the
issuing bank) on the instructions of the buyer of goods to the seller.
The payment is made under conditions stated in the undertaking.
Payments are always upto a stated limit and against stipulated
documents.
 The use of a DC provides enough safeguards for the parties involved.
The seller is ensured payment, provided he complies with terms he
agreed to while the buyer can include all terms and conditions within
the DC that satisfy him on the quality and quantity of the goods
without having to sight / inspect the goods themselves.
 Since banks act as trustworthy third parties/ intermediaries, the issues
relating to trust between the buyer and the seller are taken care of.
 DCs can be either sight or issusance depending on whether credit
period is extended to the buyer by the seller.
Documentary Credit transaction flow:
Payment Structures

Sight Credit: On presentation of documents at the

paying bank
Deferred payment: Payment on maturity date
Negotiation Credit: Advising Bank or another
Bank buys the documents from the exporter,
normally with recourse. Concept of `restricted
credit’. Also Payment and Acceptance Credits.
Advance Payment or Red Clause Credit
Revolving Credits
Back to back L/C
LoC
 Letter of Credit….
A letter from a bank guaranteeing that a buyer's
payment to a seller will be received on time and for
the correct amount. In the event that the buyer is
unable to make payment on the purchase, the bank
will be required to cover the full or remaining amount
of the purchase.
Parties to Letters of  Credit

Applicant (Opener)
Issuing Bank (Opening Bank)
Beneficiary
Advising Bank
Confirming Bank
Second Beneficiary
Types of Letters of Credit…
Confirmed Letter of Credit  L/c
Back to Back Letter of Credit  L/c
Transferable Letter of Credit  L/c
Standby Letter of Credit  L/c
Import Operations Under  L/c
Export  Operations Under L/c
Trade Document
International market involves various types of trade
documents that need to be produced while making
transactions. Each trade document is differ from other
and present the various aspects of the trade like
description, quality, number, transportation medium,
indemnity, inspection and so on.
The following is a list of documents
often used in international trade:
• Air Waybill
• Bill of Lading
• Certificate of Origin
• Combined Transport Document
• Draft (or Bill of Exchange)
• Insurance Policy (or Certificate)
• Packing List/Specification
• Inspection Certificate
Pre-shipment Finance
 What is Pre-Shipment Finance?
Why and When : When Seller want Payment before Shipment.

Provided by : Banks and Financial institutions

Termed as : Loans against Exports

Supported by : Original Irrevocable Documentary Credits(DCs)

Exporter can obtain 90% of the FOB value of the order or
75% of the CIF value of the order.
Main objectives - pre-shipment finance /
pre-export finance
To Procure Raw Materials.
Carry out Manufacturing Process.
To Provide a secure warehouse for goods
and raw materials.
For Processing and packing of Final-Goods.
To Ship the Final-Goods to the buyers.
Meet other financial cost like working
capital, advances for raw material, rents etc.
Types of pre-shipment finance
Packing Credit
Packing credits provide an exporter with finance after
goods have been manufactured but before they are shipped

Manufacturing advances
Manufacturing advances are provided to exporters to meet
manufacturing costs, such as the purchase of raw
materials.
-Advance Against Hypothecation
-Advance Against Pledge
-Advance Against Back-To-Back L/C
-Advance Against Duty Draw Back (DBK)
Different Stages of Pre Shipment Finance

1. Appraisal and Sanction of Limits

2. Disbursement of Packing Credit Advance

3. Follow up of Packing Credit Advance

4. Overdue Packing
 1)Appraisal and Sanction of Limits
 Check the different aspects like product profile, political and
economic details about country.
 The bank also looks in to the status report of the prospective
buyer, with whom the exporter proposes to do the business
 ECGC & International consulting agencies like Dun & Brad
Street etc.

The Bank extended the packing credit facilities after ensuring

the following
1). The exporter is a regular customer, a bona fide exporter and
has a goods standing in the market.
2).Whether the exporter has the necessary license and quota
permit (as mentioned earlier) or not.
3).Whether the country with which the exporter wants to deal is
under the list of Restricted Cover Countries(RCC) or not.
 2)Disbursement of Packing Credit Advance

 Once the proper sanctioning of the documents is done, bank

ensures whether exporter has executed the list of documents
mentioned earlier or not
 Running Account Packing

Particulars to be verified in the document

 Name of buyer
 Commodity to be exported
 Quantity
 Value (either CIF or FOB)
 Last date of shipment / negotiation.
 Any other terms to be complied with
3) Follow up of Packing Credit
Advance
Exporter required to be submit details :
Stock Statement
Necessary Information about the stocks
What Banks do with it?
It is then used by the banks as a guarantee for securing
the packing credit in advance.
4).Overdue Packing

Bank considers a packing credit as an overdue, if the

borrower fails to liquidate the packing credit on the
due date. And, if the condition persists then the bank
takes the necessary step to recover its dues as per
normal recovery procedure.
Preshipment Credit in Foreign
Currency
(PCFC)
 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
 The rate of interest on PCFC is linked to London Interbank
Offered Rate (LIBOR).
Post shipment Finance
 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.
 This type of export finance is granted from the date of extending
the credit after shipment of the goods to the realization date of
the exporter proceed.
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 Guarantee Corporation
Risks involved in export trade are usually more
than that involved in internal trade.
The risk of loss or damage to the goods is covered by
marine and general insurance
ECGC covers risks of exporters normally not
covered by other institutions
Standard Policies issued by ECGC cover commercial
and political risks
ECGC contd
Commercial Risks covered include:
 Insolvency of buyer
 Buyer’s protracted default to pay for goods accepted by him
 Buyer’s failure to accept the goods, when such
 non-acceptance is not due to the exporter’s action
Political Risks covered include:
 Restrictions on remittances in the buyer’s country
or any Government action which may block or
delay payment in Rupees to the exporter
 War, revolution or civil disturbances in the buyer’s country
 Cancellation of export licence or imposition of new export
licensing restriction in India
Bank Guarantee and Forefiting
Bank Guarantee
 Written contract given by a bank on the behalf of a customer
 For Govt.
1. Increases the rate of private financing for key sectors such as
infrastructure.
2. Reduces cost of private financing to affordable levels.
3. Facilitates privatizations and public private partnerships.
4. Reduces government risk exposure by passing commercial risk to
the private sector.

For Private Sector

1. Reduces risk of private transactions in emerging countries.
2. Opens new markets.
3. Improves project sustainability.
Types
 Direct or Indirect Bank Guarantee
 Confirmed Guarantee
 Tender Bond
 Performance Bonds
 Advance Payment Guarantees
 Payment Guarantees
 Loan Repayment Guarantees
 B/L Letter of Indemnity
 Rental Guarantee
 Credit Card Guarantee
Forfeiting
 To surrender ones right on something to someone else

 Benefits

 Improved cash flow

 Reduced administration cost
 Risk reduction
 Increased trade opportunity
Factoring
 Conversion of credit sales into cash
 Characteristics of Factoring
1. The normal period of factoring is 90-150 days and rarely
exceeds more than 150 days.
2. Credit rating is not mandatory.
3. It is a method of off balance sheet financing.
4. Cost of factoring is always equal to finance cost plus
operating cost.
 Factoring Services - Concept
Deliver of goods

Client Customer
Order placed

Client submits invoice

Customer pays
Factor-Prepayment

Monthly statements

Factor
 Country A Country B
Goods and invoices – Stage I
Exporter Importer

Copy Invoice Stage II Payments

Stage VI

Prepayments Stage III

Statements Stage V

Export Factor Copy Invoices Stage IV Import Factor

Payments Stage VII

Payment of Commission Stage VIII

 DIFFERENCE BETWEEN FACTORING
AND FORFAITING
1.Suitable for ongoing open
account sales, not backed by
LC or accepted bills or
exchange.
2. Usually provides financing for
short-term credit period of upto
180 days.
1. Oriented towards single
transactions backed by LC or
bank guarantee.
2. Financing is usually for
medium to long-term credit
periods from 180 days upto 7
years though shorterm credit of
30–180 days is also available
for large transactions.
 DIFFERENCE BETWEEN FACTORING
AND FORFAITING
3.Requires a continuous 3. Seller need not route or commit
arrangements between factor other business to the forfaiter.
and client, whereby all sales are Deals are concluded
routed through the factor. transaction-wise.

4. Separate charges are applied

for 4. Single discount charges is
—  financing applied which depend on
—  collection —  guaranteeing bank and
country risk,
—  administration
—  credit period involved and
—  credit protection and
—  currency of debt.
—  provision of information.
 DIFFERENCE BETWEEN FACTORING
AND FORFAITING
5. Service is available for 5. Usually available for
domestic and export export receivables only
receivables. denominated in any freely
6.Financing can be with or convertible currency.
without recourse; the . It is always ‘without
credit protection collection recourse’ and essentially a
and administration financing product.
services may also be
provided without
financing.
Risks
Transportation Risk

Risk factors related to shipping are

 Cargo
 Vessels
 People
 Financing
 Transportation Risk
Precautions to be taken handling Transportation:

 Product should be appropriate for containerization

 International code must be complied concerning the
transport of dangerous goods
 People involve in the handling of goods should be
equipped with phone, fax, email, internet and radio
Transportation Risk

 The expected sailing dates for marine transport

should be built into the production programme,
especially where payments is to be made by Letter
of Credit
 Cargo must be insured
Transport Insurance
 No matter whichever transport has been used in
international trade, necessary insurance is must for
ever good.
 Cargo insurance is effective in all the three cases
whether the goods have been transported via sea,
land or air.
Transport Insurance
 Cargo insurance also known as marine cargo
insurance is a type of insurance against physical
damage or loss of goods during transportation
 Insurance policy is not applicable if the goods have
been found to be packaged or transported by any
wrong means or methods.
Scope of Coverage
The following can be covered for the risk of loss or
damage:

 Cargo import, export cross voyage dispatched by sea,

river, road, rail post, personal courier, and including
associated storage risks.
 Good in transit (inland).
 Freight service liability.
 Associated stock.
Exclusions

 Loss by delay
 War risk
 Improper packaging
 Insolvency of carrier
Contract Credit Risk
 A contract risk is related to the Latin law of "Caveat
Emptor", which means "Buyer Beware" and refers
directly to the goods being purchase under contract,
whether it's a car, house land or whatever.

 Credit risk is defined as the risk that a counter party

bears given a transaction fails to perform according
to the terms and conditions of the contract, thus
causing the holder of the claim to suffer a loss.
Contract Credit Risk

Banks all over the world are very sensitive to

credit risk in various financial sectors like loans,
trade financing, foreign exchange, swaps, bonds,
equities, and inter bank transactions.
Credit Insurance
It is a special type of loan which pays back a
fraction or whole of the amount to the borrower in
case of death, disability, or unemployment
 It protects open account sales against non-
payment resulting from a customer's legal
insolvency or default
 It is usually required by manufacturers and
wholesalers selling products on credit terms to
domestic and/or foreign customers.
Credit Insurance
Benefits :
 Expand sales to existing customers without
increased risk.
 Offer more competitive credit terms to new
customers in new markets.
 Help protect against potential restatement of
earnings.
 Optimize bank financing by insuring trade
receivables.
 Supplement credit risk management.
Payment Risk

Payment risk arises when a customer does not pay

for operational reasons
 Payment risk can only be recovered by a well
written contract
 Recovery can not be made for payment risk using
credit insurance.
Bad Debt Protection
Confirmation of Letter of Credit.

 It is issued to an exporter or seller

 It assures payment to an exporter or seller, even if the
issuing bank defaults on its payment once the
beneficiary meets his terms and conditions.
Factoring and Forfeiting

 Where debt purchase is without recourse, the bank

will already have advanced the funds in the debt
purchase transaction
 The bank takes the risk of non-payment.
Benefits of Credit Cover
 Protection for the debtor asset or the balance sheet.
 Possible access to information on credit rating of foreign
buyer.
 Access to trade finance
 Protection of profit margin
 Advice on customers and levels of credit.
 Disciplined credit management.
 Assistance and /or advice when debts are overdue or there is
a risk of loss.
 Provides confidence to suppliers, lenders and investors.
 Good corporate governance.
 Country Political Risk
 Country risk includes a wide range of risks, associated with
lending or depositing funds, or doing other financial
transaction in a particular country
 It includes economic risk, political risk, currency blockage,
expropriation, and inadequate access to hard currencies
 Country risk can adversely affect operating profits as well as
the value of assets.
 With more investors investing internationally, both directly
and indirectly, the political, and therefore economic, stability
and viability of a country's economy need to be considered.
 Political Risk
The risk of loss due to political reasons arises in a particular
country due to changes in the country's political structure or
policies, such as tax laws, tariffs or expropriation of assets.
Following are few examples
 Licence cancellation or non renewal or imposition of an
embargo.
 Sanctions imposed against a particular country or company.
 Imposition of exchange controls causing payments to be blocked.
 Shortage of foreign exchange/transfer delay.
 War involving either importing or exporting country.
 Revoking of Import/ Exports licence.
 Changes in regulations.
Political Risk Cover
 Covering only political risk on the sale to a
particular country.
 For a portfolio of political risks.
 For the political risks in relation to the sale to
another company in your group (where there is a
common shareholding and therefore insolvency
cover is not available).
 As part of a credit insurance policy.
Need for finance in international trade
Challenging issue for developed and transition economy, specially for new enterprise and for
SME in the country. This is helpful for new enterprises and for sick organizations to revive
again.
 
Financing is not only for the export process/ demands but also for financing the import of
raw material
 
Reduced risks
Apart from capital, traders would also need support systems to help them manage risks
associated with international trade transactions.
reduce or eliminate risks associated with non-payment or payment delays, fluctuation in
exchange rates, changes in trade and financial regulations and political unrest, among
others.
 
Increased competitiveness
Terms of payment are increasingly used as competitive tools during contract negotiation.
 
 
 Reduced capital outlay
Trade finance provides companies with the necessary capital and liquidity and
helps them to better manage their cash flow, allowing them to expand and grow.
 Should subsidy be a part of WTO?

 Amount of subsidy depends on countries and their central bank policies.

 During crisis there is not much support for trade because of high interest rate.
 Wto having a fare policy for all nations can regulate subsidy even during crisis.