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INTRODUCTION Trade finance refers to financing international trading transactions. In this financing arrangement, the bank or other institution of the importer provides for paying for goods imported on behalf of the importer. Other forms of trade finance can include Documentary collection, trade credit insurance, export factoring, forfeiting and others. Trade finance is often supported by quasigovernment entities known as export credit agencies that work with commercial banks and other financial institutions OBJECTIVES
To understand the PROCEDURE to the obtain TRADE FINANCE. To study the BENEFITS of Trade Finance.
METHODOLOGY Study is based on secondary data books & journals from the basis of data collection. LIMITATIONS A study is a qualitative one , hence limitations of the same as shall apply. CHAPTERS Chapter 1 - Deals with introduction Chapter 2 - Deals with procedure to obtain with Trade Finance Chapter 3 - Brings out the benefits of Trade Finance Chapter 4 - Gives a conclution
TRADE SERVICES There are a number of ways in which banks can help corporate clients trade for a fee. Letters of credit (LC), import bills for collection, shipping guarantees, import financing, performance bonds, export LC advising, LC safekeeping, LC confirmation, LC checking and negotiation, pre-shipment export finance, export bills for collections, invoice financing and all the relevant document preparation. Despite this focus on the LC, over the years the term trade finance has been shifting away from this sometimes cumbersome method of conducting business. It is now estimated that over 80% of global trade is conducted on an open account basis. Led by large corporates, this form of trade saves costs and time and so has been adopted by smaller corporate as they become more comfortable with their buyer and supplier relationships. Open account transactions can be described as µbuy now, pay later¶ and are more like regular payments for a continuing flow of goods rather than specific transactions. This is much cheaper for corporates. In response to this development, the organisation SWIFT launched the TSU (trade services utility), a collaborative centralised data matching utility, which allows banks to build products around its core functionality to improve the speed and flow of open account trade. This is helping banks re-intermediate themselves into these trade flows. While volumes of LCs have remained flat in recent years, their value actually increased and they remain an essential part of emerging market trade and trade in countries where exchange controls are in force. This increase in value is also a reflection of the commodity price boom of 2007/08. FACTORING & FORFAITING Factoring, or invoice discounting, receivables factoring or debtor financing, is where a company buys a debt or invoice from another company. In this purchase, accounts receivable are discounted in order to allow the buyer to make a profit upon the settlement of the debt. Essentially factoring transfers the ownership of accounts to another party that then chases up the debt. Factoring therefore relieves the first party of a debt for less than the total amount providing them with working capital to continue trading, while the buyer, or factor, chases up the debt for the full amount and profits when it is paid. The factor is required to pay additional fees, typically a small percentage, once the debt has been settled. The factor may also offer a discount to the indebted party. Forfaiting (note the spelling) is the purchase of an exporter's receivables ± the amount importers owe the exporter ± at a discount by paying cash. The purchaser of the receivables, or forfaiter, must now be paid by the importer to settle the debt.
As the receivables are usually guaranteed by the importer's bank, the forfeiter frees the exporter from the risk of non-payment by the importer. The receivables have then become a form of debt instrument that can be sold on the secondary market as bills of exchange or promissory notes. EXPORT & AGENCY FINANCE This part of Trade Finance¶s remit covers the roles of the export credit agencies, the development banks, and the multilateral agencies. Their traditional role is complement lending by commercial banks at interest by guaranteeing payment. These agencies have once again become of vital importance to the trade finance market due to the role that they play in facilitating trade, insuring transactions, promoting exports, creating jobs, and increasingly through direct lending. All are important in the current global downturn. Trade Finance also follows The trade credit insurance and political risk insurance markets ± an important part of doing business in developing economies; the syndications market as banks and agencies lend funds to enable the trade finance activities of other institutions; Islamic trade finance through its increasing popularity and expansion beyond its historic markets; and finally Trade Finance follows the changes in global regulations and tracks the law firms and in-house legal teams that contribute to making deals happen . TRADE FINANCE CYCLE ± PRIMARY PLAYERS Buyers are the primary drivers of Trade finance. They are largely responsible for shaping consumer demand for the products they wish to sell. They are also the first in the chain to feel the pressure to reduce costs in a market. The raw material prices keep rising but consumers Expect prices to keep falling in this new world of large retail chains. Suppliers need good trade finance in place. As the company that manufactures the goods, they not only feel the current increases in the raw materials, energy, and labor costs but are traditionally hurt the most since they need to bear the brunt of the cost and typically go the longest between the initial outlay for raw materials, overhead, labor and the day they finally get paid for producing the product. Financing Institutions play the role of lender in global trade finance and offer various types of financing. This includes a number of trade financing services including Letter of Credit,Collections, Stand-by Letter of Credit, Pre and Post shipment finance, Bill Discounting and Purchase, Bank Acceptances. Transporters or Logistics providers cater to the physical movement of goods , and can provide visibility to all the constituents by updating the transit records of the goods shipped. Their internal systems when integrated to a trade finance solution can give an authenticated record of the goods shipped. Their current location and expected
delivery time enables not only buyers and sellers to update their records but will also act as a risk mitiigation tool for a financial institution on a finance provided. KEY CHALLENGES y Lack of an integrated platform for all players. y High Turnaround time due to delay in physical transport of documents between parties. y Difficulty in reconciling positions ± for Buyers and suppliers ± due to lack of a dashboard which reflects current payables / receivables position, and a history of recent transaction y Value of Market Knowledge: KYC y Risk and Compliance y Cost-containment Pressure y High logistics costs. y Inefficiencies due to multiple documents and manual system of keeping records. FEATURES TO CLIENT
Risk-mitigation, cost reduction with aggressive financing options and transformation of business process from paper-based trading towards cheaper electronic documents processing and exchange are concepts where major trade bank¶s have an important part to play, considering today¶s global environment. The emergence of new attractive financing techniques for the benefit of buyers and sellers from banks .
The vital steps being adopted by today¶s banks for delivering value to their corporate clients and dwell upon the concept and features of Open account management. Bank offers the following services: Import letters of credit Export letters of credit Import bills on collection Export bills on collection
Import letters of credit When dealing with overseas suppliers, especially unfamiliar ones, there are no guarantees. Bank expertise gives a leading edge in creating solutions covering risks to give complete financial security. Export letter of credit By covering risks and maximising security in payments, provide a safe and secure environment allowing business to grow to its potential. Complying with the terms and conditions of the letter of credit ensures payment. Having the letter of credit confirmed by banker gives you the additional security of covering political risk of the buyer's country as well as the economic risk (if any) of the overseas bank. Import collections Improve cashflow- By negotiating a credit period for the term payments from suppliers.
Enhance exporters bargaining position- Negotiating the costs of the collections to be borne by exporter¶s suppliers Reduce risks- If exporter dealing with a new supplier or are reluctant to pay until the goods have been shipped, collection provides evidence. More security- For greater security and control over the document received and content, bank can set up an import letter of credit. Export bills on collection Enhances trading confidence ± Documents are only teleased upon payment or acceptance of the bill of exchange. For further security, the term can be µavailsed¶by buyer¶s banker¶s, wherein they agree to guarantee payment in the event that buyer defaults. Improves cashflow- The increased certainty of payment date offered by sight payment enables to predict exporters cashflows more accurately. Receive funds in advance- With term payment , applying to have the bill of exchange µdiscounted¶ enables exporter to receive funds in advance of the due date.
PROCEDURE DOCUMENTS REQUIRED : Trade finance is the collective term for the various strategies that are employed in the process of conducting international trade transactions. The process may rely on various methods of money management, the use of different banking services, making investments, and in general utilizing all resources so that the highest degree of satisfaction possible is achieved by both the buyer and the seller. In making use of various trade finance tools and strategies, both parties are subject to laws and regulations that apply at the port of origin and the port of destination involved in the transaction. Companies that routinely utilize international trade as part of their business efforts will make sure they understand all factors that must be addressed in order to successfully execute a trade. This means identifying reliable exporting and importing professionals to help manage the process. In some cases, those professionals will be in the full-time employ of the buyer or seller. A company may also choose to outsource the trade finance process to professionals who manage the activity on behalf of a number of different clients. Whether managed in-house or via outsourcing, trade finance must comply with laws relating to the trade. This means preparing the correct documents to arrange for the export of the products, as well as the paperwork required to allow the goods to enter the country where the buyer resides. Unless the documents are in order, the successful completion of the order may be delayed or even rendered null and void. Along with the shipping documents, trade finance also addresses how payment is rendered for the products purchased. This usually involves working through the banks of both the buyer and the seller. The buyer¶s bank may provide a letter of credit to the seller¶s bank, effectively providing proof that the resources to complete the transaction are in place. Often , this letter of credit requires the presentation of documents that affirm that the items ordered have been received, with a bill of lading being the most commonly used document . Upon verification that the buyer has received his or her order, the funds are transferred to the seller¶s designated bank account, and the trade is considered complete Trade finance also normally involves insurance that helps to define which party is responsible for damages at each step in the shipping process. For example, the seller may be held liable for any damages that are discovered or incurred right up to the point that the goods are unloaded on the pier at the port of delivery. Should the goods be damaged once they are unloaded on the pier, the buyer assumes responsibility for any damages or losses. Generally, the insurance terms are highly detailed, leaving no
room for miscommunication of which party is held responsible at any time during the execution of the international trade. Unless the documents are in order, the successful completion of the order may be delayed or even rendered null and void. Along with the shipping documents, trade finance also addresses how payment is rendered for the products purchased. This usually involves working through the banks of both the buyer and the seller. Each investor or trader has their own best strategies for ETF trading, but some of the most common suggestions involve recognizing key details and tactics for getting the most out of these financial products. Exchange traded funds, or ETFs, are relatively new financial instruments . They can focus on a lot of different areas, from commodities and currencies to stocks, bonds, and indexes, but they have some core aspects in common. TRADE FINANCE IN INDIA REGULATIONS Trade Finance in India comprises of financing against imports into India, export from India and inland trade transactions. It is important to know about the regulations governing such transactions in India. Import and Export trade is regulated by the Directorate General of Foreign Trade (DGFT) under Ministry of Commerce & Industry, Department of Commerce, Government of India. Banks in India, authorized by Reserve Bank of India to deal in Foreign Exchange are known as Authorised Dealers. Authorised dealers, while undertaking import and export transactions, should ensure that the imports into India and export from India are in conformity with the Export Import Policy in force and Foreign Exchange Management (Current Account Transactions) Rules, 2000 framed by Government and the directions issued by Reserve Bank under Foreign Exchange Management Act from time to time. Banks also have to follow credit policy announced by Reserve Bank of India from time to time to ensure compliance while dealing with financing of Inland Trade transactions. Authorised dealers have to follow normal banking procedures to the provisions of various rules framed by International Chamber of Commerce, Paris and onshore credit policy of the country Banks in India use the following trade products to meet financing requirements of the clients: Imports 1. Opening of Letter of Credit and Follow up Financing 2. Buyer¶s Credit / Supper¶s Credit in the form of short term credit for Imports into India 3. Trust Receipt Financing 4. Simple Overdraft Facility 5. Issuance of some of the guarantees to facilitate imports related activities
Exports: 1. Pre-shipment Credit in Indian Rupees 2. Pre-shipment Credit in Foreign Currency 3. Post-shipment Credit in Indian Rupees 4. Post-shipment Credit in Foreign Currency 5. Forfaiting of Export Receivables 6. Factoring of Export Receivables 7. Simple Overdraft Facility 8. Issuance of some of the guarantees to facilitate Export related activities Inland Trade: 1. Local Bill Discounting backed by Bill of Exchange 2. Local Bill Discounting backed by Letter of Credit 3. Simple Overdraft Facility 4. Issuance of some of the guarantees to facilitate Inland trde activities
1. Trade Financing Instruments The main types of trade financing instruments are as follows: a) Documentary Credit This is the most common form of the commercial letter of credit. The issuing bank will make payment, either immediately or at a prescribed date, upon the presentation of stipulated documents. These documents will include shipping and insurance documents, and commercial invoices. The documentary credit arrangement offers an internationally used method of attaining a commercially acceptable undertaking by providing for payment to be made against presentation of documentation representing the goods, making possible the transfer of title to those goods. A letter of credit is a precise document whereby the importer¶s bank extends credit to the importer and assumes responsibility in paying the exporter. A common problem faced in emerging economies is that many banks have inadequate capital and foreign exchange, making their ability to back the documentary credits questionable. Exporters may require guarantees from their own local banks as an additional source of security, but this may generate significant additional costs as the banks may be reluctant to assume the risks. Allowing internationally reputable banks to operate in the country and offer documentary credit is one way to effectively solve this problem. Factoring This involves the sale at a discount of accounts receivable or other debt assets on a daily, weekly or monthly basis in exchange for immediate cash. The debt assets are sold by the exporter at a discount to a factoring house, which will assume all commercial and political risks of the account receivable. In the absence of private sector players, governments can facilitate the establishment of a state-owned factor or a joint venture set-up with several banks and trading enterprises. 2. Export Credit Insurance
In addition to financing issues, traders are also subject to risks, which can be either commercial or political. Commercial risk arises from factors like the non-acceptance of goods by buyer, the failure of buyer to pay debt, and the failure of foreign banks tohonour documentary credits. Political risk arises from factors like war, riots and civil commotion, blockage of foreign exchange transfers and currency devaluation. Export credit insurance involves insuring exporters against such risks. It is commonly used in Europe, and increasing in importance in the United States as well as in developing markets. The types of export credit insurance used vary from country to country and depends on traders¶ perceived needs. The most commonly used are as follows: Short-term Export Credit Insurance ± Covers periods not more than 180 days. Protection includes pre-shipment and post-shipment risks, the former covering the period between the awarding of contract until shipment. Protection can also be covered against commercial and political risks. Medium and Long-term Export Credit Insurance ± Issued for credits extending longer periods, medium-term (up to three years) or longer. Protection provided for financing exports of capital goods and services. Investment Insurance ± Insurance offered to exporters investing in foreign countries. Exchange Rate Insurance ± Covers losses as a result of fluctuations in exchange rates between exporters¶ and importers¶ national currencies over a period of time. FACTORING AND FORFEITING Forfeiting and factoring are services in international market given to an exporter or seller. Its main objective is to provide smooth cash flow to the sellers. The basic difference between the forfeiting and factoring is that forfeiting is a long term receivables (over 90 days up to 5 years) while factoring is a short termed receivables (within 90 days) and is more related to receivables against commodity sales. How forfeiting Works in International Trade The exporter and importer negotiate according to the proposed export sales contract. Then the exporter approaches the forfeiter to ascertain the terms of forfeiting. After collecting the details about the importer, and other necessary documents, forfeiter estimates risk involved in it and then quotes the discount rate. The exporter then quotes a contract price to the overseas buyer by loading the discount rate and commitment fee on the sales price of the goods to be exported and sign a contract with the forfeiter. Export takes place against documents guaranteed by the importer¶s bank and discounts the bill with the forfeiter and presents the same to the importer for payment on due date. Documentary Requirements
In case of Indian exporters availing forfeiting facility, the forfeiting transaction is to be reflected in the following documents associated with an export transaction in the manner suggested below: Invoice : Forfeiting discount, commitment fees, etc. needs not be shown separately instead, these could be built into the FOB price, stated on the invoice. Shipping Bill and GR form : Details of the forfeiting costs are to be included along with the other details, such 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 exports stated on the shipping bill. Forfeiting The forfeiting typically involves the following cost elements: 1. Commitment fee, payable by the exporter to the forfeiter µfor latter¶s¶ commitment to execute a specific forfeiting transaction at a firm discount rate with in a specified time. 2. Discount fee, interest payable by the exporter for the entire period of credit involved and deducted by the forfaiter from the amount paid to the exporter against the availised promissory notes or bills of exchange. Factoring Factoring is very simple and can be defined as the conversion of credit sales into cash. Here, a financial institution which is usually a bank buys the accounts receivable of a company usually a client and then pays up to 80% of the amount immediately on agreement. The remaining amount is paid to the client when the customer pays the debt. Examples includes factoring against goods purchased, factoring against medical insurance, factoring for construction services etc. Different Types of Factoring 1. Disclosed 2. Undisclosed 1. Disclosed Factoring In disclosed factoring, client¶s customers are aware of the factoring agreement. Disclosed factoring is of two types: Recourse factoring: The client collects the money from the customer but in case customer don¶t pay the amount on maturity then the client is responsible to pay the amount to the factor. It is offered at a low rate of interest and is in very common use. Nonrecourse factoring: In nonrecourse factoring, factor undertakes to collect the debts from the customer. Balance amount is paid to client at the end of the credit period or when the customer pays the factor whichever comes first. The advantage of nonrecourse factoring is that continuous factoring will eliminate the need for credit and collection departments in the organization. 2. Undisclosed In undisclosed factoring, client's customers are not notified of the factoring arrangement. In this case, Client has to pay the amount to the factor irrespective of whether customer has paid or not.
How Does Forfaiting Work? The exporter approaches a forfaiter before finalizing a transaction¶s structure. Once the forfaiter commits to the deal and sets the discount rate, the exporter can incorporate the discount into the selling price. The exporter then accepts a commitment issued by the forfaiter, signs the contract with the importer, and obtains, if required, a guarantee from the importer¶s bank that provides the documents required to complete the forfaiting. The exporter delivers the goods to the importer and delivers the documents to the forfaiter who verifies them and pays for them as agreed in the commitment. Since this payment is without recourse, the exporter has no further interest in the transaction and it is the forfaiter who must collect the future payments due from the importer. There are 3 standard ways of payment methods in the export import trade international trade market: Clean Payment Collection of Bills Letters of Credit L/c 1. Clean Payments In clean payment method, all shipping documents, including title documents are handled directly between the trading partners. The role of banks is limited to clearing amounts as required. Clean payment method offers a relatively cheap and uncomplicated method of payment for both importers and exporters. There are basically two type of clean payments y Advance Payment In advance payment method the exporter is trusted to ship the goods after receiving payment from the importer. Cash in Advance/Prepayment Cash in Advance/Prepayment occurs when a buyer sends payment in the agreed currency and through agreed method to a seller before the product is manufactured and/or shipped. Upon receipt of payment this seller then ships the goods and all the necessary shipping and commercial documents directly to the buyer. PROCESS Time of Payment- Prior to manufacturing and/or shipping, through the agreed upon method (cash, wire transfer, check, credit card, etc.). Goods Available to buyer- After payment is received. Risks to Seller- Product is manufactured and never paid for. Risks to Buyer- Seller does not ship per the order (quantity, product, quality, shipping method). *Seller does not ship when requested. When Appropriate to Quote or Use-*When there is no established relationship between the buyer and seller. *Product is a special order and can only be sold to this specific buyer since it contains company logo, etc. *Seller is confident that importing country will impose regulations deferring or blocking transfer of payment.
*Seller does not have sufficient liquidity or access to outside financing to extend deferred payment terms. Financing- Buyer must have cash or financing available. Open Account In open account method the importer is trusted to pay the exporter after receipt of goods. The main drawback of open account method is that exporter assumes all the risks while the importer get the advantage over the delay use of company's cash resources and is also not responsible for the risk associated with goods. Open account occurs when a seller ships the goods and all the necessary shipping and commercial documents directly to a buyer who agrees to pay a seller¶s invoice at a future date. Open account is typically used between established and trusted traders. PROCESS Time of Payment- As agreed between a buyer and seller, net 15, 30, 60 day terms, etc., from date of invoice or bill of lading date. Goods Available to Buyer- Before payment (depending on how the products are shipped and the length of payment option). Risks to Seller- Buyer defaults on payment obligation. Delays in availability of foreign exchange and transferring of funds from buyer¶s country occur. Payment is blocked due to political events in buyer¶s country. Risks to Buyer- Seller does not ship per the order (product, quantity, quality, and/or shipping method). Seller does not ship when requested, either early or late. When Appropriate to Quote or Use-Seller has absolute trust that buyer will accept shipment and pay at agreed time. Seller is confident that importing country will not impose regulations deferring or blocking transfer of payment. Seller has sufficient liquidity or access to outside financing to extend deferred payment terms. Used more regularly in international transactions to avoid high banking fees. Financing-Seller finances buyer through deferred payment terms. Seller may be able to obtain bank financing through pledge of receivables. Selling receivables on a non-recourse basis to a bank. Leverage and/or financing from domestic/global business.
2. Payment Collection of Bills in International Trade
The Payment Collection of Bills also called ³Uniform Rules for Collections´ is published by International Chamber of Commerce (ICC) under the document number 522 (URC522) and is followed by more than 90% of the world's banks. In this method of payment in international trade the exporter entrusts the handling of commercial and often financial documents to banks and gives the banks necessary instructions concerning the release of these documents to the Importer. It is considered to be one of the cost effective methods of evidencing a transaction for buyers, where documents are manipulated via the banking system. There are two methods of collections of bill Documents Against Payment D/P In this case documents are released to the importer only when the payment has been done. Documents Against Acceptance D/A In this case documents are released to the importer only against acceptance of a draft
. 3.Letter of Credit L/c Letter of Credit also known as Documentary Credit is a written undertaking by the importers bank known as the issuing bank on behalf of its customer, the importer (applicant), promising to effect payment in favor of the exporter (beneficiary) up to a stated sum of money, within a prescribed time limit and against stipulated documents. It is published by the International Chamber of Commerce under the provision of Uniform Custom and Practices (UCP) brochure number 500. Various types of L/Cs are Revocable & Irrevocable Letter of Credit (L/c) A Revocable Letter of Credit can be cancelled without the consent of the exporter. An Irrevocable Letter of Credit cannot be cancelled or amended without the consent of all parties including the exporter. Sight & Time Letter of Credit If payment is to be made at the time of presenting the document then it is referred as the Sight Letter of Credit. In this case banks are allowed to take the necessary time required to check the documents. If payment is to be made after the lapse of a particular time period as stated in the draft then it is referred as the Term Letter of Credit. Confirmed Letter of Credit (L/c) Under a Confirmed Letter of Credit, a bank, called the Confirming Bank, adds its commitment to that of the issuing bank. By adding its commitment, the Confirming Bank takes the responsibility of claim under the letter of credit, assuming all terms and conditions of the letter of credit are met. Sight Credit and Usance Credit L/c Sight credit states that the payments would be made by the issuing bank at sight, on demand or on presentation. In case of usance credit, draft are drawn on the issuing bank or the correspondent bank at specified usance period. The credit will indicate whether the usance draft are to be drawn on the issuing bank or in the case of confirmed credit on the confirming bank. Back to Back Letter of Credit L/c Back to Back Letter of Credit is also termed as Countervailing Credit. A credit is known as backtoback credit when a L/c is opened with security of another L/c. A backtoback credit which can also be referred as credit and countercredit is actually a method of financing both sides of a transaction in which a middleman buys goods from one customer and sells them to another. The parties to a BacktoBack Letter of Credit are 1. The buyer and his bank as the issuer of the original Letter of Credit. 2. The seller/manufacturer and his bank, 3. The manufacturer's subcontractor and his bank.
The practical use of this Credit is seen when L/c is opened by the ultimate buyer in favour of a particular beneficiary, who may not be the actual supplier/ manufacturer offering the main credit with near identical terms in favour as security and will be able to obtain reimbursement by presenting the documents received under back to back credit under the main L/c. The need for such credits arise mainly when The ultimate buyer not ready for a transferable credit The Beneficiary do not want to disclose the source of supply to the openers. The manufacturer demands on payment against documents for goods but the beneficiary of credit is short of the funds 6. Transferable Letter of Credit L/c A transferable documentary credit is a type of credit under which the first beneficiary which is usually a middleman may request the nominated bank to transfer credit in whole or in part to the second beneficiary. The L/c does state clearly mentions the margins of the first beneficiary and unless it is specified the L/c cannot be treated as transferable. It can only be used when the company is selling the product of a third party and the proper care has to be taken about the exit policy for the money transactions that take place. This type of L/c is used in the companies that act as a middle man during the transaction but don¶t have large limit. In the transferable L/c there is a right to substitute the invoice and the whole value can be transferred to a second beneficiary. A letter of credit is a bank instrument that can be used to even the risk between a buyer and a seller since a buyer is guaranteed to receive payment if when he/she has complied with the exact requirements of this buyer. A letter of credit offers a seller numerous advantages but only if that seller complies exactly with its terms and conditions of the transaction. In addition to providing reduced risk for both a seller and a buyer, there are many variables that can be used with a letter of credit to reduce the political and commercial risks that may accompany the transaction as well as provide extended terms to a buyer through the letter of credit instrument. The terminology that is used when working with letters of credit is very specific and should be understood. Involved Parties:
y y y y y
Applicant = Buyer/ Importer Beneficiary = Seller/Exporter Opening Bank = Importer¶s Bank >> Issues L/C Advising Bank= Exporter¶s Bank >> Advises L/C Confirming Bank = Advising Bank or 3rd Party Bank >> Confirms L/C
Paying Bank = Any Bank as Specified in L/C >> Pays the Draft
Activities and Terms:
y y y y y y
y y y y
Advice ± review and approval of L/C Amendment ± change to L/C Confirmed ± the commercial, political and economic risk of the transaction absorbed by the confirming bank Discrepancy ± mistake in the documentation Documentation ± documents required within L/C Draft ± negotiable order to pay o Sight Draft ± payment assured upon shipment and presentation of documents in compliance with its terms o Time Draft ± bank assurance of payment at the maturity of the banker¶s acceptance with option of obtaining immediate funds by discounting the BA (30, 60, 90 days at sight or acceptance) Irrevocable ± cannot be changed without approval from beneficiary or advising bank Issuance ± opening of L/C Negotiation ± review of documents Revocable ± can be changed without approval of beneficiary or advising bank
PROCESS OF L/C Time of Payment - As agreed between the buyer and seller and stipulated in the L/C, at sight of documents or acceptance of time draft Goods Available to Buyer - Upon release of documentation and payment or acceptance of time draft Risks to Seller-Delays in availability of foreign exchange and transferring of funds from buyer¶s country if the L/C is not confirmed. Payment blocked due to political events in buyer¶s country if the L/C is not confirmed Risks to Buyer- Seller creates documents to comply with L/C but does not ship actual product. Seller does not ship. Buyer ties up commercial lines of credit to secure L/C. When Appropriate to Quote or Use-A seller should consider a number of factors: corporate credit policy and ability to absorb risk credit standing of the buyer political environment in the importing country type of merchandise to be shipped and value of the shipment availability of foreign exchange buyer and seller are establishing a new relationship when buyer and/or seller¶s governments require use of banks to control flow of currencies and products
products and/or services comply with quality steps during production and documentation is presented for payment used less frequently in international transactions because of the high bank fees and timeconsuming process Financing- Often a bank will favorably consider a request for an increase in a credit line to finance production of the goods. This is done with the knowledge that letters of credit have been opened and advised to an exporter for an export order. The bank may further require that the beneficiary assign its interest in the letter of credit to them. Letters of Credit Fees Depending on what has been negotiated, bank charges may be placed against (for the account of) a buyer/applicant or may be shared between a buyer/applicant and a seller/beneficiary. Rarely will all charges be for the account of a seller/beneficiary. If the charges are to be shared, the customary procedure is that each party will pay the applicable fees for his respective country and/or bank. On average the charges could be 1% of the face amount of the letter of credit. These rates are negotiable and may be reduced if a significant amount of letter of credit business is done with a particular bank. In addition to the normal and customary fees, additional fees could be charged for
y y y y y y y y y y y y y y y y y y y y
issuance pre-advice advice amendments extension confirmation documentary examination payment negotiation acceptance reimbursement collection without examination transfer assignment of proceeds SWIFT handling courier discrepancy cancellation discounting
The important step is to identify these costs before the methods of payment are finalized since both parties may feel the costs outweigh the risks and will then choose a less costly method of payment.
Illustrative Letter of Credit Transaction
1. The importer arranges for the issuing bank to open an LC in favor of the exporter. 2. The issuing bank transmits the LC to the advising bank, which forwards it to the exporter. 3. The exporter forwards the goods and documents to a freight forwarder. 4. The freight forwarder dispatches the goods and submits documents to the advising bank. 5. The advising bank checks documents for compliance with the LC and pays the exporter. 6. The importer¶s account at the issuing bank is debited. 7. The issuing bank releases documents to the importer to claim the goods from the carrier. ROLE OF VARIOUS PARTIES Exporter The seller ships the goods and then hands over the document related to the goods to their banks with the instruction on how and when the buyer would pay. Exporter's Bank The exporter's bank is known as the remitting bank , and they remit the bill for collection with proper instructions. The role of the remitting bank is to Check that the documents for consistency. Send the documents to a bank in the buyer's country with instructions on collecting payment. Pay the exporter when it receives payments from the collecting bank. Buyer/Importer The buyer / importer is the drawee of the Bill. The role of the importer is to Pay the bill as mention in the agreement (or promise to pay later). Take the shipping documents (unless it is a clean bill) and clear the goods. Importer's Bank This is a bank in the importer's country : usually a branch or correspondent bank of the remitting bank but any other bank can also be used on the request of exporter. The collecting bank act as the remitting bank's agent and clearly follows the instructions on the remitting bank's covering schedule. However the collecting bank does not guarantee payment of the bills except in very unusual circumstance for undoubted customer , which is called availing. Importer's bank is known as the collecting / presenting bank. The role of the collecting banks is to Act as the remitting bank's agent
Present the bill to the buyer for payment or acceptance. Release the documents to the buyer when the exporter's instructions have been followed. Remit the proceeds of the bill according to the Remitting Bank's schedule instructions. If the bill is unpaid / unaccepted, the collecting bank : May arrange storage and insurance for the goods as per remitting bank instructions on the schedule. Protests on behalf of the remitting bank (if the Remitting Bank's schedule states Protest) Requests further instruction from the remitting bank, if there is a problem that is not covered by the instructions in the schedule. Once payment is received from the importer, the collecting bank remits the proceeds promptly to the remitting bank less its charges. Documents Against Payments (D/P) This is sometimes also referred as Cash against Documents/Cash on Delivery. In effect D/P means payable at sight (on demand). The collecting bank hands over the shipping documents including the document of title (bill of lading) only when the importer has paid the bill. The drawee is usually expected to pay within 3 working days of presentation. The attached instructions to the shipping documents would show "Release Documents Against Payment" Risks Under D/P terms the exporter keeps control of the goods (through the banks) until the importer pays. If the importer refuses to pay, the exporter can: Protest the bill and take him to court (may be expensive and difficult to control from another country). Find another buyer or arrange a sale by an auction. With the last two choices, the price obtained may be lower but probably still better than shipping the goods back, sometimes, the exporter will have a contact or agent in the importer's country that can help with any arrangements. In such a situation, an agent is often referred to as a Case of Need, means someone who can be contacted in case of need by the collecting bank. If the importers refuses to pay, the collecting bank can act on the exporter's instructions shown in the Remitting Bank schedule. These instructions may include
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Removal of the goods from the port to a warehouse and insure them. Contact the case of need who may negotiate with the importer. Protesting the bill through the bank's lawyer.
PRE SHIPMENT FINANCE Pre Shipment Finance is issued by a financial institution when the seller want the payment of the goods before shipment. The main objectives behind preshipment finance or pre export finance is to enable exporter to Procure raw materials. Carry out manufacturing process. Provide a secure warehouse for goods and raw materials. Process and pack the goods. Ship the goods to the buyers. Meet other financial cost of the business. Types of Pre Shipment Finance Packing Credit Advance against Cheques/Draft etc. representing Advance Payments. Preshipment finance is extended in the following forms : Packing Credit in Indian Rupee Packing Credit in Foreign Currency (PCFC) Requirment for Getting Packing Credit This facility is provided to an exporter who satisfies the following criteria A ten digit importerexporter 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 Licence), 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 the following evidences to the bank: Formal application for release the packing credit with undertaking to the effect that the exporter would be ship the goods within stipulated due date and submit the relevant shipping documents to the banks within prescribed time limit. Firm order or irrevocable L/C or original cable / fax / telex message exchange between the exporter and the buyer. Licence 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 reveal the information about the full name and address of the overseas buyer, description quantity and value of goods (FOB or CIF), destination port and the last date of payment. Eligibility Pre shipment credit is only issued to that exporter who has the export order in his own name. However, as an exception, financial institution can also grant credit to a third party manufacturer or supplier of goods who does not have export orders in their own name. In this case some of the responsibilities of meeting the export requirements have been out sourced to them by the main exporter. In other cases where the export order is divided between two more than two exporters, pre shipment credit can be shared between them Quantum of Finance The Quantum of Finance is granted to an exporter against the LC or an expected order. The only guideline principle is the concept of NeedBased Finance. Banks determine the percentage of margin, depending on factors 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. Before making any an allowance for Credit facilities banks need to check the different aspects like product profile, political and economic details about country. Apart from these things, the bank also looks in to the status report of the prospective buyer, with whom the exporter proposes to do the business. To check all these information, banks can seek the help of institution like ECGC or International consulting agencies like Dun and Brad street etc. The Bank extended the packing credit facilities after ensuring the following" The exporter is a regular customer, a bona fide exporter and has a goods standing in the market. Whether the exporter has the necessary license and quota permit (as mentioned earlier) or not. Whether the country with which the exporter wants to deal is under the list of Restricted Cover Countries(RCC) or not. Disbursement of Packing Credit Advance 2. Once the proper sanctioning of the documents is done, bank ensures whether exporter has executed the list of documents mentioned earlier or not. Disbursement is normally allowed when all the documents are properly executed. Sometimes an exporter is not able to produce the export order at time of availing packing credit. So, in these cases, the bank provide a special packing credit facility and is known as Running Account Packing. Before disbursing the bank specifically check for the following particulars in the submitted documents" Name of buyer Commodity to be exported Quantity Value (either CIF or FOB) Last date of shipment / negotiation. Any other terms to be complied with The quantum of finance is fixed depending on the FOB value of contract /LC or the domestic values of goods, whichever is found to be lower. Normally insurance and freight charged are considered at a later stage, when the goods are ready to be shipped. In this case disbursals are made only in stages and if possible not in cash. The payments are made directly to the supplier by drafts/bankers/cheques. The bank decides the duration of packing credit depending upon the time required by the exporter for processing of goods. The maximum duration of packing credit period is 180 days, however 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 giving all the necessary information about the stocks. It is then used by the banks as a guarantee for securing the packing credit in advance. Bank also decides the rate of submission of this stocks. Apart from this, authorized dealers (banks) also physically inspect the stock at regular intervals.
Liquidation of Packing Credit Advance 4. Packing Credit Advance needs be liquidated out of as the export proceeds of the relevant shipment, thereby converting preshipment credit into postshipment credit. This liquidation can also be done by the payment receivable from the Government of India and includes the duty drawback, payment from the Market Development Fund (MDF) of the Central Government or from any other relevant source. In case if the export does not take place then the entire advance can also be recovered at a certain interest rate. RBI has allowed some flexibility in to this regulation under which substitution of commodity or buyer can be allowed by a bank without any reference to RBI. Hence in effect the packing credit advance may be repaid by proceeds from export of the same or another commodity to the same or another buyer. However, bank need to ensure that the substitution is commercially necessary and unavoidable. Overdue Packing 5. Bank considers a packing credit as an overdue, if the borrower fails to liquidate the packing credit on the due date. And, if the condition persists then the bank takes the necessary step to recover its dues as per normal recovery procedure. POST SHIPMENT FINANCE Post Shipment Finance is a kind of loan provided by a financial institution to an exporter or seller against a shipment that has already been made. This type of export finance is granted from the date of extending the credit after shipment of the goods to the realization date of the exporter proceeds. Exporters don¶t wait for the importer to deposit the funds. Basic Features The features of postshipment finance are: Purpose of Finance Postshipment finance is meant to finance export sales receivable after the date of shipment of goods to the date of realization of exports proceeds. In cases of deemed exports, it is extended to finance receivable against supplies made to designated agencies. Basis of Finance Postshipment finances is provided against evidence of shipment of goods or supplies made to the importer or seller or any other designated agency. Types of Finance Postshipment finance can be secured or unsecured. Since the finance is extended against evidence of export shipment and bank obtains the documents of title of goods, the finance is normally self liquidating. In that case it involves advance against undrawn balance, and is usually unsecured in nature. Further, the finance is mostly a funded advance. In few cases, such as financing of project exports, the issue of guarantee (retention money guarantees) is involved and the financing is not funded in nature. Quantum of Finance As a quantum of finance, postshipment finance can be extended up to 100% of the invoice
value of goods. In special cases, where the domestic value of the goods increases the value of the exporter order, finance for a price difference can also be extended and the price difference is covered by the government. This type of finance is not extended in case of preshipment stage. Banks can also finance undrawn balance. In such cases banks are free to stipulate margin requirements as per their usual lending norm. Period of Finance Postshipment finance can be off short terms or long term, depending on the payment terms offered by the exporter to the overseas importer. In case of cash exports, the maximum period allowed for realization of exports proceeds is six months from the date of shipment. Concessive rate of interest is available for a highest period of 180 days, opening from the date of surrender of documents. Usually, the documents need to be submitted within 21days from the date of shipment. Financing For Various Types of Export Buyer's Credit Postshipment finance can be provided for three types of export : Physical exports: Finance is provided to the actual exporter or to the exporter in whose name the trade documents are transferred. Deemed export: Finance is provided to the supplier of the goods which are supplied to the designated agencies. 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 exporter. Supplier's Credit Buyer's Credit is a special type of loan that a bank offers to the buyers for large scale purchasing under a contract. Once the bank approved loans to the buyer, the seller shoulders all or part of the interests incurred. Types of Post Shipment Finance The post shipment finance can be classified as : Export Bills purchased/discounted. Export Bills negotiated Advance against export bills sent on collection basis. Advance against export on consignment basis Advance against undrawn balance on exports Advance against claims of Duty Drawback. 1. Export Bills Purchased/ Discounted.(DP & DA Bills) Export bills (Non L/C Bills) is used in terms of sale contract/ order may be discounted or purchased by the banks. It is used in indisputable international trade transactions and the proper limit has to be sanctioned to the exporter for purchase of export bill facility. 2. Export Bills Negotiated (Bill under L/C) The risk of payment is less under the LC, as the issuing bank makes sure the payment. The risk is further reduced, if a bank guarantees the payments by confirming the LC. Because of the inborn security available in this method, banks often become ready to extend the finance against bills under LC. However, this arises two major risk factors for the banks: The risk of nonperformance by the exporter, when he is unable to meet his terms and conditions. In this case, the issuing banks do not honor the letter of credit. The bank also faces the documentary risk where the issuing bank refuses to honour its commitment. So, it is important for the for the negotiating bank, and the lending bank to properly check all the necessary documents before submission. 3. Advance Against Export Bills Sent on Collection Basis
Bills can only be sent on collection basis, if the bills drawn under LC have some discrepancies. Sometimes exporter requests the bill to be sent on the collection basis, anticipating the strengthening of foreign currency. Banks may allow advance against these collection bills to an exporter with a concessional rates of interest depending upon the transit period in case of DP Bills and transit period plus usance period in case of usance bill. The transit period is from the date of acceptance of the export documents at the banks branch for collection and not from the date of advance. 4. Advance Against Export on Consignments Basis Bank may choose to finance when the goods are exported on consignment basis at the risk of the exporter for sale and eventual payment of sale proceeds to him by the consignee. However, in this case bank instructs the overseas bank to deliver the document only against trust receipt /undertaking to deliver the sale proceeds by specified date, which should be within the prescribed date even if according to the practice in certain trades a bill for part of the estimated value is drawn in advance against the exports. In case of export through approved Indian owned warehouses abroad the times limit for realization is 15 months. 5. Advance against Undrawn Balance It is a very common practice in export to leave small part undrawn for payment after adjustment due to difference in rates, weight, quality etc. Banks do finance against the undrawn balance, if undrawn balance is in conformity with the normal level of balance left undrawn in the particular line of export, subject to a maximum of 10 percent of the export value. An undertaking is also obtained from the exporter that he will, within 6 months from due date of payment or the date of shipment of the goods, whichever is earlier surrender balance proceeds of the shipment. 6. Advance Against Claims of Duty Drawback Duty Drawback is a type of discount given to the exporter in his own country. This discount is given only, if the inhouse cost of production is higher in relation to international price. This type of financial support helps the exporter to fight successfully in the international markets. In such a situation, banks grants advances to exporters at lower rate of interest for a maximum period of 90 days. These are granted only if other types of export finance are also extended to the exporter by the same bank. After the shipment, the exporters lodge their claims, supported by the relevant documents to the relevant government authorities. These claims are processed and eligible amount is disbursed after making sure that the bank is authorized to receive the claim amount directly from the concerned government authorities. Bank Guarantees vs. Letters of Credit Introduction A bank guarantee is a written contract given by a bank on the behalf of a customer. By issuing this guarantee, a bank takes responsibility for payment of a sum of money in case, if it is not paid by the customer on whose behalf the guarantee has been issued. In return, a bank gets some commission for issuing the guarantee. Any one can apply for a bank guarantee, if his or her company has obligations towards a third party for which funds need to be blocked in order to guarantee that his or her company fulfils its obligations (for example carrying out certain works, payment of a debt, etc.).
In case of any changes or cancellation during the transaction process, a bank guarantee remains valid until the customer dully releases the bank from its liability. In the situations, where a customer fails to pay the money, the bank must pay the amount within three working days. This payment can also be refused by the bank, if the claim is found to be unlawful. Legal Requirements Bank guarantee is issued by the authorised dealers under their obligated authorities notified vide FEMA 8/ 2000 dt 3 rd May 2000.or in case of revocation of guarantees should be reported to Reserve Bank of India(RBI). Types of Bank Guarantees 1. Direct or Indirect Bank Guarantee: A bank guarantee can be either direct or indirect. Direct Bank Guarantee It is issued by the applicant's bank (issuing bank) directly to the guarantee's beneficiary without concerning a correspondent bank. This type of guarantee is less expensive and is also subject to the law of the country in which the guarantee is issued unless otherwise it is mentioned in the guarantee documents. Indirect Bank Guarantee With an indirect guarantee, a second bank is involved, which is basically a representative of the issuing bank in the country to which beneficiary belongs. This involvement of a second bank is done on the demand of the beneficiary. This type of bank guarantee is more time consuming and expensive too. 2. Confirmed Guarantee It is cross between direct and indirect types of bank guarantee. This type of bank guarantee is issued directly by a bank after which it is send to a foreign bank for confirmations. The foreign banks confirm the original documents and thereby assume the responsibility. 3. Tender Bond This is also called bid bonds and is normally issued in support of a tender in international trade. It provides the beneficiary with a financial remedy, if the applicant fails to fulfill any of the tender conditions. 4. Performance Bonds This is one of the most common types of bank guarantee which is used to secure the completion of the contractual responsibilities of delivery of goods and act as security of penalty payment by the Supplier in case of nondelivery of goods. 5. Advance Payment Guarantees This mode of guarantee is used where the applicant calls for the provision of a sum of money at an early stage of the contract and can recover the amount paid in advance, or a part thereof, if the applicant fails to fulfill the agreement. 6. Payment Guarantees This type of bank guarantee is used to secure the responsibilities to pay goods and services. If the beneficiary has fulfilled his contractual obligations after delivering the goods or services but the debtor fails to make the payment, then after written declaration the beneficiary can easily obtain his money form the guaranteeing bank. 7. Loan Repayment Guarantees
This type of guarantee is given by a bank to the creditor to pay the amount of loan body and interests in case of nonfulfillment by the borrower. 8. B/L Letter of Indemnity This is also called a letter of indemnity and is a type of guarantee from the bank making sure that any kind of loss of goods will not be suffered by the carrier. 9. Rental Guarantee This type of bank guarantee is given under a rental contract. Rental guarantee is either limited to rental payments only or includes all payments due under the rental contract including cost of repair on termination of the rental contract.
10. Credit Card Guarantee Credit card guarantee is issued by the credit card companies to its customer as a guarantee that the merchant will be paid on transactions regardless of whether the consumer pays their credit.
BENEFITS The benefits of the import letter of credit: Control & Security - Payment is made only against the documents you specify. letters of credit are always irrevocable and cannot be amended or cancelled without the consent of all parties involved in the transaction. The advantage of experience - extensive experience puts us in a position to guide client on which documents to ask for and on wording the terms. Enhance your bargaining position - Negotiate longer credit periods and reduce costs with suppliers by using the significant benefits that gain as the basis for clients negotiations. Improve client competitive status - Display financial credibility and enhance competitive position, particularly with suppliers who insist on payment by letter of credit.
THE BENEFITS OF THE EXPORT LETTER OF CREDIT Improve cashflow management - receive guaranteed funds, will simply 'discount' or 'negotiate' bills of exchange to improve cashflow. Extend payment terms - suppliers may agree to extend payment terms if assign the proceeds of the letter of credit to them. This will also improve cashflow. Hedge currency exposures - Knowing the payment date, amount and currency in which the payment is to be made allows to predict cashflow more accurately. can help to cover such currency exposures. Save insurance costs - Reduced risk of payment default reduces need for separate credit insurance and by simply confirming your letter of credit, can also reduce the need for political insurance. Benefits to Exporter(forfeiting) 100 per cent financing : Without recourse and not occupying exporter's credit line That is to say once the exporter obtains the financed fund, he will be exempted from the responsibility to repay the debt. Improved cash flow : Receivables become current cash in flow and its is beneficial to the exporters to improve financial status and liquidation ability so as to heighten further the funds raising capability. Reduced administration cost : By using forfeiting , the exporter will spare from the management of the receivables. The relative costs, as a result, are reduced greatly. Advance tax refund: Through forfeiting the exporter can make the verification of export and get tax refund in advance just after financing. Risk reduction : forfeiting business enables the exporter to transfer various risk resulted from deferred payments, such as interest rate risk, currency risk, credit risk, and political risk to the forfeiting bank. Increased trade opportunity : With forfeiting, the export is able to grant credit to his buyers freely, and thus, be more competitive in the market.
Benefits to Banks Forfeiting provides the banks following benefits: Banks can offer a novel product range to clients, which enable the client to gain 100% finance, as against 8085% in case of other discounting products. Bank gain fee based income. Lower credit administration and credit follow up. Benefits of Bank Guarantees For Governments 1. Increases the rate of private financing for key sectors such as infrastructure. 2. Provides access to capital markets as well as commercial banks. 3. Reduces cost of private financing to affordable levels. 4. Facilitates privatizations and public private partnerships. 5. Reduces government risk exposure by passing commercial risk to the private sector.
For Private Sector 1. Reduces risk of private transactions in emerging countries. 2. Mitigates risks that the private sector does not control. 3. Opens new markets. 4. Improves project sustainability.
BENEFITS FOR FINANCIAL INSTITUTIONS
Collaborative relationship ±Bank¶s can build a stronger collaborative relationship withclients, by widening the scope of their services to cover their customer¶s end-to end Trade Finance. This enables banks to improve their bottom lines, by exploring new revenue streams and provide scope to innovate customized funding solutions. Enhance customer retention - Customers provided with end-to-end solution which integrates with their internal applications and workflow will become completely attached to the Bank, as any shift of allegiance will shake up their entire procurement & collections processes. Increased reach & customization - Our solution is a scalable model. With an integrated solution system in place it is possible to build customization across various types of business. It also provides for standardization of specific industry segments which if Bank requires can become a niche player. Expand the product portfolio offered in Trade Finance ± With a clear visibility of document movement & physical movement of items. It is possible for banks to offer structured financing solutions to their clients. Funding can be staggered to meet the finance requirements at various stages of physical goods flow i.e. Customs clearance, duty payment, freight payment etc. Risk Mitigation - The biggest challenge in an open account trade is in confirming the authenticity of transaction, and in obtaining the correct picture of the flow at any given moment. With visibility provided by movement of trade documents through a Banks portal, Banks are well assured on these, which reduce their risk exposure.