13576808 International Trade Finance

8/12/2019 13576808 International Trade Finance

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Chapter 23

International Trade

Finance


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The Trade Relationship

Trade financing shares a number of common characteristics withthe traditional value chain activities conducted by all firms.

All companies must search out suppliers for the many goods andservices required as inputs to their own goods production or

service provision processes. Issues to consider in this process include the capability of

suppliers to produce the product to adequate specifications, deliversaid products in a timely fashion, and to work in conjunction on

product enhancements and continuous process improvement.

All of the above must also be at an acceptable price and paymentterms.


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The Trade Relationship

The nature of the relationship between the exporter andthe importer is critical to understanding the methodsfor import-export financing utilized in industry.

There are three categories of relationships (see nextexhibit):

Unaffiliated unknown

Unaffiliated known

Affiliated (sometimes referred to as intra-firm trade)

The composition of global trade has changeddramatically over the past few decades, moving fromtransactions between unaffiliated parties to affiliatedtransactions.


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Exhibit 23.1 Alternative International

Trade Relationships

UnaffiliatedKnown Party

A long-term customer

with which there is an

established relationship of

trust and performance

UnaffiliatedUnknown Party

A new customer

which with exporter has

no historical business

relationship

AffiliatedParty

A foreign subsidiary

or affiliate

of exporter

Requires:

1. A contract

2. Protection against

non-payment

Requires:

1. No contract

2. No protection against

non-payment

Requires:

1. A contract

2. Possibly some protection

against non-payment

Exporter

Importer is .


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The Trade Dilemma

International trade (i.e. between and importer andexporter) must work around a fundamental dilemma:

They live far apart

They speak different languages They operate in different political environments

They have different religions

They have different standards for honoringobligations

In essence, there could be distrust, and clearly theimporter and exporter would prefer two differentarrangements for payment/goods transfer (next exhibit)


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Exhibit 23.2 The Mechanics of Import and Export

Importer

Importer

Exporter

Exporter

Importer Preference

Exporter Preference

1st: Exporter ships the goods

2nd

: Importer pays after goods received

1st: Importer pays for goods

2nd: Exporter ships the goods after being paid


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The Trade Dilemma

The fundamental dilemma of being unwillingto trust a stranger in a foreign land is solved byusing a highly respected bank as an

intermediary. The following exhibit is a simplified view

involving a letter of credit(a banks promise topay) on behalf of the importer.

Two other significant documents are an orderbill of ladingand asight draft.


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Exhibit 23.3 The Bank as the Import/Export Intermediary

Importer

Exporter

Bank

1st: Importer obtains banks promise

to pay on importers behalf.

2nd: Bank promises exporterto pay on behalf of importer.

3rd

: Exporter ships to the banktrusting banks promise.

4th: Bank pays the

exporter.

6th: Importer pays

the bank.

5th: Bank gives merchandise

to the importer.


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Benefits of the System

The system (including the threedocuments discussed) has beendeveloped and modified over centuries to

protect both importer and exporter from:The risk of noncompletion

Foreign exchange risk

To provide a means of financing


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Elements of an Import/Export

Transaction

Each individual trade transaction must cover threebasic elements: description of goods, prices, anddocuments regarding shipping and deliveryinstructions.

Contracts:

An import or export transaction is by definition a contractualexchange between parties in two countries that may havedifferent legal systems, currencies, languages, religions or

units of measure All contracts should include definitions and specifications for

the quality, grade, quantity, and price of the goods in question


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Transaction

Prices:

Price quotations can be a major source ofconfusion

Price terms in the contract should conformto published catalogs, specify whetherquantity discounts or early paymentdiscounts are in effect, and state whether

finance charges are relevant in the case ofdeferred payment, and should address otherrelevant fees or charges


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Transaction

Documents:

Bill of ladingissued to the exporter by a common carriertransporting the merchandise

Commercial invoiceissued by the exporter and contains a

precise description of the merchandise (also indicates unitprices, financial terms of the sale etc.)

Insurance documentsspecified in the contract of sale andissued by insurance companies (or their agents)

Consular invoicesissued in the exporting country by the

consulate of the importing country

Packing lists


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International Trade Risks

The following exhibit illustrates the sequenceof events in a single export transaction.

From a financial management perspective, the

two primary risks associated with aninternational trade transaction are currency risk(currency denomination of payment) and riskof non-completion(timely and complete

payment).

The risk of default on the part of the importeris present as soon as the financing period

begins.


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Exhibit 23.4 The Trade Transaction Time-Line

and Structure

Time and Events

Price

quote

request

Export

contract

signed

Goods

are

shipped

Documents

are

accepted

Goods

are

received

Negotiations Backlog

Documents Are

Presented

Cash

settlement

of the

transaction

F inancing Peri od


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Letter of Credit (L/C)

A letter of credit (L/C) is a banks conditionalpromise to pay issued by a bank at the requestof an importer, in which the bank promises to

pay an exporter upon presentation ofdocuments specified in the L/C.

An L/C reduces the risk of noncompletionbecause the bank agrees to pay against

documents rather than actual merchandise.

The following exhibit shows the relationshipbetween the three parties.


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Exhibit 23.5 Parties to a Letter of Credit (L/C)

I ssuing Bank

Beneficiary(exporter)

Applicant(importer)

The relationship between the importer and the

exporter is governed by the sales contract.

The relationship between the

importer and the issuing bank is

governed by the terms of the

application and agreementfor the letter of credit (L/C).

The relationship between the

issuing bank and the exporter

is governed by the terms of the

letter of credit, as issued bythat bank.


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The essence of the L/C is the promise of the issuing bank to payagainst specified documents, which must accompany any draft drawnagainst the credit.

To constitute a true L/C transaction, all of the following five elementsmust be present with respect to the issuing bank:

Must receive a fee or other valid business consideration for issuingthe L/C

The L/C must contain a specified expiration date or definitematurity

The banks commitment must have a stated maximum amount of

money The banks obligation to pay must arise only on the presentation of

specific documents

The banks customer must have an unqualified obligation toreimburse the bank on the same condition as the bank has paid


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Commercial letters of credit are also classified:

Irrevocable versus revocable

Confirmed versus unconfirmed

The primary advantage of an L/C is that it reduces riskthe exporter can sell against a banks promise to payrather than against the promise of a commercial firm.

The major advantage of an L/C to an importer is that

the importer need not pay out funds until thedocuments have arrived at the bank that issued the L/Cand after all conditions stated in the credit have beenfulfilled.


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Exhibit 23.6 Essence of a Letter of Credit (L/C)

Bank of the East, Ltd.[Name of I ssuing Bank]

Date: September 18, 2003

L/C Number 123456

Bank of the East, Ltd. hereby issues this irrevocable documentary Letter of Credit

to Jones Company [name of exporter] for US$500,000, payable 90 days after sight

by a draft drawn against Bank of the East, Ltd., in accordance with Letter of

Credit number 123456.

The draft is to be accompanied by the following documents:

1. Commercial invoice in triplicate

2. Packing list3. Clean on board order bill of lading

4. Insurance documents, paid for by buyer

At maturity Bank of the East, Ltd. will pay the face amount of the draft to the

bearer of that draft.Authori zed Signature


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Draft

A draft, sometimes called a bill of exchange(B/E), isthe instrument normally used in internationalcommerce to effect payment.

A draft is simply an order written by an exporter(seller) instructing and importer (buyer) or its agent to

pay a specified amount of money at a specified time.

The person or business initiating the draft is known asthe maker, drawer, or originator.

Normally this is the exporter who sells and ships themerchandise.

The party to whom the draft is addressed is the drawee.


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Exhibit 23.7 Essence of a Time Draft

Name of ExporterDate: October 10, 2003

Draft number 7890

Ninety (90) days after sight of this First of Exchange, pay to the order of Bank

of the West [name of exporters bank] the sum of Five-hundred thousand U.S.

dollars for value received under Bank of the East, Ltd. letter of credit

number 123456.

Signature of Exporter


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Bill of Lading (B/L)

The third key document for financinginternational trade is the bill of ladingor B/L.

The bill of lading is issued to the exporter by a

common carrier transporting the merchandise.

It serves three purposes: a receipt, a contract,and a document of title.

Bills of lading are either straight or to order.


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Exhibit 23.8 Steps in a Typical Trade Transaction

Exporter

Bank X Bank I

Importer

Public

Investor

1. Importer orders goods

2. Exporter agrees to fill order

6. Exporter ships goods to Importer

4. Bank I sends

L/C to Bank X

9. Bank I accepts draft, promising to pay in 60

days, and returns accepted draft to Bank X

7. Exporter presents

draft and documents

to its bank, Bank X

12. Bank I obtains

importers note

and releases shipment

3. Importer

arranges L/C

with its bank

13. Importerpays

its bank

8. Bank X presents draft and

documents to Bank I

5. Bank X

advises

exporter

of L/C 10. Bank X sells

acceptance to investor

14. Investor presents acceptance

and is paid by Bank I

11. Bank Xpays

exporter


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Government Programs

to Help Finance Exports

Governments of most export-oriented industrialized countrieshave special financial institutions that provide some form ofsubsidized credit to their own national exporters.

These export finance institutions offer terms that are better thanthose generally available from the competitive private sector.

Thus domestic taxpayers are subsidizing lower financial costs forforeign buyers in order to create employment and maintain atechnological edge.

The most important institutions usually offer export credit

insurance and a government-supported bank for export financing.


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Export Credit Insurance in India

Provided by Export Credit & GuaranteeCorporation of India (ECGC).

ECGC provides a range of services to

exporters against loss of goods.

Offers guarantees to banks and financialinstitutions which are involved in export

financing. Provided overseas investment insurance

to Indian companies investing abroad.


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EXIM Bank of India

Exim Bank of India, provides financial assistance to promoteIndian exports through:

1. Direct financial assistance,

2. Overseas investment finance,

3. Term finance for export production and export development,

4. Pre-shipping credit,5. Buyer's credit,

6. Lines of credit,

7. Relending facility,

8. Export bills redixcounting,

9. Refinance to commercial banks.10. The Exim Bank also extends non-founded facility to Indian

exporters in the form of guarantees.


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Setting Up EOUs

The Government amended in November 1983 aconcession scheme to facilitate the setting upof export-oriented units (EOUs) in order toenable them to meet requirements of foreign

demand in terms of pricing, quality, precisionetc.

EOUs can be set up anywhere in the countryand may be engaged in the manufacture and

production of software, floriculture,horticulture, agriculture, aquaculture, animalhusbandry, pisciculture, poultry and sericultureor other similar activities.


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Marketing Finance from EXIM Bank

Exim Bank seeks to create and enhance exportcapabilities and international competitivenessof Indian companies.

Under the lending programme for ExportMarketing Finance, the Banks addresses theterm finance reqirement for a structured andstrategic export marketing and development

effort of companies.


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Trade Financing Alternatives

In order to finance international tradereceivables, firms use the same financinginstruments as they use for domestic tradereceivables, plus a few specialized instrumentsthat are only available for financinginternational trade.

There are short-term financing instruments and

longer-term instruments in addition to the useof various types of barter to substitute for theseinstruments.


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Forfaiting

Forfaiting is a specialized technique to eliminate therisk of nonpayment by importers in instances where theimporting firm and/or its government is perceived bythe exporter to be too risky for open account credit.

The following exhibit illustrates a typical forfaitingtransaction (involving five partiesimporter, exporter,forfaiter, investor and the importers bank).

The essence of forfaiting is the non-recourse sale by an

exporter of bank-guaranteed promissory notes, bills ofexchange, or similar documents received from animporter in another country.


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Exhibit 23.10 Typical Forfaiting Transaction

Exporter(private industrial firm)

Importer(private firm or government

purchaser in emerging market)

FORFAITER(subsidiary of a

European bank)

Importers Bank(usually a private bank in

the importers country

Investor(institutional or individual)

Step 1

Step 3

Step 2

Step 7

Step 5

Step 4

Step 6


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Countertrade

The word countertraderefers to a variety ofinternational trade arrangements in which goods andservices are exported by a manufacturer withcompensation linked to that manufacturer accepting

imports of other goods and services. In other words, an export sale is tied by contract to an

import.

The countertrade may take place at the same time as

the original export, in which case credit is not an issue;or the countertrade may take place later, in which casefinancing becomes important.


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International Trade Financing by

Commercial Banks in India.

Indian commercial banks offer Trade finance related fund needsfor both pre shipment and post shipment activities.

1. Various schemes to provide financing to exporters are as follows.

Rupee Export Credit (Pre-Shipment and Post-Shipment) Pre-Shipment Export Credit Post-Shipment Export Credit Pre-Shipment Credit in Foreign Currency (PCFC) Getting Started - Opening a PCFC Operating PCFC Export Bill Rediscounting

Letter of Credit2. Various schemes to provide financing to importers are as follows.

Foreign Currency import credit Supplier's credit

13576808 International Trade Finance

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