What is Trade Finance

What is Trade Finance

12 Jun 2018 04:33 PM

Trade finance refers to the monetary activities related to both domestic and international trade transactions. Trade finance requires 2 parties namely: seller of goods and services as well as buyer. In case of international trade, we have exporters and importers. Various intermediaries such as banks and other financial institutions, export credit agencies and service providers facilitate the process of trade credit.

While a seller (or 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 Documentary Collection, Trade Credit Insurance, Fine trading, Factoring or Forfaiting. Some forms are specifically designed to supplement traditional financing.

Trade Finance Products & Services

Trade finance in itself involves various products and services. These products and services are offered by various banks, financial institutions and intermediaries that deal in this field. They enable smooth functioning in the sector. Some of the products and services are:

Buyer’s Credit: Buyer’s credit refers to a tool used to avail short term credit by the importer. It involves an overseas bank (funding bank) which lends funds to the buyer of goods and services. This serves the purpose for both the exporter (seller) and the importer (buyer), as it helps to make payment to the exporter at sight and gives the required time to the importer to arrange funds. The funding bank funds the payment of the exporter and later the importer’s bank remits the funding bank with the amount that was lend. It gets an upper edge as a mode of finance over the locally available funds as it is cost effective and is based upon LIBOR linked rates. However, buyer’s credit is no longer in operation.

Supplier’s Credit: Supplier’s Credit refers to a mode of short term finance wherein the importer can avail credit from an overseas bank to make payment for the imported goods. The overseas bank makes the payment to the exporter on the date of payment. Later on, the importer’s bank remits the funding bank on behalf of the importer for the amount lend. Amount cannot be remitted on rollover basis and this mode of credit is slightly costly. All transactions here are treated as fresh transactions (no rollover allowed) and although the cost is high, this form of credit ensures safety of transaction. Since buyer’s credit is no longer operational, supplier’s credit is the best option to avail cheap credit at LIBOR linked interest rates.

Letter of Credit: It refers to an undertaking given by a Financial Institution on behalf of the Buyer/Importer to the Seller/Exporter, which serves as a guarantee stating that if the exporter (seller) presents the complying required documents to the importer’s designated financial institution, then the buyer’s bank will make payment to the exporter. A letter of credit (LC) is also known as a documentary credit or a banker’s commercial credit. Is serves as a guarantee mostly in case of international trade by allocating the risk undertaken by the contracting parties involved. It is a vital payment mechanism in international trade.

Bank Guarantee: It is a written promise made by a Bank on behalf of the Applicant and in favor of the Beneficiary Wherein, the Bank agrees to an undertaking that in case the applicant fails to fulfill his/her obligation either in financial or non-financial terms as per the contract with the beneficiary, then the guarantor bank will fulfill the obligation upon receipt of a demand or claim from the beneficiary. A bank guarantee can be of various types, like: tender bond, advance payment, performance bond, financial, retention and labor. A bank guarantee may be direct or indirect.

Read more about export and import finance

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