FIN 6002 – Session 28

Pradeepta Sethi
TAPMI
 Trade Finance

¢ Trade – Purchase of merchandise from a seller by a purchaser for

his onward selling for a profit.
¢ Trade is mostly working capital intensive.
¢ Trade finance usually indicates finance against an international
trade transaction involving either import/export of goods from/to a
foreign country.
¢ Trade finance involves financing of individual transactions or a
series of revolving transactions which are often self-liquidating in
nature.
¢ Trade finance – Export trade finance & Import trade finance
 Correspondent Banking

• Relationship between two banks which have mutual accounts with

each other.
• In a larger sense, this means a relationship and servicing of banking
needs, as agents, without having accounts also.
• A bank is able to handle business in another city or country through
their local banks.
• The local banks act as agent of the former and charge fees for the
services rendered.
• Eliminates the need to have a global network of branches which
involves high cost.
• It is also not possible for all banks to obtain permission for opening
branches.
• Correspondent banking system allows banks to take advantage of
business opportunities on other countries without a branch network of
its own.
 Bank Accounts
• Nostro account – “Our account with you”

• For example, SBI, Mumbai maintaining a USD account with CITI Bank,
New York

• This is Nostro accounts in the books of SBI.

• Vostro account – “Your account with us”

• HSBC, New York maintaining a Rupee account with SBI, Mumbai

• This is Vostro accounts in the books of SBI.

• Loro account – “Their account with them”

• CITI Bank referring to the Rupee account of HSBC Bank with SBI,
Mumbai

• Third Party Account

 Letters of Credit (LC)
• Facilitates trade : Domestic and International.
• Helps in reducing Fund Based Working Capital (FBWC)
requirement for buyer - Documentary Credit.
• Helps seller to get immediate payment though credit is
extended by him.
• Bank intermediate lends its creditworthiness for which it charges
the applicant.
• Transactions are guided by UCPDC (Uniform Customs &
Practices for Documentary Credit).
• Documentary Credit is an undertaking issued by a bank (the
issuing bank), on behalf of the buyer (the applicant), to the
seller (the beneficiary) to pay for goods and services provided
that the seller presents documents which comply with the terms
and conditions of the Documentary Credit.
• Documentary Credits (LCs) are subject to the terms and
conditions of UCPDC, ICC Publication No. 600 (2007).
Parties in an LC transaction

• Applicant (Buyer – Importer)

• Issuing Bank (LC Opening Bank)
• Advising Bank
• Confirming Bank
• Beneficiary (Seller – Exporter)
• Negotiating Bank (Paying Bank)
• Reimbursing Bank
• Second Beneficiary
• Communications happen through SWIFT –
Society for Worldwide Interbank Financial
Telecommunications
 Parties in an LC transaction

¢ Issuing Bank (opening bank)

l The prime obligator - Ensure credit-worthiness and trust-worthiness of the applicant.
l Once credit is opened, the bank is placing itself as a substitute for the buyer.

¢ Advising Bank
l The advising bank is an agent bank of the issuing bank in the country of the exporter.
l It advises the LC beneficiary that there is an LC issued in his favour.

l Has the obligation to authenticate the credit once it is received and passing it promptly
on to the beneficiary.

¢ Confirming Bank
l A confirming bank is usually the advising bank.
l Adds its own undertaking to pay the LC beneficiary if all terms and conditions of the
credit are complied with.
l takes over the responsibilities of the issuing bank as far as the beneficiary is concerned.
 Parties in an LC transaction

¢ Nominated Bank
l is a bank authorized by the Issuing bank in the credit to pay, negotiate, issue
a deferred payment undertaking or accept drafts under the LC.
l The role of negotiating bank may be played by an issuing bank, an advising
bank or another bank depending on the terms of the LC.
¢ Negotiating Bank
l examines the drafts and/or documents presented by the LC beneficiary and
gives values to such drafts and/or documents.
l The role of negotiating bank may be played by an issuing bank, an advising
bank or another bank depending on the terms of the LC.
¢ Reimbursing Bank
l is the paying agent appointed by the Issuing Bank to honour claims submitted
by the nominated or negotiating bank.
 Mechanics of Documentary Credit

CONTRACT

GOODS GOODS
SHIPPING
IMPORTER EXPORTER
DOCS COMPANY DOCS

OPEN CREDIT

OPENING DOCUMENTS
BANK DOCUMENTS ADVISING/
NEGOTIATING
PAYMENT BANK PAYMENT
 Negotiating Bank
CONTRACT

IMPORTER EXPORTER
D
O P
C A
OPENING ISSUE CREDIT ADVISING
S Y
BANK BANK
DOCUMENTS NEGOTIATING
BANK
PAYMENT
Negotiating bank pays beneficiary first and claims
reimbursement from the opening / confirming bank.
 Stages of LC transaction

¢ Seller & buyer enter into a sales contract in which they agree that payment
shall be made by a LC.

¢ The buyer applies to a bank at his place of business (issuing bank) for opening
LC in favor of the seller (Beneficiary)

¢ The issuing bank may invite another bank into the transaction preferably with a
presence in the country of seller.

¢ The second bank (correspondent bank) may act as an advising bank, if it

merely informs the seller of the LC without any obligation on its part. It may also
act as a confirming bank, if it confirms the LC issued by the issuing bank and
thus undertakes the primary obligation to effect the payment to beneficiary. It
may also be a nominated bank, if the LC calls for negotiation.
 Stages of LC transaction
¢ As soon as the seller receives the LC, he is in a position to effect shipment.
¢ The seller then presents the documents stipulated under the credit to the
corresponding bank, which is authorized to take up the document. If the
documents meet the terms and conditions of the credit, the corresponding bank
makes payment to the seller as per the credit terms and conditions.
¢ Correspondent bank then sends document to the issuing bank which examines
the document and if the documents are in order it reimburse the correspondent
bank that has effected the payment to the seller.
¢ Issuing bank sends the document to the buyer and obtains reimbursement in the
manner agreed upon when he opened the LC.
¢ On receiving the document, the buyer is in position to take over the goods.
¢ Communication is through SWIFT (Society for Worldwide Interbank Financial
Telecommunication)
¢ SWIFT messages are preset and categorized in specific MT(message transfer),
e.g. MT300’s only deal with foreign currency exchanges.
 Types of LC

¢ With / without backing of documents:

l Clean LC – No document backing - draft, issued to customers who are
high credit worthy,

l Documentary LC – with documents

¢ Security wise:
l Revocable LC – withdrawn since UCPDC 600

l Irrevocable LC – Neither be amended nor cancelled without an

express agreement of all the parties involved

l Confirmed LC – is guaranteed by adding payment confirmation by the

confirming bank
 Types of LC

¢ Payment wise:
l Sight LC – Payment at sight, beneficiary gets immediate payment upon
presentation of proper documents as per the LC. The verification of documents
by banks should not exceed seven banking days following the day of receipt of
documents.
l Acceptance (Usance) LC – If the beneficiary grant a period of credit to the
importer after sight e.g. 90 days from the date of invoice or the date of
shipment.

¢ With advance payment:

l Red Clause LC – The issuing bank authorizes the advising bank to advance a
part of the LC amount to the seller to meet pre-shipment expenses. The credit
risk is borne by the applicant.
l Green Clause LC – Extension of red clause, the applicant also provides
storage facility at the port of shipment, goods are however stored in the name
of the bank – Not permitted for commercial banks in India.
 Types of LC

¢ Involving middlemen:

l Transferable LC – Beneficiary may request the bank to transfer the credit

available in whole or in part to one or more other beneficiary. First beneficiary
makes available the LC to the actual producer of goods with out making use
of his credit lines.

l Back-to-back LC – Trading house/Middle man – Issuing LC in favor of the

supplier on the strength of the existing LC.

¢ Others:

l Revolving LC – Buyers may need a specific product on a regular basis / lump

sum purchase for discount where delivery is often made in installments and
stipulated intervals. The seller may lay down a condition of revolving credit be
issued in favor of guaranteeing payments against individual consignments
 Documents under a LC

¢ Transport document

l Bill of lading, air-way bill, lorry receipts, sea-way bill etc.

¢ Insurance document

l Risk of fire, shipwreck, pilferage, loss on account of war etc.

¢ Bills of exchange

l Legal document that establishes the liability of various parties

involved in the credit process, attract stamp duty

¢ Commercial invoice

l Record of compliance of main parameters of the original

commercial agreement between buyer & seller
 Documents under a LC

¢ Certificate of origin
l Country in which product is grown/manufactured. Important document for
custom clearance at the importing center.

¢ Packing list
l Description of the goods, Net & gross weight of individual package, details
of buyer, seller, shipping particulars, number of packages in master carton,
weight & measurement of each master carton
¢ Quality certificate
l External agency nominated by the buyer for the purpose of obtaining an
independent confirmation of the quality of goods

¢ Beneficiary's certificate
l Certificate from beneficiary side that all the requirements necessary to
facilitate customs and port formalities have been complied with.
 Inco Terms

¢ International Commercial Terms (‘Incoterms’) are internationally

recognized standard trade terms used in sales contracts.

¢ They’re used to make sure buyer and seller know:

¢ Who is responsible for the cost of transporting the goods, including

insurance, taxes and duties.

¢ Where the goods should be picked up from and transported to.

¢ Who is responsible for the goods at each step during transportation.

 https://iccwbo.org/publication/incoterm
Incoterms s-2020-practical-free-wallchart/
2020