Trade Finance

What is Trade Finance?

Trade finance signifies financing for trade, 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. The main function of trade finance is to introduce a third-party to an ongoing transaction to remove the payment risk and the supply risk while providing the exporter with receivables according to the agreement and the importer with extended credit. Suppliers, banks, syndicates, trade finance houses and buyers all provide trade financing.

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, Finetrading, Factoring or Forfeiting. Some forms are specifically designed to supplement traditional financing.

Banks and financial institutions offer the following products and services in their trade finance branches.

1. Letter of credit: It is an undertaking/promise given by a Bank/Financial Institute on behalf of the Buyer/Importer to the Seller/Exporter, that, if the Seller/Exporter presents the complying documents to the Buyer’s designated Bank/Financial Institute as specified by the Buyer/Importer in the Purchase Agreement then the Buyer’s Bank/Financial Institute will make payment to the Seller/Exporter.
2. Bank guarantee: It is an undertaking/promise given by a Bank on behalf of the Applicant and in favor of the Beneficiary. Whereas, the Bank has agreed and undertakes that, if the Applicant failed to fulfill his obligations either Financial or Performance as per the Agreement made between the Applicant and the Beneficiary, then the Guarantor Bank on behalf of the Applicant will make payment of the guarantee amount to the Beneficiary upon receipt of a demand or claim from the Beneficiary.

Trade finance is the financing of international trade flows. It exists to mitigate, or reduce, the risks involved in an international trade transaction.
There are two players in a trade transaction: (1) an exporter, who requires payment for their goods or services, and (2) an importer who wants to make sure they are paying for the correct quality and quantity of goods.

RISKS INVOLVED

As international trade takes place across borders, with companies that are unlikely to be familiar with one another, there are various risks to deal with. These include:

Payment risk: Will the exporter be paid in full and on time? Will the importer get the goods they wanted?

Country risk: A collection of risks associated with doing business with a foreign country, such as exchange rate risk, political risk and sovereign risk. For example, a company may not like exporting goods to certain countries because of the political situation, a deteriorating economy, the lack of legal structures, etc.

Corporate risk: The risks associated with the company (exporter/importer): what is their credit rating? Do they have a history of non-payment?

To reduce these risks, banks – and other financiers – have stepped in to provide trade finance products.

Popular methods of payment used in international trade include:

1. advance payment– the buyer arranges for their bank to pay the supplier around 30% of the order value upfront when ordering, and the other 70% when the goods are released or shipped.
2. letter of credit (L/C) – this document gives the seller two guarantees that the payment will be made by the buyer:one guarantee from the buyer’s bank and another from the seller’s bank.
3. bills for collection (B/E or D/C) – here a bill of exchange (B/E) is used; or documentary collection (D/C) which is a transaction whereby the exporter entrusts the collection of the payment for a sale to its bank (remitting bank), which sends the documents that its buyer needs to the importer’s bank (collecting bank), with instructions to release the documents to the buyer for payment.
4. open account – this method can be used by business partners who trust each other; the two partners need to have their accounts with the banks that are correspondent banks.

BBCI Finance only helps provide SBLCs either on lease or through outright purchase. Please click on the link below to understand SBLC issuance procedure