Basic Concepts of Trade Finance

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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

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

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’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

• Providing assurance

for right quality of

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

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

For the seller:• Providing finance

• to arrange for

• to provide

credit to buyer

Seller’s BankBuyer’s Bank

Seller

Flow of Goods

Shipper

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

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

Seller Buyer

ForeignInland Foreign

CollectionPurchase/

Negotiation

Non LC

Inland

Collection LC Collection LCCollectionPurchase/

Negotiation

Remittance

Non LC

Seller

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