This action might not be possible to undo. Are you sure you want to continue?
(Ministry of Tou rism, Go v ernmen t of In dia)
Prog ram: PGDM (I ntern ational Business ) IInd Se mester Ro ll No : 209400 1
I would like to express my gratitude to Faculty of Business Research this Methodology and (Mrs. Sareeta the vital Pradhan), information for and guiding and providing us with valuabl e feedback throughout project providing knowledge of this topic. Furthermore, I would also like to acknowledge my friends and relatives, with whom I have worked side-by-side during the entire process Finally, my sincere thanks goes to the entire respondent for sharing their valuable time and voicing their opinions and for scribing idea, without whose co -operation the research would have bee n impossible.
Place: Bhubaneswar Date: Signature
IMPORTANCE OF TRADE FINANCE
PRE-SHIPMENT TRADE FINANCE
POST-SHIPMENT TRADE FINANCE
FORFAITING AND FACTORING
DOMESTIC TRADE FINANCE
IMPORTANCE OF TRADE FINANCE
Trade Finance is a specific topic within the financial services industry. It‟s much different, for example, than commercial lending, mortgage lending or insurance. A product is sold and shipped overseas, therefore, it takes longer to get paid. Extra time and energy is required to male sure that buyers are reliable and creditworthy. In addition, foreign buyers are just like domestic buyers prefer to delay payment until they receive and resell the goods. Due diligence and careful financial management can mean the difference between profit and loss on each transaction. Trade Finance provide alternative solution that balance risk and payment. In this overview, we‟ll outline the two broad categories of trade finance: Pre-shipment Financing to produce or purchase the material and labor necessary to fulfill the sales order. Post-shipment Financing in order to generate immediate cash while offering payment to buyers.
GENERAL CONSIDERATION The following factors and considerations apply to financing in general: Financing can make the sale In some cases, favorable payment terms make a product more competitive. If the competition offers better terms and has a similar product, a sale can be lost. In other cases, the exporter may need financing to produce the goods or to other aspects of sale, such as promotion and selling cost, engineering modification, and shipping cost. Various financing source are available to
exporters, depending on the specifics of the transaction and the exporter‟s overall financing needs. Financing Costs The costs of borrowing, including interest rates, insurance and fees will vary. The total cost and its effects on the price of the product and profit from the transaction should be well understood before a pro-forma invoice is submitted to the buyer. Financing Terms Costs increase with the length of terms. Different methods of financing are available for short, medium, and long terms. Exporters need to be fully aware of financing limitations so that they secure the right solution with the most favorable terms for seller and buyer. Risk Management The greater the risk associated with the transaction, the grater the cost. The creditworthiness of the buyer directly affects the probability of payment to an exporter, but it is not the only factor of concern to potential lender. The political and economic stability of the buyer‟s country are also taken into consideration. Banks/Lenders are generally concerned with two questions: Can the exporter perform? They want to know that the exporter can produce and ship the product on time, and that the product will be accepted by the buyer. Can the buyer pay? They want to know that the buyer is reliable with the good credit history. They will evaluate any commercial or political risk.
If a lender is uncertain about the exporter‟s ability to perform, or if additional credit capacity is needed, government guarantee programs are available that may enable the lender to provide additional financing.
FEATURES OF TRADE FINANCE PRESPECTIVES Trade Finance generally refers to the financing of individual transaction or a series of revolving transactions. In addition, trade finance loans are often self liquidating that is the lending bank stipulates that all sales proceeds are to be collected, and then applied to payoff the loan. The remainder is credited to the exporter‟s account. The self-liquidating feature of trade finance is critical to many small, undercapitalized businesses. Lender who may otherwise have reached their lending limits for such businesses may nevertheless finance individual export sales, if the lenders are assured that the loan proceeds will be first be collected by them before the balance is passed on to the exporter. Given the extent of the control lenders can exercise over such transaction and existence of guaranteed payment mechanisms unique to or established for international trade, trade finance can be less risky for banks/lenders then general working capital loans. Working Capital Loans For exporters, working capital loan programs are normally associated with pre-shipment financing. Many small businesses need pre-export financing to cover the operating costs related to a sales order or contract. Loans proceeds are commonly used to finance three different areas: Labor: The people needed to built or but the export product. Material: The raw material needed to produce the export product. Inventory: The costs associated with buying the export product.
Term Financing for Foreign Buyers Frequently, foreign buyers don‟t have the cash on hand to pay for major purchase. So the buyers ask for extended credit terms and/or financing. Few exporters can manage the cash flow dilemma or commercial or political risk caused by these long term contracts. Exporting country‟s government institutions often back buyer credit programs. Under this program, the exporting country‟s financial institution lend credit to the foreign buyer in order allow the foreign importer to pay the exporter immediately. The payment is usually made directly to the exporter. This is an effective solution that benefits the exporter, their buyer and commercial lender providing the loans. The exporter benefit because they‟re paid cash on delivery and acceptance of the product or service. The foreign buyer benefit because they get extended credit terms at market rate or better. The lender benefits because guarantees, many backed by the respective governments, means fully repayment of loan and a reasonable return of funds lent. IMPORTER AND EXPORTER? Through the Pre-shipment and Post-shipment finance options offered to importers and exporters are fundamentally similar, their perspectives might be different. Export Trade Finance Exporters, using pre and/or post shipment finance, may improve their cash flow by utilizing trade finance to fund their purchase and/or manufacturing of goods pending receipt of payment form their buyer. An exporter is also able to offer advantageous credit terms to buyers as te repayment is usually made after the goods were sold.
Import Trade Finance Importers may use pre and post shipment finance to improve their cash flow. Post-shipment trade finance can allow time for goods to be sold prior to the payment being made. It also enables importers to offer payment at a sight basis to the supplier, rather than utilizing supplier terms(prices are often increase to cover supplier terms). This provides a importer with a negotiating advantage in realizing a potentially lower price. Pre-shipment trade finance enables an importer to pay for goods prior to shipment, when the method of payment agreed upon with the exporter is ‘Pre-payment by Clean Remittance’
PRE-SHIPMENT TRADE FINANCE
Pre-shipment finance is credit granted to the exporters by a financial institution. Pre-shipment credit is a part of working capital finance. The main objectives behind pre-shipment finance are: Procure raw materials. Carry out manufacturing process. Provide a secure warehouse for goods and raw material. Process and pack the goods. Ship the goods to the buyers. Meet other financial costs of the business.
TYPES OF PRE-SHIPMENT FINANCE Packing credit. Advance against receivables from government, like duty drawback etc. Advance against cheques/drafts etc., representing advance payment pre-shipment finance is extended in the following forms: Packing credit in Indian Rupee. Packing credit in Foreign Currency (PCFC).
REQUIREMENT FOR GETTING PACKING CREDIT This facility is provided to an exporter who satisfies the following criteria: Exporter should have a ten-digit importer-exporter code number allotted by DGFT. Exporter should not be in the caution list of RBI. If the goods to be exported are not under OGL (Open General License), the exporter should have the required license/quota permit to export the goods.
Packing credit facility can be provided to an exporter on production of following evidences to the bank: 1. Formal application for realizing the packing credit with undertaking to the effect that the exporter would ship the goods within stipulated due date and submit the relevant shipping document to the bank within prescribed time limit. 2. Firm order or irrevocable L/C or original Cable/Fax/Telex message exchange between the exporter and the buyer. 3. License issued by DGFT if the goods to be exported fall under the restricted or canalized category. If the item falls under quota system, proper quota allotment proof needs to be submitted. The confirmed order received from the overseas buyer should reveals the information about the full name and address of the overseas buyer, description, quantity and value of goods (FOB or CIF), destination and last date of payment. Eligibility Pre-shipment credit is granted to an exporter who has the export order or LC in his own name. the exporter is the person or the company who actually delivers the goods to the importers/buyers. However, as an exception, financial institution also grant credit to the third-party manufacturer or supplier of goods who does not have export orders or LCs in their name, but some of the responsibilities of meeting the export requirement have been out sourced to them, by the main exporter. In cases where the export order is divided between more than one exporter, pre-shipment credit can be shared between them. Quantum of Finance There is no fixed formula to determine the quantum of finance that is granted to an exporter against a specific order/LC or an expected order. The only guiding principle is the concept of Need-Based-Finance.
Banks determine the percentage of margin, depending on factor such as: The nature of order. The nature of the commodity. The capability of exporter to bring in the requisite contribution. DIFFERENT STAGES OF PRE-SHIPMENT FINANCE Appraisal and sanction of limits 1. Pre-shipment finance or packing credit is essentially a working capital advance made available for the specific purpose for procuring/processing/manufacturing of goods meant for export. All costs before shipment would be eligible for being financed under the packing credit. Packing credit advance should be liquidated from export proceeds only. While considering credit facilities for export activities, banks look specifically into the aspects of product profile, country profile and the commodity profile. The bank also look into the status report of the prospective buyer, with whom the exporter proposes to do business. In order to get the status report on foreign buyer, service of the institutions like ECGC or international consulting agencies like Dun and Brad Street etc may be utilized. The Bank extends the packing credit facilities after ensuring the following: The exporter is a regular customer, a bona-fide exporter and has a good standing in the market. The exporter has the necessary licenses and quota permits. Whether the country with which the exporter wants to deal is under the list of Restricted Cover Countries (RCC). Disbursement of Packing Credit Advance 2. After proper sanctioning of the limits, the bank ensures that the exporter has executed proper documents. On the basis of these documents, disbursements are normally allowed.
There are special types of export activities that may be seasonal in nature, in which the exporter may not be able to produce the export order at time of availing Packing Credit. In these cases, the bank may provide a special packing credit facility, known as Running Account Packing Credit. Before disbursing, the bank specifically checks for the following particulars in the submitted documents: a) Name of the Buyer. b) Commodity to be exported. c) Quantity. d) Value (either CIF or FOB). e) Last date of shipment/negotiation. f) Any other terms to be compiled with. The quantum of finance is fixed based on the FOB value of contract/LC or on the domestic value of goods, whichever is lower. Normally insurance and freight charges are considered at later stage, when the goods are ready to be shipped. Disbursals are made only in stages and preferably, not in cash. The payments are made directly to the suppliers by drafts/Banker‟s cheques. The period for which the packing credit is provided is decided by the bank depending upon the time required by the exporter for procuring and manufacturing/processing the goods. Normally the Packing Credit period should not exceed 180 days. The bank may provide a further 90 days extension on its own discretion, without referring to RBI. Follow-up of Packing Credit Advance 3. Exporter needs to submit stock statement reporting the stocks, which are under pledge or hypothecation to the bank for securing the Packing Credit Advance. The bank decides frequency of submission of the stock statements at the time of sanctioning the Packing Credit.
The authorized dealer (Banks) also physically inspect the stock at regular intervals. Liquidation of Packing Credit Advance 4. Packing Credit Advance will always be liquidated with export proceed of the relevant shipment. At this stage, the pre-shipment credit will be converted into post-shipment credit will be converted into post-shipment credit. Packing Credit Advance can also be liquidated with proceeds of payment receivable from Government of India. This payment includes the duty drawback, payment from the Market Development Fund (MDF) of the Central Government or from any other relevant source. For any reason, if the export does not take place at all, the entire advance is recovered at commercial interest rate plus a penal rate as decided by the bank. Overdue Packing 5. If the borrower fails to liquidate the packing credit on the due date/extended due date, the bank considered it an overdue. In case of overdue position persists, the bank takes steps to realize its dues as per usual recovery procedures. Nursing programme may be initiated, if found feasible. SPECIAL CASES Packing Credit to sub-supplier 1. Packing Credit may be shared between an Export Order Holder (EOH) and the manufacturer of goods on the basis of a disclaimer issued by EOH to the effect that he has not availed/is not availing credit facility against the portion of the order transferred in the name of the manufacturer. This disclaimer may preferably be countersigned by the banker of EOH. The banker of EOH may open an inland L/C specifying the goods to be supplied by the sub-supplier to the EOH as part of the export transaction. On the basis of such an L/C, the sub-supplier‟s bank may grant a packing
credit to the sub-supplier to manufacture the components required for exports. On supply of goods, the L/C opening bank will pay to the subsupplier‟s bank against the inland documents received on the basis of inland L/C opened by them. The EOH is finally responsible for exporting the goods as per export order and any delay in the process will subject him to penal provisions issued from time to time. The scheme is intended to cover only the first stage of production cycle, and is not to be extended to cover supplies of raw material etc. Running account facility is not granted to the sub-suppliers. In case the EOH is a trading house, the facility is available commencing from the manufacturer to whom the order has been passed by the trading house. Banks however, ensure that there is no double financing and the total period of packing credit does not exceed the actual cycle of production of the commodity. Running Account Facility 2. Banks have been authorized to grant pre-shipment advances for export of any commodity without insisting on prior lodgment of L/C or firm export order under „Running Account‟ facility. The bank may extend the facility provided the exporter has a good track record and the need for „Running Account‟ has been established by the exporter to the satisfaction of the bank. In case where this facility has been provided, the exporter should produce L/C or firm export order within a reasonable period of time. Banks mark off the individual export bill as and when they are received for negotiation/collection against the early outstanding pre-shipment credit, on a “First In First Out” (FIFO) basis. Pre-shipment Credit in Foreign Currency (PCFC) 3. with the objective of making credit available to the exporters at internationally competitive rates , Authorized dealers have been permitted to extend Pre-shipment Credit in Foreign Currency(PCFC) to exporters.
This is an additional window available to Indian exporters, along with the existing INR packing credit. Under this scheme credit is provided in foreign currency in order to facilitate the purchase of raw material, components etc. required to fulfill the export order. The procurement of raw material, components etc. may be made from the international market or from the domestic market. Packing Credit Facilities to Deemed Exports 4. Deemed exports made to multilateral funds aided projects and programmes, under order secured through global tender for which payment will be made in foreign exchange, are eligible for concessional rate of interest facility both at pre and post supply stages. Packing Credit Facilities for Consulting Services 5. In case of consultancy services, exports do not involve physical movement of goods out of Indian Custom Territory. In such cases, preshipment finance can be provided by the bank to allow the export to mobilize resource like technical personnel and training them. Advance Against Cheques/Drafts received as Advance Payment 6. Where exporters receive direct payments from abroad by means of Cheques/Drafts etc. the bank may grant export credit at concessional rate to the exporter of good track record, till the time of realization of the proceeds of the cheques or drafts etc. The banks, however, must satisfy themselves that the proceeds are against an export order.
POST-SHIPMENT TRADE FINANCE
Post-shipment finance is a loan, advance or any other credit provided by an institution to an exporter of goods from India. This finance is granted from the date of extending the credit after shipment of the goods to the realization date of the export proceeds. FEATURES The features of post-shipment finance are: Purpose of Finance Post-shipment Finance is meant to finance export sales receivables after the date of shipment of goods to the date of realization of exports proceeds. In case of deemed exports, it is extended to finance the receivables against supplies made to designated agencies. Basis of Finance Post-shipment finance is provided against evidence of shipment of goods or supplies made to the importer or any other designated agency. Form of Finance Post-shipment finance can be secured or unsecured, Since the finance is extended against evidence of export shipment and banks obtain the document of title of goods, the finance is normally self liquidating. In case that involve advances against undrawn balance, it is unsecured in nature. Further, the finance is mostly a funded advance. In few cases, such as financing of project exports, the issue of guarantees (retention money guarantees) is involved, the financing is non funded in nature.
Quantum of Finance Post-shipment finance can be extended upto 100% of the value of goods. However, where the domestic value of goods exceeds the value of the export order or the invoice value, finance for the price difference can also be extended if such a price difference is covered by receivables from the government. This form of finance is not extended at the pre-shipment stage. Banks can also finance undrawn balance. In such cases banks are free to stipulate margin requirements as per their usual lending norms. Period of Finance Post-shipment finance can be short term or long term, depending on the payment term offered by the exporter to the overseas buyer. In case of cash export, the maximum period allowed for realization of exports proceeds is six months from the date of shipment. Banks can extend post-shipment finance at lower rate up to normal transit period/notional due date, subject to maximum of 180 days. In case of deferred payment exports, requiring prior approval of the Authorized dealer, RBI or EXIM Bank, post-shipment finance can be extended at non-concessional rates up to the approved period. FINANCING FOR VARIOUS TYPES OF EXPORTS Post-shipment finance can be provided for three types of exports: Physical Exports In case of physical exports, post-shipment finance is provided to the actual exporter or to the exporter in whose name the trade documents are transferred. Deemed Exports In case of deemed exports, finance is forwarded to the supplier of the goods. These goods are supplied to the designated agencies.
Capital Goods and Project Exports In case of export of capital goods and project exports, finance is sometimes extended in the name of overseas buyer. The disbursal of money is directly made to the domestic (Indian) exporter. BUYER’S CREDIT As seen in the case of capital goods and project exports, credit is sometime extended directly to the foreign buyer. Buyer‟s Credit is a financial arrangement whereby a financial institution in the exporting country, or another country, extends a loan directly or indirectly to a foreign buyer to finance the purchase of goods and services from the exporting country. This arrangement enables the buyer to make payment due to the supplier under the contract. SUPPLIER’S CREDIT Finance extended by supplier to buyers in their own name is referred to as Supplier‟s Credit. Hence, Supplier‟s Credit is a financing agreement under which an exporter extends credit to the buyer in the importing country to finance the buyer‟s purchases. TYPES OF POST-SHIPMENT FINANCE The post-shipment finance can be classified as : 1. Export Bills purchased/discounted. 2. Export Bills negotiated. 3. Advance against export bills sent on collection basis. 4. Advance against export on consignment basis. 5. Advance against undrawn balance on exports. 6. Advance against receivables from Government of India. Export Bills Purchased/Discounted (DP & DA Bills) 1. Export bills (Non-L/C Bills) representing genuine international trade transactions, strictly drawn in terms of sale contract/live firm
contract/order may be discounted or purchased by the banks. Proper limit has to be sanctioned to the exporter for the purchase of export bill facility. If the export is not covered under L/C, risk of non-payment may arise. The risk is more pronounced in case of documents under acceptance. Export Bills Negotiated (Bills under L/C) 2. Letter of Credit is a secure mode of trade transaction, since the issuing bank guarantees payment, subject to the condition that the beneficiary meets the terms and condition of the L/C, hence the risk of payment is low. Also, if a reputed bank guarantees the payment by confirming the L/C, the risk is reduced further. Due to this inherent security provided by this mode, banks are often ready to extend finance against bill under L/C. However, it is to be noted that the bank still faces two major risk in this case. First is the risk of non performance by the exporter, wherein case the exporter is unable to meet his terms and conditions, the issuing bank would not honor the L/C. Secondly, the bank also faces the documentary risk, wherein if the issuing bank notices some discrepancy in the document supplied, it may refuse to honor the commitment. Hence it becomes extremely important for the negotiating bank, and the lending bank to thoroughly scrutinize the terms and conditions of the L/C and the document submitted by the beneficiary in support of the same. Advance Against Export Bills Sent on Collection Basis 3. At times, the exporter might have fully utilized his bills limit and in certain cases the bills drawn under L/C may have some discrepancies. In such cases, the bills will be sent on collection basis. In some cases, the exporter himself may request the bill to be sent on collection basis, anticipating the strengthening of foreign currency. Banks may allow advance against these collection bills to an exporter. Concessional rates of interest can be charged for this advance until the
transit period in case of DP Bills and transit period plus usance period in case of Usance Bills, depending upon the type of drawing. For computing the Eligible Transit Period, the period commences from the date of acceptance of the export documents at the bank‟s branch for collection and not from the date of advance. Advance Against Export on Consignment Basis 4. Goods are exported on consignment basis at the risk of the exporter. Eventual remittance of sale proceeds is made by agent/consignee. The overseas branch/correspondent of the bank is instructed to deliver the documents against trust receipt. Advances granted against export bills covering goods sent on consignment basis are liquidate from remittance of the sale proceeds within 6 months from the date of shipment, conforming to relevant RBI guidelines. In case of exports through approved Indian owned warehouses abroad, the time limit for realization is 15 months. Advance Against Undrawn Balance on Exports 5. In certain lines of export trade, it is common practice to leave a certain amount as undrawn balance. Adjustments are made by buyer for difference in weight, quality etc. ascertained after arrival and inspection of goods. Authorized Dealer (Banks) can handle such bills provided the undrawn balance is in conformity with the normal level of balance left undrawn in the particular line of export trade, subject to the maximum of 10% of the full export value. The export has to give an undertaking that he shall surrender or account for the balance of the proceeds within a period prescribed realization, such advance can be provided at concessional rate up to a maximum period of 90 days.
Advance Against Receivables from Government of India 6. where the domestic cost of production of goods is higher in relation to international price, the exporter may get support from the government so that he may compete effectively in the overseas market. Just as in the case of various foreign governments. The Government of India and other agencies provide support to exporter under the Export Promotion Scheme. This can be in the form of refund of Excise and Custom duty, known as Duty Drawback. Banks can grant advances to exporters against their entitlement under this category at lower rate of interest at maximum period of 90 days. These advances being in the nature of unsecured advances cannot be granted in isolation. These are granted only if other types of export finance are also extended to the exporter by the same bank. After the shipment, the exporter lodge their claims, supported by relevant documents to the relevant government authorities. These claims are processed and eligible amount is disbursed. These advance are liquidated out of the settlement of claims lodged by the exporters. It has to be ensured that the bank is authorized to receive the claim amount directly from the concerned government authorities. CRYSTALLIZATION OF OVERDUE EXPORT BILLS If the export bill purchased /negotiated/discounted is not realized on due date (in case of Demand Bills within Normal Transit Period and in case of Usance Bills on notional due date), exporter‟s foreign exchange liability is converted into Rupee liability on the 30th day after the expiry of NTP in case of DA bills, at prevailing TT selling rate ruling on the day of crystallization, or the original bill buying rate, whichever is higher. However, if the exporter want to crystallize the overdue export bills earlier he apply in writing to the AD even before the 30th day after the notional due date. If the crystallized export bill realizes subsequently, conversion of foreign exchange will be made at the market rate prevailing
on the day of the payment. In this case, the exchange profit/loss is borne by the exporter. EXPORT BILLS ARE RE-DISCOUNTED FACILITY (EBRD) This is an additional window available to exporters, along with the existing financing scheme at post-shipment stage. The facility is available in all convertible currencies. The scheme covers export bills up to 180 days from the date of shipment (inclusive of normal transit period and grace period, if any applicable). Under the scheme of Ads rediscount the export bills in overseas market by arranging with an overseas agency/bank by way of line of credit or banker‟s acceptance facility or any other similar facility at rates linked to 6 month LIBOR rates. Spread between borrowing and lending is left to the discretion of the bank concerned. Ultimately, the cost to the exporter should not exceed 0.75% above 6 month LIBOR/EURILIBOR/EURIBOR, excluding withholding tax. In case of re-discounting of export bills on without – recourse basis, the credit limits of the exporter are restored immediately. ADs have been permitted to utilize the on-shore foreign exchange funds available with them by way of balances in Exchange Earner‟s Foreign Currency account (EEFC), Resident Foreign Currency Account and Foreign Currency (nonresident) account schemes. Exporters can also directly arrange for rediscounting facilities abroad without prior permission from the RBI, subject to compliance of guidelines prescribed by the Reserve Bank. OPTIONS FOR THE EXPORTER Having gone through the detail of various pre-shipment and postshipment Trade Finance options, we see that the exporter has the following financing options: 1. Pre-shipment credit and post-shipment credit in rupees. 2. Pre-shipment in Rupees and post-shipment under export bill rediscounting in foreign currency, EBRD.
3. Pre-shipment in Foreign Currency (PCFC) and post-shipment under export bill re-discounting in foreign currency, under EBRD. An exporter may avail any facility in a denominated foreign currency, depending on the premium/discount factor of the currency in which he has got exposure. For example, if the exporter has got an exposure in Euro and this currency is at a premium, the exporter may not want to avail any facility in foreign currency. Instead, the exporter may prefer to avail a Rupee loan and try to earn the premium factor of the foreign currency.
FORFAITING AND FACTORING
BRIEF HISTORY Factoring has a long and rich tradition, dating back 4,000 years to the days of Hammurabi. Hammurabi was the king of Mesopotamia, which gets credit as the “cradle of civilization”. In addition to many other things, the Mesopotamians first developed writing, put structure into business codes and government regulation and came up with the concept of factoring. The first widespread, documented use of factoring occurred in the American colonies before the revolution. During this time, cottons, furs and timber were shipped from the colonies. Merchant bankers in London and other parts of Europe advanced fund to the colonist for these raw materials, before they reached the continent. This enabled the colonist to continue to harvest their new land, free from the burden of waiting to be paid by their European customer. These were not banking relationships, as they exist today. If the colonist had been forced to use modern banking services in eighteenth century England, the process would have been much slower. The bank would have waited to collect from the European buyers of the raw material before paying the seller of these goods. This was not practical for anyone involved. So, just as today, the “factors” of colonial times made advances against the accounts receivable of clients. With the advent of Industrial Revolution, factoring become more focused on the issue of credit, although the basic premise remained the same. By assisting clients in determining the creditworthiness of their customers and setting credit limits, factors could actually guarantee payment for approved customer. This is known as factoring without recourse (or nonrecourse factoring) and is quite common in business today. Today, factors exist in all shapes and sizes as division of large financial institution or, in large numbers, as individually owned and operated entrepreneurial endeavors.
Forfaiting and Factoring Forfaiting and factoring are similar services that serve to provide better cash flows and risk mitigation to the seller. It may be mentioned that factoring is for short term receivables (under 90 days) and is more related to receivables against commodity sales. Forfaiting can be for receivables against which payments are due over a longer term, over 90 days and even up to 5 years. The difference in the risk profiles of receivables is the fundamental difference between factoring and forfaiting, which has implications for the cost of services. Both factoring and forfaiting are like bill discounting, but the bill discounting is more domestic-related and usually falls within the working capital limit set by the bank for the customer. FORFAITING Forfaiting is a mechanism of financing exports: By discounting export receivables. Evidence by bills of exchange or promissory notes. Without recourse to the seller (such as exporter). Carrying medium to long term maturities. On a fixed rate basis (discount). Up to 100% of the contract value. In a forfaiting transaction, the exporter surrenders his rights to claim for payment on goods delivered to an importer, in return for immediate cash payment from a forfaiter. As a result, an exporter can convert a credit sale into cash sale, with no recourse either to him or his banker. FORFAITING – OPERATING PROCEDURE 1. Exporter initiates negotiations with prospective overseas buyer, finalizes the contract and open an L/C through this bank. 2. Exporter ships the goods as per the schedule agreed with the buyer.
3. The exporter draws a series of bills of exchange and send them along with the shipping documents, to his banker for presentation to importer for acceptance through latter‟s bank. Bank returns avalised and accepted bills of exchange to his client (the exporter). 4. Exporter informs the Importers bank about assignment of proceeds of transaction to the forfaiting bank. 5. Exporter endorses avalised Bill of Exchange (BOE) with a word “without re-course” and forwards them to the Forfaiting Agency (FA) through his bank. 6. The FA effects payments of discounted value after verifying the Aval‟s signature and other particulars. 7. Exporter‟s bank credits Exporter‟s A/C. 8. On maturity of BOE/Promissory notes, the Forfaiting Agency presents the instruments to the Aval (Importer‟s Bank) for payment. DOCUMENTARY REQUIREMENT In case of Indian exporters availing Forfaiting facility, the forfaiting transaction is to be reflected in the following three documents associated with an export transaction, in the manner suggested below: Invoice: Forfaiting discount, commitment fees, etc. need to be shown separately, instead, these could be built into the FOB price, stated on the invoice. Shipping Bill and GR form: Details of the forfaiting costs are to be included along with the other details, such as FOB price, commission insurance, normally included in the “Analysis of Export Value” on the Shipping Bill. The claim for duty drawback if any is to be certified only with reference to the FOB value of the export stated on the shipping bill.
BENEFIT TO EXPORTER 100% Financing – Without recourse and not occupying exporter‟s credit line. That is to say once the exporter obtains the financed fund, he will be except from the responsibility to repay the debt. Improved Cash Flow – Receivables become current cash inflow and it is beneficial to the exporter to improve financial status and liquidation ability so as to heighten further the fund raising capabilities. Reduced Administration Cost – By using forfaiting, the exporter will spare from the management of the receivables. The relative costs, as a results are reduced greatly. Advanced Tax Refund – Through Forfaiting, the exporter can make the verification of export and get tax refund in advance just after financing . Risk Reduction – Forfaiting business enables the exporters to transfer various risks resulted from deferred payment, such as interest-rate risk, currency risk, credit risk and political risk to the forfaiting bank. Increased Trade Opportunity – With forfaiting, the export is able to grant credit to his buyer freely, and thus, be more competitive in the market. FEE TYPE DESCRIPTION COMMITMENT FEE This is payable to the forfaiter for his commitment to execute a specific forfaiting transaction at a firm discount rate within a specified time. It ranges between 0.5% to 1.5% per annum of the unutilized amount to be forfaited and is charged for the period between the date the discounting takes place or until the validity of the forfait contract, whichever is earlier.
DISCOUNT FEE This is the interest cost payable by the exporter for the entire period of credit involved and is deducted by the forfaiter from the amount paid to the exporter against the availed promissory notes or bills of exchange. BENEFIT TO BANK Forfaiting services provide the bank with the following benefits: Banks can provide an innovative product range to clients, enabling the client to avail 100% finance, as against 80-85% in case of other discounting products. Banks gain fee-based income. Lower credit administration and credit follow up. FACTORING Factoring is a continuing arrangement between a financial institution (the Factor) and a business concern (the Client), selling goods or services to trade customers. The Factor purchases the client‟s book debt (account receivables) either with or without recourse to the client. The purchase of book debts or receivables is central to the functioning of factoring. The supplier submits invoices arising from contracts of sale of goods to the factor. The Factor performs at least two of the following services: Financing for the seller, by way of advance payments. Maintenance of accounts relating to the account receivables. Collection of account receivables. Credit protection against default in payment by the buyer.
The buyer is informed in writing that all payment of receivables should be made to the Factor.
DIFFERENT MODELS OF FACTORING Export Factoring can be done based on two distinct models: 1. Two-Factor System. 2. Direct Factoring. 1. A TWO-FACTOR SYSTEM It essentially involves an export factor in the country of the seller (exporter) and its correspondent factor (import factor) in the country of the debtor (importer). The correspondent factor typically performs a mutually agreed set of services for the export factor. It could be any one or both the below mentioned services: A. Credit Guarantee Protection: The import factor undertakes to pay the export factor in the event the importer fails to pay by a specified period after due date. The import factor sets up limits on buyers present in that country and the export factor discounts invoices for its customers based on these limits. The credit guarantee protection cover insolvency/protracted default of buyer, However it does not cover trade disputes. B. Collection Services: The import factor undertakes to follow up with debtors for payment and in cases where payment is not forthcoming they would be in a position to detect early indications as they would be based in the same location and would be familiar with local business intelligence as well as practices. The factoring quotes given by various import factors would differ depending on their location and comfort regarding the overseas buyer. In this situation, the export factor would need to monitor its correspondent relation with various import factors across the globe. Also the possibility of undertaking any factoring business by the export factor would be depend on the response of the import factors for each transaction.
2. DIRECT FACTORING Factoring can also be offered by availing credit insurance for the entire factoring portfolio. Credit insurance will cover insolvency/protracted default by the buyer as well as country risk but it would not cover trade disputes. The credit insurer will set up limits on overseas buyers and based on these limits export bills would be discounted. Thereafter, detail of the invoice would be passed on to the collection agency that will follow up for payment with the overseas buyer. In case the overseas buyer does not respond, the collection agent can monitor potential default cases, so that credit insurer can be informed in advance. Using services of a collection agency could reduce significantly the delays and to some extent the uncertainty in payments from overseas buyers. BENEFITS OF FACTORING Turnover Linked Finance – So as an exporter, you can finance a higher level of sales than before and plan growth more effectively. Flexible Cash Flow – To finance working capital requirements and improve profitability. No Collateral/Security – So availing the financing is comparatively easier. More Time for Core Business – Since sales ledger management and collections are handled by the factor. Credit Protection – Reduces the incidence of bad-debts. Pre-assessments beforehand. Regular MIS Report – MIS reports from Factors reduce the time spend on reconciliation of outstanding. FACTORING: OPERATING PROCEDURE For the factoring operation, the pre-requisite is the establishment of a factoring relationship between the client and the factor. On the basis of credit evaluation, the factor fixes limits for individual customers of the – So buyers‟ creditworthiness is checked
client indicating the extent to which, and the period for which the Factor is prepared to accept the client‟s receivables for such customers. 1. The client (seller) sells the goods to the customer (buyer) and invoices him in the usual way inscribing a notification to the effect that the debt due on the invoice is assigned to and must be paid to the Factor. 2. The client offers the assigned invoices to the Factor under cover of a schedule of offer accompanied by copies of invoices and receipted delivery challans. 3. The Factor provides immediate prepayment up to 80% of the value of the assigned invoices and notifies the customer sending a statement of account. 4. Factor follows up with the customer and sends him the statement. 5. The customer makes the payment to the Factor. 6. When the customer makes the payment for the invoice, the Factor will pay the balance 20% of the invoice value. The prominent features of the arrangement are: 1. The drawings in the client‟s account will be regulated on the basis of the drawing eligibility available from time to time, against the debt so purchased by the Factor, less the amount of retention money. 2. The client will be free to draw funds at any time up to the drawing eligibility, which will be adjusted for: New debts factored, Factored debts collected, charges debited. 3. The Factor will send age-wise statements of accounts to the client at the agreed periodicity. FEE TYPE DESCRIPTION FINANCE CHARGE Finance charge is computed on the pre-payment outstanding in export‟s account at monthly intervals.
SERVICE FEE Service charge is a nominal charge levied at monthly intervals to cover the cost of services, For example collection, sales ledger management and periodical MIS reports. It ranges from 0.1% to 0.3% on the total value of invoices factored/collected by the bank.
Guarantees are given by bank on behalf of its customer regarding specific performance/obligation by the customer to the other party. The guarantees ensure payment to the party the bank‟s customer is doing business. Under a bank guarantee/surety bond arrangement, the bank acts as guarantor of a claim or obligation in lieu of the debtor. The bank cannot be held liable in the event that the debtor fails to “perform”. The banks obligation is limited to its pledge to pay a maximum specified amount on fulfillment of the term of commitment. A bank guarantee/surety bond may only be issued if the customer has been granted a line of credit. In certain cases, the bank may require adequate collateral. One may note that even though in both Letter of Credit and Bank Guarantee ensure that the issuing bank guarantees payment, the difference lies in that fact that while L/C is a „positive action‟ instrument, BG is a non-performance instrument. Hence, payment is released under L/C as and when all the terms of the underlying trade transaction are met. On the other hand, payment is released under BG if and when the term of underlying transactions are not compiled with. TYPES OF BANK GUARANTEES In principle, there are two types of guarantee: 1. Direct Guarantee A Direct Guarantee occurs when the client instructs the bank to issue a guarantee directly in favor of the beneficiary. 2. Indirect Guarantee Within an Indirect Guarantee, a second bank is involved. The second bank usually a foreign bank with a head office in the beneficiary‟s country of domicile, is requested by the initiating bank to issue a guarantee in return for the latter‟s country-liability and counter-guarantee.
In this case, the initiating bank will cover the guaranteeing (foreign) bank against the risk of any losses that it may incur in the event that a claim is made under the guarantee. It formally pledges to pay the amount claimed under the guarantee upon first demand by the guaranteeing bank. Depending on the purpose of the Guarantee, the Bank Guarantees may be classified as under: 1. Tender Bond This type of bank guarantee is also known as bid bond. The purpose of a tender bond is to prevent a company from submitting a tender, winning the contract and then declining to accept it on the grounds that the deal is no longer lucrative. Tender bonds offer buyers security against dubious or unqualified bids. They are often mandatory for public invitations to tender. 2. Performance Bond This is also known as performance guarantee. A performance bond/guarantee provides security for any costs that may be incurred by the bond beneficiary and/or on non-performance with of a the contractually agreed service non-compliance
contractual deadline. 3. Credit Guarantee Borrowers are often required to provide collateral for a credit line or a loan. A third party may also provide collateral. A bank guarantee is one of the options creditors have to ensure that a loan will be repaid.(On the condition that the lending and guaranteeing banks are not identical.) 4. Payment Guarantee A payment guarantee, or payment default guarantee, provides security against default for the goods to be delivered, for example. If the debtor fails to make payment when due, and beneficiary has fulfilled his or her contractual obligations , e.g. goods have been
delivered and/or services have been provided in accordance with the contract, a written declaration to this effect is generally sufficient to redeem payment from the guaranteeing bank. This instrument can be used instead of a Letter of Credit if, for example, the buyer does not require or demand proof of delivery by means of the usual original delivery documents. 5. Confirmed Payment Order This is an irrevocable obligation on the part of the bank to pay a specified sum at a specified time to the beneficiary (creditor) on behalf of the customer. 6. Advance Payment Guarantee The advance payment guarantee is intended to bind the supplier to use the advance payment for the purpose stated in the contract between the buyer and the supplier. An advance payment provides the supplier with funds to purchase equipment or components. In general, the advance payment guarantee should contain a reduction clause that automatically reduces the amount in proportion to the value of the (partial) delivery(ies). The advance payment guarantee should only become effective once the advance payment has been received. 7. B/L Letter of Indemnity This is also called a Letter of Indemnity. Individual bill of lading or the full set can go missing or be held up in the mail. Carriers may be liable for damages if they deliver the consignment before receiving the original bill of lading. A bank guarantee in the carrier‟s favor for 100-200% of the value of the goods enables them to delivers the goods to the consignee without presentation of the original documents. 8. Rental Guarantee This a guarantee of payment under a rental contract. The guarantee is either limited to rental payments only, or includes all payments
due under the rental contract. (e.g. including cost of repairs on termination of the rental contract). 9. Credit Card Guarantee In a certain circumstances, credit card companies will not issue a high value credit card without a bank guarantee. Such kind of guarantee extended by a bank is known as a Credit Card Guarantee. CLAIM (GUARANTEE UTILIZATION) If the beneficiary under the guarantee considers that the supplier has violated the supplier‟s contractual obligation, the former may utilize the guarantee. Claims must be made during the period of validity and strictly in accordance with the guarantee conditions. GENERAL GUIDELINES The RBI has issued some general guidelines for bankers to follow while doing the guarantee business. The Authorized Dealer/EXIM Bank have been authorize to furnish (without prior permission of Reserve Bank), bid bonds/tender guarantees and advance payment/performance guarantees in cases where the RBI has been authorized to approve proposals of exporters. As per the recent guidelines, the Authorized Dealers/EXIM Bank/Working Group may consider and approve project export proposal/service contracts abroad. These may involve all types of guarantees to be furnished in connection with execution of projects/contract abroad. In order to get the latest updates on these guidelines, one should refer to relevant circulars of RBI, available at RBI‟s website: While issuing guarantees on behalf of customers, the following safeguards are observed: In the case of Financial Guarantees, banks should ensure that the customer would be in a position to reimburse the amount in case the bank is required to make the payment under the guarantee.
In the case of Performance Guarantees, banks should exercise due caution and should know the customer sufficiently well, to satisfy themselves that he has the necessary experience, capacity and means to perform the obligations under the contract and is not likely to commit any default.
Banks should normally refrain from issuing guarantees on behalf of customers who do not enjoy credit facilities with them. Banks should ideally guarantee shorter maturities, and leave longer maturities to be guaranteed by other institutions. A Bank Guarantee should ideally not have tenure for more than 10 years.
A Bank should ensure that 20% of its outstanding unsecured guarantees plus the total of its unsecured outstanding unsecured advances should not exceed 15% of its total outstanding advances.
DOMESTIC TRADE FINANCE
Fundamentally, the trade finance business is the domestic arena is similar to the trade finance business on an international level. However, since no multi-currency or cross country transactions occurs, hence the regulatory framework is much simpler. The goods do not require customs clearance and the remittance do not need to be reported to the Forex regulatory bodies. Naturally, export/import licenses are not required and export quota restrictions do not limit growth. Also, since both the buyer and the seller operates within the same legal and administrative framework, and are often known to each other, the level of mutual confidence is higher. Modes of transactions in domestic trade within national boundaries are basically similar to the modes of transaction in International Trade. These include: Clean payments. Open A/C transactions. Advance payments. Documentary collections. Delivery against payment. Delivery against acceptance. Documentary credit. It is natural that due to higher degree of confidence enjoyed by the buyers and sellers within the same regulatory and administrative boundaries, the easier to carry out and less documentation intensive trade option like clean payments and documentary collections are used more often. Most of the Trade Finance options available in International Trade are also available in domestic trade. However, some financing options that are specifically more relevant in domestic trade.
CHANNEL FINANCING Through channel financing, Dealers are able to leverage their relationship with reputed companies in sourcing low cost funds with support from their counterparts. Channel Financing is a product that extends working capital finance to dealer having business relationships with large companies in India. This may be in the form of either cash credit facilities or as a bill discounting line of credit. Under this, the bank can extend: Discounting of trade bills drawn by the reputed supplier and accepted by the dealer/distributor. Limited overdraft facility to the dealer/distributor for his business dealing with large corporate. By providing short term lending to clients utilizing qualified receivables and improved control of the sales/distribution channels. In addition, payables discounting serves to add value by improving supplier relationships and enhancing cash-flow management. VENDOR FINANCING Vendors can leverage their relationship with reputed companies by sourcing low cost bill discounting line of credit. Vendor Financing is a product to extend working capital finance to vendors having business relationships with large corporate in India. Herein the bank undertakes to discount bills drawn by the supplier/vendor and accepted by the corporate.
CHALLENGES BEFORE TRADE FINANCE SERVICE PROVIDERS
Traditional standardized trade finance products are outdated and belong to a bygone era. Traditionally, Trade Finance services have been suited to meet the needs of the industrial age, wherein disparate parties engaged in trade of goods. The competitive advantage and profitability of the company was determined by its strength relative to the strength of the next member of the supply chain. The trade was transaction specific and each deal could be looked at and dealt with independently. In the information age, it is not the companies that compete with each other rather it‟s the “Networks” that compete with each other networks. In this context, a “Networks” can be loosely described as the summation of the entire supply chain, commencing from raw material procurement, through various stage of value addition, and finally to the end user. In knowledge industries, a network can be defined as the summation of organizations that create, process and distribute information to serve a particular purpose. In such a scenario, the survival/growth of each member in the networks depends on the strength of the network as a whole and vice-versa. As a result, the relationship between various member of the supply chain changes from a „Buyer-Seller‟ relationship to that of a „partner-in-growth‟ relationship. It is to be noted that an organization can be a member of more than one, sometimes rival „networks‟. However, a combination of all the member of the network would make a unique supply chain structure, usually dominated by one dominant member that competes with other networks. Such „networks‟ are already becoming dominant in the International market. E.g. Dell Computers, Microsoft, Oracle, Ford Motor Company, GM, Toyota, GE, Boeing, Wal-Mart etc. are all examples wherein all the members of the network operates in tandem with each other through
careful information processing and Supply Chain Management by sharing critical data on a continuous basis. Domestic and International trade has experienced dramatic changes due to the introduction of supply chain management techniques that have reduced the dollar size of individual shipments. In 2001, the average value of an international shipment was 42% of what it was in the 1970s. Managing the supply chain carefully reduces inventory and brings companies close to just-in-time production. This change has had a tremendous impact on the trade finance business, because traditional trade finance solutions such as letters of credit are far less relevant to this new reality of international trade business. THE WAY AHEAD The challenge before the banks is to provide solution that are „network‟ specific and not just transaction specific. Just putting an “e” before a “LC” (Letter of Credit) won‟t make the e-LC a killer app. Moving traditional Trade Finance tools to the internet is not the answer. New age trade finance solutions should strive to achieve 2 goals: 1. Move from a transaction focus solution to network management solution. 2. Customize and package solutions that are relevant to a particular customer. Most banks operating in the trade finance business have moved their trade features online, for reason of efficiency and cost reduction, either via proprietary solutions or by outsourcing the operation to another institution. Even if this move has created efficiencies, reduced costs, and fulfilled clients‟ needs, it has failed to address the issue of today‟s trade finance business. This step is very similar to integrating third-party solutions, which cannot alone completely address customer needs. The real added value to customer in the trade business today stems from the merger of trade finance with supply chain and cash management, and
packaging and providing the information on real-time basis to the customer in an easily accessible manner. As Businesses move towards operating in a more integrated manner across political boundaries, so would their supporting financial structures. This would require banks to provide for internationally integrated financial solutions, like Global cash management solutions and integrated multinational treasury solutions. The underlying principal towards all future growth would be integration – integration of markets leading to integration of services, further leading to integration of processes and databases.
www.eximbankindia.com www.eximin.net www.investopedia.com www.fieo.org www.iibf.org.in www.rbi.org.in www.cio.com/enterprise/scm
BOOKS PRACTITIONERS‟ BOOK ON TRADE FINANCE By IIBF INTERNATIONAL TREASURY MANAGEMENT By IIBF
This action might not be possible to undo. Are you sure you want to continue?
We've moved you to where you read on your other device.
Get the full title to continue reading from where you left off, or restart the preview.