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Trade Finance
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International Trade Finance has been one of the important functions of international banking. Retreating from sovereign lending as a result of the recent world debt crisis, many banks have returned to Trade Finance financing as the core of their business.
International Trade Finance involves two-way transactions. One is the delivery of the goods or services and the other is making payment. Banks provides services to facilitate both delivery of goods and making payment. A buyer and seller in international transactions are separated by distance as well as by national boundaries, each party faces greater potential risks. The exporter is particularly concerned about the buyers potential payment default, while the importer is concerned about the sellers potential delivery.
When there is a time gap between shipment of goods (or delivery of services) and the payment, either the seller or the buyer must bear trade financing cost. If the payment is made after the shipment of goods, the exporters bears the cost. Conversely, if the payment is made before receiving goods, the importer bears the burden. The required documentation for international trade transactions is essential to discern clear responsibility of each party involved so that disputes arising from ambiguity can be minimized. The various methods of payments results in alternative methods of trade financing.
Methods of payment in International Trade:
The method of payment for Exporters and Importers is important because it determines who is going to bear the greater risk and who is going to pay Trade Finance financing cost. The incidence of trade financing cost depends on the selling price, which is in turn determined by the supply and demand for the goods. An elastic supply curve shifts the burden to buyers. The four basic methods of payments and their relative advantage and disadvantages for the exporters and importers are 1) Cash deposit in advance 2) Open account 3) Documentary draft for collection and 4) Documentary letters of Credit.
In Cash deposit in advance terms, the seller requests payment in cash in whole or in part before shipping the merchandise. Advance payment is customarily requested when a buyer places a special order to the seller to produce tailor-made products for which the seller may not be able to find ready buyers.
In Open account the goods are sold on credit terms, as agreed between the seller and the buyer, and payment is due in a specified number of days after the invoice date. An open account sale does not accompany any negotiable instrument such as a bill of exchange or a promissory note evidencing the buyers payment obligation. This method of payment, the importer has the major advantage, since she receives the merchandise before making payments.
In Documentary drafts for collections after shipment of goods, the exporter forwards shipping and other documents plus a payment order ( a draft drawn on the importer) through his bank to the importers bank for collection. The draft orders the importer to pay how or to pay later, as stipulated in the sales contract. The draft accepted by the buyer for a later payment is termed a trade acceptance. In forwarding a set of documents, the exporter instructs the collection bank not to release the documents to the importer unless the later makes the sight payment or accepts the draft for time payment. In certain cases the exporter may request for an endorsement of a third party on the accepted draft. The document collection method is the most widely used methods of payments for exports of goods and services to foreign buyers.
In Documentary Letter of Credits is one of the most common instruments used to facilitate international Trade Finance and its financing. A Letter of credit is a notification letter issued by a bank to the seller stating that it will make payment on behalf of the buyer under specified conditions. On behalf of the buyer, the letter of credit bank stands as the first obligor, whose credit standing is purportedly higher than the buyer. Both buyer and seller are protected by letter of credit similar to documentary collections as it sets forth the pre-condition for payment, which are in essence to require presentation of stated documents. Letter of Credits may be issued in revocable or irrevocable form. Letter of credit, the source of credit risk shifts from the buyer to the letter of credit bank. The exporter still faces two types of risks 1) Credit risk originating from the letter of credit bank which may be unknown to him and 2) Cross border transfer risk.
Export/Import Documentation and Terms and Conditions of Sales:
Documentation in international trade transactions is of great importance, which are commonly used for several purposes. First they are used to give a general indication that the exporter has fulfilled his obligations. Secondly, a certain document is specifically prepared to claim payment. Thirdly, some documents are used to give further indications that merchandise to be shipped by the exporter purportedly meets the specifications of the contracts. Fourth, in addition to other documents, certain documents are specifically required to clear the merchandise through ports of entry or exit. Fifth, documents are also prepared for the buyers convenience in handling and warehousing merchandise. Finally, because of high transit risks in transporting goods between countries, documents are needed to give evidence of reasonable coverage of such risks to comfort and to protect parties involved. Insurance policies or certificate of insurance are needed for this purpose. The document are A bill of lading, Export Drafts, Commercial invoice, Insurance policy or certificate, other certificate etc..,
Terms and conditions of Sales:
To minimize the potential disputes, international sales contract should be drawn to stipulate the exact obligations of each party. It should include a merchandise sold, price, method of payment, shipping arrangements, and designation of the payers of various charges such as shipping charges, insurance, taxes, analysis fees, and weighing fees. Other shipping arrangement to be taken care are Ex-factory, Free on board, Cost, insurance and freight charges etc..
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