Finance trade & loan agreement methods

Barter Trade is not a very viable proposition for the 21st Century as markets, international finances currency valuation take place in commodity exchanges where purchase point of delivery and ultimate consumer might not be in the same lane. 

SOURCES AND INSTRUMENTS FOR FINANCIAL TRADE

1. Sources of trade finance

2. Instruments of trade finance

3. Impediments/Challenges in accessing trade finance

Financing trade is different than regular bank lending. It includes innovative financial products and services that assist importers and exporters fulfill their financing needs. Trade Finance is a source of working capital for many traders in need of credit lines to purchase, process or manufacture products for sale in the future. These financial instruments can be important for individual traders and firms trading internationally, because it can shape competitiveness on their terms of trade contracts. As a market expands so is the need for financing instruments that facilitate transactions across borders.

Any nation that does not have access to financial instruments can be considered blocked from trade. Importers or exporters not having access to trade finance, have limited opportunities to offer competitive terms to their vendors or buyers such as instruments of credit and payment assurance. Exporters will also have difficulties penetrating a market, because importer may prefer to buy on open account, or on deferred terms, the exporter may not be in position to accept/offer such terms if trade finance is unavailable.

Commercial Banks are the main source of trade finance.

1. Provide pre-export financing (Term Loans)

2. Help in the collection process

3. Issue and confirm letters of credit

4. Book acceptance and discounting drafts

5. Offer fee-based services such as credit and country information on buyers.

6. Taking foreign exchange risks (spot, forward, swap and so on)

7. Taking market risks (options, futures)

8. Discounting documents under letters of credit

9. Advance under red clause letters of credit

10. Structured Finance

For example a supplier can offer credit to a buyer by releasing goods against bills of exchange, by which a seller can pay at a specified future date.

Specialized trading institutions purchase from exporters receivables without recourse at a discounted rate to allow them access to financing before maturity of the bill. In this case the receivable becomes a tradable security

Governments and other institutions like World Bank, regional bank, community bank can be good source of trade finance especially in less developed economies where financial markets and money markets are not easily available.

Such financial facilitation include:

1. Establish scheme of guarantees to support exporters

2. Establish floating line of credit to support imports for and exports from specific sectors

3. Establish guarantees schemes for small companies or micro group

4. Support trade facilitation policies, e.g. tax deferral for export/import on extended terms

Sources of Trade Finance: Government and other related institutions

1. Letters of Credit (Documentary Credit)

2. Bank Guarantees

3. Pre and Post shipment finance loan facilities

4. Buyers and Sellers credit

5. Bills Acceptance

6. Structured Finance

7. Leasing

8. Factoring and Forfeiting

9. Counter-trade

A Letter of Credit is a document issued by a bank (issuing bank) stating its commitment to pay a seller (beneficiary) a stated amount of money on behalf of a buyer so long as the seller presents specific documents and conditions.

• Letters of Credit can be issued as “Revocable” or “Irrevocable” form and are either “Unconfirmed” or “Confirmed”, payable at “Sight” or at a deferred period “Use”
• Letters of Credit can also be special types, namely: Revolving letters of credit, Standby Letter of Credit (SBLC), Red Clause letters of credit, Transferable letter of credit, and Back-to-back letters of credit.
• Letters of credit issued against L/C facility allows importer to delay payments to exporter, thus easing cash flow problems and interest expenses. It allows supplier to access credit against presentation of documents at the counters of negotiating bank without waiting for goods to reach the buyer. It allows buyer to obtain credit terms from a seller under active period or differed L/C terms whereby the bank books acceptance for payment of bills to be made at future agreed date (maturity date).
• Supplier can discount documents and obtain credit before due date.
• Red clause Letters of credit allows exporter to obtain pre-export advance payment
• A Letter of guarantee is a written promise issued by the Bank to compensate the beneficiary (third party, local or foreign) in the event that the obligor (customer) fails to honor its obligations in accordance with the terms and conditions of the guarantee/agreement/contract. Types include Bid, Custom, Payment, Performance, Advance payment, Government export guarantees etc.
• Advance payment guarantee allows its beneficiary to access advance payments to facilitate procurement or production of goods for delivery to the intended party
• Custom Bonds allow a buyer or seller to postpone payment of tax until the goods are sold
• Customs Bonds for Temporary Transit facilitates movement of goods on transit or sent abroad for a trade fair, or goods, which are imported with intention of re-exportation without paying related custom duties.
• Structured finance refers to transferring risks in trade financing from parties less able to bear those risks to those better equipped to bear them in a manner that ensures automatic reimbursement of advances from the underlying assets.

Some examples of structured finance include:

1. 1. Inventory/Ware house financing
2. 2. Receivable financing
3. Leasing
4. Factoring and forfeiting are both forms of receivables discounting
5. A specialized financial firm pays up-front for the amounts due to them by their customers.
6. While forfeiting is mostly used for international transactions, factoring is mostly used for domestic trade. Factoring is the assignment to a third party receivables from its customers for a discounted factor (fee) in different ways:
7. Advance-based factoring
8. Maturity-based factoring
9. Collection-based factoring

• Forfeiting is a term generally used to denote the purchase of obligations falling due at some future date, from deliveries of goods and services-mostly export transactions-without recourse to any previous holder of the obligation.
• In a forfeiting transaction, an exporter/seller remits guaranteed debt, which results from a sale on credit, to a forfeiting company.
• The forfeiting company pays a seller up-front for the face value of the debt minus a discounted factor.
• The debt has to be enhanced through guarantee from a bank or other financially strong institution.
• Once the debt has been accepted by the forfeit er, the exporter is no longer liable for a failure of the buyer to pay-the forfeit er, except where there was fraudulent transaction.
• Counter-trade involves the exchange of goods and/or services as a condition of purchase, or as financing of purchases as in bartering.
• Under such arrangements valued goods are exchanged at an agreed value without cash or credit terms.

This method of trade is particularly valuable in markets where there is a shortage of foreign exchange reserves, where the currency is not freely convertible, or where there is difficulty in obtaining export credit. It is method for a range of reciprocal or compensatory trade mechanisms including barter, compensation, counter-purchase, buyback- offset, switch trading and tolling.