Trade finance signifies financing for trade (purchase or sale of goods), and it concerns both domestic and international trade transactions. A trade transaction requires a seller of goods and services as well as a buyer. Various intermediaries such as banks and financial institutions can facilitate these transactions by financing the trade.
a) Advance Payment
b) Stand-by Letter of Credit (financial guarantee)
c) Letter of Credit (L/C) at Sight
d) Letter of Credit (L/C) with Usance
e) Documents Against Payment (DP)
f) Documents Against Acceptance (DA)
g) Open Account (Direct Documents / Payment)
The payment method is relevant as the funding instrument (financing product) is determined basis which payment method is being used. For example, in cases of advance payment, no trade finance product is possible as goods have not been shipped yet (therefore documents are not prepared yet) and only clean financing such as Cash Credit / overdraft / working capital loan is possible. Another example, in cases of DA, pre-shipment and post-shipment financing is available to exporter and Buyer's Credit for importers.
Anyone who is authorised by RBI. This includes Banks, Financial Institutions, Supplier, Buyer etc. Given that International Trade financing involves foreign exchange, this is covered and governed by RBI as regulator.
Trade loans are the facilities used by importers, exporters and domestic traders for specific transactions used for product purchase and sales. Trade loans are short term in nature and parties involved are borrower and lender.
International trade finance involves using the underlying trade (import or export) and using various payment methods to arrange financing. There are various products used and this includes the following:
1. Issuing Letters of Credit (LCs) with or without Supplier's Credit
2. Export factoring (companies receive funds against invoices or accounts receivable)
3. Forfaiting (purchasing the receivables or traded goods from an exporter)
4. Export credits (to reduce risks to funders when providing trade or supply chain finance)
5. Insurance (during delivery and shipping, also covers currency risk and exposure)
6. Buyer's Credit backed by SBLC
Yes, there are various instruments that can be used to pay your suppliers directly and financing can be extended to you for repayment on due date. Usance L/C payable at Sight (Supplier's Credit), Buyer's Credit backed by SBLC etc are some of the products readily used.
Document against acceptance is a payment method in which importer receives the documents of ownership of imported goods only when importer has accepted and promised to pay the related bill of exchange.
A letter from a bank guaranteeing that a buyer's payment to a seller will be made on time and for the correct amount subject to the seller submitting documents in full compliance with the LC. 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.
1. The Draft or Bill of Exchange
2. The commercial Invoice or Trade invoice
3. Certificate of origin
4. Weight List / certificate
5. Inspection certificate
6. Transport Document
7. Discrepancy Checklist
There are various scenarios when a Letter of Credit is used widely.
1. LC is used when Buyer's and Sellers are new in business
2. LC is used arrange financing for either parties in a transaction.
3. LC is used to remove financial risks in a transaction.
Buyer's Bank guarantees payment to seller through seller's bank when required documents are presented as mentioned in Letter of Credit. This mode of payment minimizes the credit risk for exporter. It is still a relevant instrument widely used in the international trade.
Buyer's Credit refers to loans for payment of imports into India and arranged on behalf of the importer through an overseas bank where Importer's bank provides a Standby Letter of Credit on behalf of importer to funding bank.
Terms loans are taken from Indian Banks in Indian Currency and the tenor of the loan is greater than 1 year. The borrower needs to pay the interest and principal as per terms of the lender. Given the longer tenor and borrowing cost in INR, interest rate in case of term loan is on the higher side.
Buyer's Credit is taken from the overseas bank in foreign currency against imports. It can be for import of raw material (tenor < 1 year) or for import of capital goods (tenor > 1 years and below 3 years). Given the borrowing is in foreign currency, in most cases, the cost of borrowing is cheaper than borrowing locally.
In funding related transaction, the intermediator brings the borrower and lender together at optimal cost. Myforexeye, on behalf of our client reaches out to multiple overseas banks for interest rates and we negotiate to get best rates for our clients.
LIBOR (London Interbank Offer Rate) / EURIBOR (Euro Interbank Offer Rate) is a benchmark rate that some of the world's leading banks charge each other or other financial institutions for short-term loans in USD/EURO. It is arrived at on a daily basis for various tenors after taking into account rates from various banks in London. Generally, this rate is treated as a benchmark for lending & borrowing between entities in USD/EURO.
Indian Bank's Credit rate is for financing in the Indian Currency and may differ from bank to bank.
LIBOR/EURIBOR is a benchmark rate for financing in foreign currency that is fixed on a daily basis in London for various tenors.
LIBOR is calculated on a daily basis after taking into account lending rates across a host of banks in London and is published daily for various tenors. It is dependent on a variety of macro-economic factors in addition to the cost of funds of individual banks.
SWIFT is an international financial network that financial institutions use to communicate securely with each other. A SWIFT code is an international bank code that identifies particular banks worldwide. It's also known as a Bank Identifier Code (BIC).
* MT202 Cov is a SWIFT message format for financial institution transfer. It is used to order the movement of funds to the beneficiary institution via another financial institution / Intermediary Bank.
* MT799 is a free format message that is sent between banks to communicate a variety of things that cannot be communicated otherwise in a secure manner. For example, it can be used to provide additional details of a transaction, or it may be used to place a request on the receiving bank. It is important to note that it is not used as a method of transferring funds or an undertaking to do the same.
Myforexeye provides foreign exchange related service and information to its clients. It was founded with a principle of helping clients largely in the MSME space by providing access to information and bring down their FX margins / Trade Finance cost.
High Sea sales (HSS) is a sale carried out by the carrier document consignee to another buyer while the goods are yet on high seas or after their dispatch from the port/ airport of origin and before their arrival at the port / airport of destination.
RBI issued a notification on Dec 17, 2018 wherein it allowed a borrower operating in an SEZ to obtain Trade credits for purchases within the SEZ or from other SEZ entities. What this means is that any entity operating inside an SEZ can avail Trade Credit for the following
a. Physical imports (goods crossing into India) of the SEZ entity
b. Purchases from another entity operating within the same SEZ (goods are moving within the same SEZ).
c. Purchases from another entity operating in another SEZ (goods are moving between two SEZs).
The most preferred route for transaction depends upon the nature and transactional details of the transaction. For purchases within the same SEZ most preferred route can be Reimbursement against Acceptance Financing (here LC is required to be opened) & in case documents are routed through Banking Channel (that is, DA/DP documents) then SBLC backed Buyer's credit is the preferable route of Funding.
Following are the key differences between raising funds in INR & Foreign Currency.
1. Rates The INR cost of borrowing generally ranges around 9 12 %, whereas the cost of borrowing in FCY ranges in 3.10- 4.00%. Even after factoring in the forward premium, there is benefit in borrowing in FCY.
2. Documentation Even though borrowing in INR comes with simpler documents, FCY borrowings are simple & convenient and is usually bundled together with the documentation on exports/imports as prescribed by RBI.