Trade Finance

Introduction

Trade Finance refers to financing of trade, both, domestic or international. Trade Finance helps in expanding business across borders and in connecting to businesses not familiar via a direct relationship.

Stakeholders

Trade Finance involves the following stake holders:

1.       Seller – Refers to producer of goods or services.

2.       Seller Bank/Financial Institution

3.       Buyer – Refers to purchaser of goods or services.

4.       Buyer Bank/Financial Institution

Requirement of Trade Finance

Trade Financing is required as Sellers/Buyers want to trade on various terms and condition (related to payment and procurement of products). Few of them are as follows:

·         Payment to seller only after the product is shipped/received by the buyer.

·         Seller ensures once the product is delivered, payment is guaranteed.

·         Financing the transaction cost to improve liquidity.

·         Covering the risks involved.

·         Exporters of goods and services many a times lack the support of the importing country’s establishment ex: banks/legal framework and the presence of seller in it.

·         Similarly, importers lack the support of establishment at exporters’ country. The importer might have problems routing the funds for transactions to exporters’ country.

 

Business Model

Business Model can be summarized in the following steps:

1.       Buyer/Seller presents itself to counterpart with a recommendation from a Bank/Financial Institution.

2.       Seller and Buyer enters into an agreement and starts the trade relationship.

3.       Buyer places an order.

4.       Seller ships the product.

5.       Seller produces relevant proof for product shipping, generally termed as “Bill of Lading”.

6.       Buyer Bank transfers the fund to seller and provides time to buyer for payment refund.

7.       Buyer Bank obtains a commission on the fund transferred for the duration it is not refunded.

8.       Seller Bank might obtains fees for the network services provided.

Banking/Financial Institutions provides the following methods for “facilitating transaction”:

1.  Letter of credit: It is an undertaking/promise given by a Bank/Financial Institute on behalf of the Buyer/Importer to the Seller/Exporter, that, if the Seller/Exporter presents the complying documents to the Buyer's designated Bank/Financial Institute as specified by the Buyer/Importer in the Purchase Agreement then the Buyer's Bank/Financial Institute will make payment to the Seller/Exporter.
2. Bank guarantee: It is an undertaking/promise given by a Bank on behalf of the Applicant and in favor of the Beneficiary. Whereas, the Bank has agreed and undertakes that, if the Applicant failed to fulfill his obligations either Financial or Performance as per the Agreement made between the Applicant and the Beneficiary, then the Guarantor Bank on behalf of the Applicant will make payment of the guarantee amount to the Beneficiary upon receipt of a demand or claim from the Beneficiary.

The problems of exporters/importers are generally resolved with the help of Financial Institutions/Banks which can act as guarantor as well as facilitator for the transactions.

Banks/Financial Institutions in return of the services provided charge fees to the seller and buyer.

Services offered by Financial Institutions can be as follows:

1.       Financing the Transactions. – Seller Bank or Buyer Bank, or both jointly can finance the deal between buyer and seller.

2.       Risk Coverage: Covering the risk during transit in return of a premium charged.

3.       Providing Network Services: Banks can extend their network/coverage to Seller/Buyer for making new relationships between seller and buyer.

4.       Transferring of funds globally using SWIFT (Society for Worldwide Interbank Financial Telecommunication).

Summary

Trade finance is of vital importance to the global economy, with the World Trade Organization estimating that 80 to 90% of global trade is reliant on this method of financing.