FIN 6002 – Session 30

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 HDFC, Mumbai

• This is Vostro accounts in the books of HDFC.

• Loro account – “Their account with them”

• CITI Bank referring to the Rupee account of HSBC Bank with HDFC,
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.
 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
Documentary Collections

• A documentary collection (D/C) is a transaction whereby the

exporter entrusts the collection of a payment to the remitting
bank (exporter’s bank), which sends documents to a collecting
bank (importer’s bank), along with instructions for payment.
• Funds are received from the importer and remitted to the
exporter through the banks in exchange for those documents.
• D/Cs involve using a bills of exchange (draft) that requires the
importer to pay the face amount either at sight (document
against payment [D/P]) or on a specified date (document
against acceptance [D/A]).
• In D/C, collecting bank acts as an agent for both buyers and
sellers and maintains control of the title documents, but it
does not contain an assurance of payment by the bank.
 The D/P transaction utilizes a sight Bills
of Exchange. Payment is on demand.

After the goods are shipped, the

exporter sends the sight draft to the
clearing bank, along with documents
D/P – necessary for the importer/buyer to
Documents obtain the goods from customs.

against The buyer has to settle the payment

Payment with the bank before the documents are
released and he can take delivery of the
goods.
If the buyer fails or refuses to pay, the
exporter has the right to recover the
goods and resell them.
 The D/A transaction utilizes a time bills of
exchange.

In this case, the documents required to take

possession of the goods are released by the
clearing bank only after the buyer accepts a time
D/A – draft drawn upon him.

Documents
against In essence, this is a deferred payment or credit
arrangement. The buyer’s assent is referred to
Acceptance as a trade acceptance.

D/A terms are usually after sight, for instance “at

90 days sight”, or after a specific date, such as
“at 150 days bill of lading date.”
 Process flow D/P
Seller ships the goods to the buyer’s country as per the
Step 1
sales contract.

Seller presents documents to the Remitting Bank with

Step 2
clear instructions for collection of payment.

Remitting Bank forwards the documents and collection

Step 3
instructions to the Collecting/Presenting Bank.

Collecting/Presenting Bank presents documents to the

Step 4
buyer for payment.

Step 5 Buyer pays for the document or take up import financing.

Collecting/Presenting Bank remits the net proceeds to the

Step 6
Remitting Bank after deducting its own charges.

Remitting Bank credits the net proceeds into the seller’s

Step 7
account after deducting its own charges.
 Authorized Money Changers

¢ Authorized Money Changers (AMCs) are entities,

authorized by the Reserve Bank under Section 10
of the Foreign Exchange Management Act, 1999.
¢ An AMC is a Full-Fledged Money Changer
(FFMC) authorized by the Reserve Bank to deal
in foreign exchange for specified purposes.
¢ Authorized Dealer Category - I Banks (AD
Category–I Banks),
¢ Authorized Dealers Category - II (ADs Category–
II)
¢ Full Fledged Money Changers (FFMCs).
 Trade Credit

• Trade Credits refer to the credits extended by the

overseas supplier, bank and financial institution for
maturity up to five years for imports into India.

• Depending on the source of finance, such trade

credits include suppliers’ credit or buyers’ credit.

• Suppliers’ credit relates to the credit for imports into

India extended by the overseas supplier.

• Buyers’ credit refers to loans for payment of imports

into India arranged by the importer from overseas
bank or financial institution.
 Buyers Credit
• Buyer’s Credit refers to loans for payment of imports
into India arranged by the importer from a bank or
financial institutions outside India.
• The supplier (exporter) is not ready to give any credit
while the buyer (importer) is also not in a position to
make immediate payment.
• The importer approaches his bank and requests for
arrangement of payment to the exporter on immediate
terms.
• The bank through their own resources or correspondent
relationships ties up with a foreign bank/financial
institution and after agreeing upon on the pricing and
costs.
• The importer’s bank provides a Letter of Undertaking
(LoU) or Letter of Comfort (LoC) to this foreign bank.
• Based on letter of undertaking of Importer’s bank,
foreign bank credits the Nostro of the importer’s bank
which in turn uses the funds to make payment to the
Suppliers bank against the import bill.
 Buyers Credit

• Regulated by exchange control guidelines issued

by RBI.

• Automatic Route: Banks are permitted to approve

trade credit up to USD 150 million or equivalent per
import transaction for oil/gas refining & marketing,
airline and shipping companies. For others, up to
USD 50 million or equivalent per import transaction.

• Cost of raising Trade Credit: The all-in-cost ceiling

for raising Trade Credit is Benchmark rate plus 250
bps spread.

• The all-in-cost include arranger fee, upfront fee,

management fee, handling/ processing charges,
out of pocket and legal expenses, if any.
 Process flow Buyers Credit
Step 1 Importer (Buyer) imports the goods under LC, D/A or D/P.

Buyer approaches its bank to arrange for banker’s credit

Step 2
before the due date of the bill.

The buyer’s bank through their correspondent

Step 3 relationships ties up with a foreign bank after agreeing for
costs.

Buyer’s bank provides LoC/LoU in favor of the overseas

Step 4
bank through SWIFT.

As per the instructions provided in LoC/LoU, the overseas

Step 5 bank either directly credits the exporter’s bank or credit
the nostro account.

On due date importer’s bank will recover principal and

Step 6 interest from importer and remit the same to overseas
bank.
 Export Credit

¢ The RBI first introduced the scheme of Export Financing in 1967.

¢ The scheme is intended to make short-term working capital finance
available to exporters at internationally comparable interest rates.
¢ Export credit is available both in rupee as well as in foreign currency.
¢ Pre-shipment - working capital requirements till the shipment stage – for
purchase of raw materials, manufacturing, processing, packaging,
transportation, and warehousing of goods.
¢ Post-shipment - credit facility extended after goods are shipped. Working
capital requirements locked in the form of export receivables during the
period of shipment of goods to the realization of export proceeds.
 Rupee Pre-shipment Credit/Packing
Credit
¢ 'Pre-shipment / Packing Credit’ - means any loan or advance granted by a bank
to an exporter for financing the purchase, processing, manufacturing or packing of
goods prior to shipment / working capital expenses towards rendering of services
on the basis of letter of credit opened in his favour by an overseas buyer.
¢ Packing credit is generally provided to eligible exporters when it lodges
irrevocable LCs established by the foreign buyer in their favor through a
reputed bank.
¢ Copies of confirmed orders or contracts placed by the foreign buyers to the Indian
exporter may also be accepted for this purpose.
¢ Computation of export credit limits are outside the purview of Maximum
Permissible Banking Finance (MPBF).
¢ Margin requirements are little lower in comparison to a normal WC.
¢ The period for which a packing credit advance will be given is decided by
individual banks.
 Running Account Facility
¢ Pre-shipment credit to exporters is normally provided on lodgment of LCs or firm
export orders.

¢ Availability of raw materials is seasonal in some cases. In some other cases, the
time taken for manufacture and shipment of goods is more than the delivery
schedule as per export contracts.

¢ In many cases, the exporters have to procure raw material, manufacture the
export product and keep the same ready for shipment, in anticipation of receipt of
letters of credit / firm export orders from the overseas buyers.

¢ Having regard to difficulties being faced by the exporters in availing of adequate

pre-shipment credit in such cases, banks have been authorized to extend Pre-
shipment Credit Running Account Facility in respect of any commodity, without
insisting on prior lodgment of letters of credit / firm export orders

¢ Interest rate charged on EPC account are in general lower.

 Exchange Earners Foreign Currency
A/C (EEFC A/C)

¢ An account maintained in foreign currency with an Authorized Dealer

Category - I bank

¢ It is a facility provided to the foreign exchange earners, including

exporters, to credit 100 per cent of their foreign exchange earnings to the
account, so that the account holders do not have to convert foreign
exchange into Rupees and vice versa, thereby minimizing the transaction
costs.

¢ Maintained only in the form of non-interest-bearing current account.

¢ No credit facilities, either fund-based or non-fund based is permitted

against the security of balances held in EEFC accounts.
 Pre-shipment Credit in Foreign
Currency (PCFC)

¢ EPC facility in foreign currencies - Pre-shipment Credit in Foreign Currency

(PCFC)

¢ Making credit available to exporters at internationally competitive rates.

¢ Exporters normally resort to this mode when they feel that Rupee may not
depreciate much in comparison to the currency in which the credit is
denominated.

¢ PCFC is available in US Dollars, Pound Sterling, Japanese Yen, Euro

¢ Is available for a maximum of 360 days (initially for 180 days which can be
extended further to a maximum of 360 days).