Trade Finance is the process of financing certain activities in international trade and commerce. It includes lending, factoring, letters of credit, insurance and export credit. Import and Export Companies, Financiers and Banks, Export Credit Agents and Insurers are the main participants in this form of financial service.
How Does it Work?
1. Repayment terms are short term.
2. Financing is considered a “safety-net” to assist and protect the interests of B2B, buyers, and sellers in the international marketplace, by ensuring that the efforts of all parties are completed satisfactorily, notably where multiple currencies are involved.
3. Trade Finance has developed into a broad ecosystem, contributing to the growth of international trade. The WTO (World Trade Organisation) estimates that 80% to 90% of international trade is reliant on this method of finance.
4. Insolvency or lack of funds are not reasons why a company will take Trade Finance. Instead, it is a prudent method of protection against currency fluctuation, political instability, non-payment problems or credit worthiness of involved parties.
- “A” (exporter) wants to be paid upfront for a shipment from “B” (importer).
- The risk to the “B” is that “A” could take the money and not send the goods.
- “A” (exporter) extends a personal line of credit to “B” (importer), only to find that “B” refuses to pay on delivery or delays payment indefinitely.
Trade Finance Solution:
- A “Letter of Credit” for the goods, which become “tradeable assets” is issued by the bank of “B” (importer) to “A’s” (exporter) name and with his home bank or finance house. This letter of credit guarantees payment to “A.” by “B.” upon proof of receipt of shipment.
- The Letter of Credit forms the legal document and the goods become the Tradeable Asset: The bank has a lien on the goods should they not be paid for.
- Although relatively cumbersome, this form of payment is still one of the most used financial mechanisms for International Trade Finance.
- Trade Finance takes many forms both for domestic and international shipping and covers pre and post shipment finance, direct payment to suppliers, loans, revolvers and Letters of Credit.
- The system is well known in the UK as a method of obtaining funds to bridge the gap between shipping and payment.
Pros and Cons of Trade Finance
- A tailored option for businesses that need to offer LCs or cash deposits to secure orders with suppliers, both locally and internationally
- Funding can be up to 100% of eligible purchase orders
- LC (Letter of Credit) might need to be “cash backed” or have a property asset as security.
- The Non-bank Fund Providers do not always require a Property Security. The caveat is that goods must be pre-sold and be a finished (fully manufactured and saleable) product. Anything which requires further manufacturing or packaging is not eligible for this funding option.