Chapter 23

International Trade
Finance
The 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.

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The Trade Relationship

• The nature of the relationship between the exporter and 
the importer is critical to understanding the methods 
for import­export 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.
23-3
 Exhibit 23.1 Alternative International
Trade Relationships

Exporter

Importer is ….

Unaffiliated Unaffiliated Affiliated

Unknown Party Known Party Party

A new customer A long-term customer A foreign subsidiary

which with exporter has with which there is an or affiliate
no historical business established relationship of of exporter
relationship trust and performance

Requires: Requires: Requires:

1. A contract 1. A contract 1. No contract
2. Protection against 2. Possibly some protection 2. No protection against
non-payment against non-payment non-payment 23-4
The Trade Dilemma

• International trade (i.e. between and importer and 
exporter) must work around a fundamental dilemma:
– They live far apart
– They speak different languages
– They operate in different political environments
– They have different religions
– They have different standards for honoring 
obligations
• In essence, there could be distrust, and clearly the 
importer and exporter would prefer two different 
arrangements for payment/goods transfer (next exhibit)
23-5
Exhibit 23.2 The Mechanics of Import and Export

1st: Exporter ships the goods

Importer Importer Preference Exporter

2nd: Importer pays after goods received

1st: Importer pays for goods

Importer Exporter Preference Exporter

2nd: Exporter ships the goods after being paid

23-6
The Trade Dilemma

• The fundamental dilemma of being unwilling 
to trust a stranger in a foreign land is solved by 
using a highly respected bank as an 
intermediary.
• The following exhibit is a simplified view 
involving a letter of credit (a bank’s promise to 
pay) on behalf of the importer.
• Two other significant documents are an order 
bill of lading and a sight draft.

23-7
 Exhibit 23.3 The Bank as the Import/Export Intermediary
1st: Importer obtains bank’s promise
to pay on importer’s behalf.
Importer
6th: Importer pays
the bank.

2nd: Bank promises exporter

to pay on behalf of importer.
Bank
5th: Bank ‘gives’ merchandise
to the importer. 4th: Bank pays the
exporter.

Exporter
3rd: Exporter ships ‘to the bank’
trusting bank’s promise. 23-8
Benefits of the System

• The system (including the three 
documents discussed) has been 
developed and modified over centuries to 
protect both importer and exporter from:
– The risk of noncompletion 
– Foreign exchange risk
– To provide a means of financing

23-9
Elements of an Import/Export
Transaction
• Each individual trade transaction must cover three 
basic elements: description of goods, prices, and 
documents regarding shipping and delivery 
instructions.
• Contracts:
– An import or export transaction is by definition a contractual 
exchange between parties in two countries that may have 
different legal systems, currencies, languages, religions or 
units of measure
– All contracts should include definitions and specifications for 
the quality, grade, quantity, and price of the goods in question

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Elements of an Import/Export
Transaction
• Prices:
– Price quotations can be a major source of 
confusion
– Price terms in the contract should conform 
to published catalogs, specify whether 
quantity discounts or early payment 
discounts are in effect, and state whether 
finance charges are relevant in the case of 
deferred payment, and should address other 
relevant fees or charges

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Elements of an Import/Export
Transaction
• Documents:
– Bill of lading – issued to the exporter by a common carrier 
transporting the merchandise
– Commercial invoice – issued by the exporter and contains a 
precise description of the merchandise (also indicates unit 
prices, financial terms of the sale etc.)
– Insurance documents – specified in the contract of sale and 
issued by insurance companies (or their agents)
– Consular invoices – issued in the exporting country by the 
consulate of the importing country
– Packing lists

23-12
International Trade Risks

• 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 non­completion (timely and complete 
payment).
• The risk of default on the part of the importer 
is present as soon as the financing period 
begins.
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 Exhibit 23.4 The Trade Transaction Time-Line
and Structure
Time and Events

Price Export Goods Documents Goods Cash

quote contract are are are settlement
request signed shipped accepted received of the
transaction

Negotiations Backlog

Documents Are
Presented

Financing Period 23-14

Letter of Credit (L/C)

• A letter of credit (L/C) is a bank’s conditional 
promise to pay issued by a bank at the request 
of an importer, in which the bank promises to 
pay an exporter upon presentation of 
documents specified in the L/C.
• An L/C reduces the risk of noncompletion 
because the bank agrees to pay against 
documents rather than actual merchandise.
• The following exhibit shows the relationship 
between the three parties.
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 Exhibit 23.5 Parties to a Letter of Credit (L/C)

Issuing Bank

The relationship between the

The relationship between the
importer and the issuing bank is
issuing bank and the exporter
governed by the terms of the
is governed by the terms of the
application and agreement
letter of credit, as issued by
for the letter of credit (L/C).
that bank.

Beneficiary Applicant
(exporter) (importer)

The relationship between the importer and the

exporter is governed by the sales contract. 23-16
 Letter of Credit (L/C)

• 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
23-17
Letter of Credit (L/C)

• 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.

23-18
 Exhibit 23.6 Essence of a Letter of Credit (L/C)

Bank of the East, Ltd.

[Name of Issuing Bank]
Date: September 18, 2003
L/C Number 123456
Bank of the East, Ltd. hereby issues this irrevocable documentary Letter of Credit
to Jones Company [name of exporter] for US$500,000, payable 90 days after sight
by a draft drawn against Bank of the East, Ltd., in accordance with Letter of
Credit number 123456.

The draft is to be accompanied by the following documents:

1. Commercial invoice in triplicate

2. Packing list
3. Clean on board order bill of lading
4. Insurance documents, paid for by buyer
At maturity Bank of the East, Ltd. will pay the face amount of the draft to
the
Authorized Signature
bearer of that draft.
23-19
Draft

• A draft, sometimes called a bill of exchange (B/E), is 
the instrument normally used in international 
commerce to effect payment.
• A draft is simply an order written by an exporter 
(seller) instructing and importer (buyer) or its agent to 
pay a specified amount of money at a specified time.
• The person or business initiating the draft is known as 
the maker, drawer, or originator.
• Normally this is the exporter who sells and ships the 
merchandise.
• The party to whom the draft is addressed is the drawee.
23-20
Draft

• If properly drawn, drafts can become negotiable instruments.
• As such, they provide a convenient instrument for financing the 
international movement of merchandise (freely bought and sold).
• To become a negotiable instrument, a draft must conform to the 
following four requirements:
– It must be in writing and signed by the maker or drawer
– It must contain an unconditional promise or order to pay a 
definite sum of money
– It must be payable on demand or at a fixed or determinable 
future date
– It must be payable to order or to bearer
• There are time drafts and sight drafts.

23-21
 Exhibit 23.7 Essence of a Time Draft

Name of Exporter
Date: October 10, 2003
Draft number 7890

Ninety (90) days after sight of this First of Exchange, pay to the order of Bank
of the West [name of exporter’s bank] the sum of Five-hundred thousand U.S.
dollars for value received under Bank of the East, Ltd. letter of credit
number 123456.

Signature of Exporter

23-22
Bill of Lading (B/L)

• The third key document for financing 
international trade is the bill of lading or B/L.
• The bill of lading is issued to the exporter by a 
common carrier transporting the merchandise.
• It serves three purposes: a receipt, a contract, 
and a document of title.
• Bills of lading are either straight or to order.

23-23
Documentation in a Typical
Trade Transaction
• 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.
• The following exhibit illustrates such a 
transaction.
23-24
 Exhibit 23.8 Steps in a Typical Trade Transaction
3. Importer
1. Importer orders goods
arranges L/C
with its bank

2. Exporter agrees to fill order

Exporter Importer
6. Exporter ships goods to Importer

7. Exporter presents 12. Bank I obtains

draft and documents importer’s note
11. Bank X 13. Importer
to its bank, Bank X and releases shipment
pays pays
exporter its bank

8. Bank X presents draft and

documents to Bank I

Bank X Bank I
9. Bank I accepts draft, promising to pay in 60
days, and returns accepted draft to Bank X
5. Bank X
4. Bank I sends
advises
L/C to Bank X Public
exporter
of L/C 10. Bank X sells Investor 14. Investor presents acceptance
acceptance to investor and is paid by Bank I 23-25
Government Programs
to Help Finance Exports
• Governments of most export­oriented industrialized countries 
have special financial institutions that provide some form of 
subsidized credit to their own national exporters.
• These export finance institutions offer terms that are better than 
those generally available from the competitive private sector.
• Thus domestic taxpayers are subsidizing lower financial costs for 
foreign buyers in order to create employment and maintain a 
technological edge.
• The most important institutions usually offer export credit 
insurance and a government­supported bank for export financing.

23-26
Export Credit Insurance in India

• Provided by  Export Credit & Guarantee 
Corporation of India (ECGC).
• ECGC provides a range of services to 
exporters against loss of goods.
• Offers guarantees to banks and financial 
institutions which are involved in export 
financing.
• Provided overseas investment insurance 
to Indian companies investing abroad.
23-27
EXIM Bank of India

• Exim Bank of India, provides financial assistance to promote 
Indian exports through:
2. Direct financial assistance, 
3. Overseas investment finance, 
4. Term finance for export production and export development, 
5. Pre­shipping credit, 
6. Buyer's credit, 
7. Lines of credit, 
8. Relending facility, 
9. Export bills redixcounting, 
10. Refinance to commercial banks. 
11. The Exim Bank also extends non­founded facility to Indian 
exporters in the form of guarantees. 

23-28
Setting Up EOUs

• The Government amended in November 1983 a 
concession scheme to facilitate the setting up 
of export­oriented units (EOUs) in order to 
enable them to meet requirements of foreign 
demand in terms of pricing, quality, precision 
etc. 
• EOUs can be set up anywhere in the country 
and may be engaged in the manufacture and 
production of software, floriculture, 
horticulture, agriculture, aquaculture, animal 
husbandry, pisciculture, poultry and sericulture 
or other similar activities. 

23-29
Marketing Finance from EXIM Bank

• Exim Bank seeks to create and enhance export 
capabilities and international competitiveness 
of Indian companies. 
• Under the lending programme for Export 
Marketing Finance, the Banks addresses the 
term finance reqirement for a structured and 
strategic export marketing and development 
effort of companies. 

23-30
Trade Financing Alternatives

• In order to finance international trade 
receivables, firms use the same financing 
instruments as they use for domestic trade 
receivables, plus a few specialized instruments 
that are only available for financing 
international trade.
• There are short­term financing instruments and 
longer­term instruments in addition to the use 
of various types of barter to substitute for these 
instruments.

23-31
Forfaiting

• Forfaiting is a specialized technique to eliminate the 
risk of nonpayment by importers in instances where the 
importing firm and/or its government is perceived by 
the exporter to be too risky for open account credit.
• The following exhibit illustrates a typical forfaiting 
transaction (involving five parties – importer, exporter, 
forfaiter, investor and the importers bank).
• The essence of forfaiting is the non­recourse sale by an 
exporter of bank­guaranteed promissory notes, bills of 
exchange, or similar documents received from an 
importer in another country.

23-32
 Exhibit 23.10 Typical Forfaiting Transaction

Exporter
Step 1 Importer
(private industrial firm) (private firm or government
purchaser in emerging market)

Step 2 Step 4

FORFAITER
(subsidiary of a Step 3
Step 5 European bank)

Step 6

Investor Importer’s Bank

(institutional or individual) Step 7 (usually a private bank in
the importer’s country

23-33
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.

23-34
International Trade Financing by
Commercial Banks in India.
•  Indian commercial banks offer Trade finance related fund needs 
for both pre shipment and post shipment activities. 
 
3. Various schemes to provide financing to exporters are as follows.
          
 Rupee Export Credit (Pre­Shipment and Post­Shipment) 
•  Pre­Shipment Export Credit 
•  Post­Shipment Export Credit 
•  Pre­Shipment Credit in Foreign Currency (PCFC) 
•  Getting Started ­ Opening a PCFC 
•  Operating PCFC 
•  Export Bill Rediscounting 
•  Letter of Credit 
4. Various schemes to provide financing to importers are as follows.
•  Foreign Currency import credit  
•  Supplier's credit  

23-35