Basic Concepts of Trade Finance

What is Trade Finance

TRADE FINANCE+

TRADE FINANCE

Business Objectives of the Players

• Desired quantity and quality of the goods in time

• A managed cash flow, with bank finance

• An assuring third party

• Convenient payment channel

• Protection against regulatory errors

Buyer Seller

• Timely payment

• Bank finance for buyer’s credit & goods arrangement

• An assuring third party

• Payment to be received at own location

• Protection against regulatory errors

Risks Involved in Trade Finance

Seller runs a risk of non-payment even when he has delivered the goods

Buyer Seller

Payment on Delivery

1

X


Buyer runs a risk of non-delivery of goods or poor quality of goods even when he has paid the money

Buyer Seller

Advance payment

1

X

Risks Involved for the Players

• Non-delivery / delayed delivery of goods

• Short shipment/inferior goods

• Goods received before the documents

• Foreign exchange fluctuation

• Regulatory changes

Buyer Seller

• Non-payment/Delayed payment

• Exchange risk

• Foreign exchange fluctuation

• Regulatory changes

Role of the Bank

The Buyer’s bank can assist in:

• Providing payment assurance to seller on behalf of the buyer

• Providing assurance for right quality of goods

• Providing finance in respect of the sale

• Effecting payment to the seller on behalf of the buyer

• Handling documents covering the sale

Bank’s business interests are:

• Providing finance

• Providing fee based services

• Risk mitigation

Buyer

Buyer’s Bank

Role of the Bank

The seller’s bank can assist in:

• Assuring payment as a third party


• to arrange for goods

• to provide credit to buyer

• Handling documents for regulatory

requirements

• Obtaining payment for seller

Bank’s business interests are:


• Providing fee based services

• Risk mitigation

Seller

Seller’s Bank

Trade Finance Products: Assurance

Bank’s products

• Letter of Credit

• Bank Guarantee

For the buyer

• Providing payment

assurance to seller

on behalf of the

buyer

• Providing assurance

for right quality of

goods

For the seller

• Assuring

payment as a

third party

Trade Finance Products: Payment

Bank’s products

• Bills for Collection

• Remittance

For the buyerEffecting payment

to the seller on

behalf of the

buyer

For the SellerObtaining payment for seller

Trade Finance Products: Finance

Bank’s products: • Negotiation /

Purchase of Bills (Post-shipment)

• Packing Credit(pre-shipment)*

• Term Loans*

For the buyer:• Providing

finance in

respect of the

sale

For the seller:• Providing finance

• to arrange for

goods

• to provide

credit to buyer

Buyer

Seller’s BankBuyer’s Bank

Seller

Flow of Goods

Shipper

Buyer


Seller

Flow of Documents

Shipper

Documents can flow in 3 directionsa) Seller - Buyerb) Seller - Buyer’s bank - Buyerc) Seller - Seller’s Bank - Buyer’s Bank - Buyer

Buyer


Seller

Flow of Payments

Shipper

Inland vs. Foreign

• If the seller and buyer are from the same country it becomes an Inland product

• These products are simpler because of the absence of exchange/trade control requirements

Service Tree for Trade Finance

Bills

Seller Buyer

ForeignInland Foreign

CollectionPurchase/

Negotiation

LC

Non LC

Inland

Collection LC Collection LCCollectionPurchase/

Negotiation

Remittance

LC

Non LC


Seller

Buyer

WAR!

If the players are in different countries, they face Country Risk.

Risks go up as the situation becomes more complex

Critical Risk Considerations

• Transport-related risks (damage, loss, theft)

• Credit risk or non-payment risk

• Quality of goods risk

• Exchange rate risk

• Unforeseen events

• Legal risks

• Country risk/Political risk

• Fraud risk

• The risk of misunderstanding

How Would the Bank Mitigate Risks

• Transport – related risks (damage, loss, theft)

• Credit risk or non-payment risk

• Quality of goods risk

• Exchange rate risk

• Legal risk

• Country risk / Political risk

• Fraud risk

• The risk of misunderstanding

• Ensuring insurance coverage/ carrier’s liability

• Ensuring credit-worthiness of party: Financial standing, quality of goods being sold

• Proper document scrutiny • Forward cover• Procedures verified by legal

experts• Taking cover• Substantial credit and

compliance scrutiny• Well-drafted contracts

Risk MitigationRisk