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Trade finance is a phrase used to describe different strategies that are employed to make international trade easier. It signifies financing for trade, and it concerns both domestic and international trade transactions. A trade transaction requires a seller of goods and services as well as a buyer. Various intermediaries such as
bank A bank is a financial institution that accepts Deposit account, deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital m ...
s and
financial institutions Financial institutions, sometimes called banking institutions, are business entities that provide services as intermediaries for different types of financial monetary transactions. Broadly speaking, there are three major types of financial insti ...
can facilitate these transactions by financing the trade. Trade finance manifest itself in the form of letters of credit (LOC), guarantees or insurance and is usually provided by intermediaries.


Description

While a seller (or
exporter An export in international trade is a good produced in one country that is sold into another country or a service provided in one country for a national or resident of another country. The seller of such goods or the service provider is an ...
) can require the purchaser (an
importer An import is the receiving country in an export from the sending country. Importation and exportation are the defining financial transactions of international trade. In international trade, the importation and exportation of goods are limited ...
) to prepay for goods shipped, the purchaser (importer) may wish to reduce risk by requiring the seller to document the goods that have been shipped.
Bank A bank is a financial institution that accepts Deposit account, deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital m ...
s may assist by providing various forms of support. For example, the importer's bank may provide a
letter of credit A letter of credit (LC), also known as a documentary credit or bankers commercial credit, or letter of undertaking (LoU), is a payment mechanism used in international trade to provide an economic guarantee from a creditworthy bank to an ex ...
to the exporter (or the exporter's bank) providing for payment upon presentation of certain documents, such as a
bill of lading A bill of lading () (sometimes abbreviated as B/L or BOL) is a document issued by a carrier (or their agent) to acknowledge receipt of cargo for shipment. Although the term historically related only to carriage by sea, a bill of lading may toda ...
. The exporter's bank may make a loan (by advancing funds) to the exporter on the basis of the export contract. Other forms of trade finance can include export finance,
documentary collection A documentary collection is a process in which a seller instructs their bank to forward documents related to the export of goods to a buyer's bank with a request to present these documents to the buyer for payment, indicating when and on what condi ...
, trade credit insurance, fine trading, factoring,
supply chain finance Supply chain financing (or reverse factoring) is a form of financial transaction wherein a third party facilitates an exchange by financing the supplier on the customer's behalf. Also it refers to the techniques and practices used by banks and ...
, or
forfaiting In trade finance, forfaiting is a service providing medium-term financial support for export/import of capital goods. The third party providing the support is termed the forfaiter. The forfaiter provides medium-term finance to, and will commonl ...
. Some forms are specifically designed to supplement traditional financing. Export finance - When an exporter’s operating cycle (length of time it takes to sell its inventory and collect on its sales) exceeds the credit terms extended by its trade creditors (suppliers), the exporter has a financing requirement. Export finance is needed to cover the gap between when an exporter is able to turn inventory and trade receivables to cash and when it has to pay on its trade payables.What is Export Finance?
/ref> Secure trade finance depends on verifiable and secure tracking of physical risks and events in the chain between exporter and importer. The advent of new information and communication technologies allows the development of risk mitigation models which have developed into advance finance models. This allows very low risk of advance payment given to the Exporter, while preserving the Importer's normal payment credit terms and without burdening the importer's
balance sheet In financial accounting, a balance sheet (also known as statement of financial position or statement of financial condition) is a summary of the financial balances of an individual or organization, whether it be a sole proprietorship, a business ...
. As trade transactions become more flexible and increase in volume, demand for these technologies has grown.


Products and services

Banks and financial institutions offer the following products and services in their trade finance branches. *
Letter of credit A letter of credit (LC), also known as a documentary credit or bankers commercial credit, or letter of undertaking (LoU), is a payment mechanism used in international trade to provide an economic guarantee from a creditworthy bank to an ex ...
: 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. *
Bank guarantee A bank guarantee is a kind of guarantee from a lending organization. The bank guarantee signifies that the lending institution ensures that the liabilities of a debtor are going to be met. In other words, if the debtor fails to perform the obligat ...
: It is an undertaking/promise given by a Bank on behalf of the Applicant and in favour 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. Bank guarantee has various types like 1. Tender Bond 2. Advance Payment 3. Performance Bond 4. Financial 5. Retention 6. Labour 7. ready for basic analysis *
Export An export in international trade is a good produced in one country that is sold into another country or a service provided in one country for a national or resident of another country. The seller of such goods or the service provider is a ...
*
Import An import is the receiving country in an export from the sending country. Importation and exportation are the defining financial transactions of international trade. In international trade, the importation and exportation of goods are limited ...
* Collection and discounting of bills: It is a major trade service offered by the Banks. The Seller's Bank collects the payment proceeds on behalf of the Seller, from the Buyer or Buyer's Bank, for the goods sold by the Seller to the Buyer as per the agreement made between the Seller and the Buyer. Supply Chain intermediaries have expanded in recent years to offer importers a funded transaction of individual trades from foreign supplier to importers warehouse or customers designated point of receipt. The Supply Chain products offer importers a funded transaction based on customer order book.


Methods of payment

Popular methods of
payment A payment is the voluntary tender of money or its equivalent or of things of value by one party (such as a person or company) to another in exchange for goods, or services provided by them, or to fulfill a legal obligation. The party making the ...
used in
international trade International trade is the exchange of capital, goods, and services across international borders or territories because there is a need or want of goods or services. (see: World economy) In most countries, such trade represents a significa ...
include: Advance payment- the buyer arranges for their bank to pay the supplier around 30% of the order value upfront when ordering, and the other 70% when the goods are released or shipped. Letter of credit (L/C) - this document gives the seller two guarantees that the payment will be made by the buyer :one guarantee from the buyer's
bank A bank is a financial institution that accepts Deposit account, deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital m ...
and another from the seller's bank. Bills for collection (B/E or D/C) - here a
bill of exchange A negotiable instrument is a document guaranteeing the payment of a specific amount of money, either on demand, or at a set time, whose payer is usually named on the document. More specifically, it is a document contemplated by or consisting of a ...
(B/E) is used; or documentary collection (D/C) which is a transaction whereby the exporter entrusts the collection of the payment for a sale to its bank (remitting bank), which sends the documents that its buyer needs to the importer’s bank (collecting bank), with instructions to release the documents to the buyer for payment. Open account - this method can be used by
business partner A business partner is a commercial entity with which another commercial entity has some form of alliance. This relationship may be a contractual, exclusive bond in which both entities commit not to ally with third parties. Alternatively, it may be ...
s who trust each other; the two partners need to have their accounts with the banks that are
correspondent bank A correspondent account is an account (often called a nostro or vostro account) established by a banking institution to receive deposits from, make payments on behalf of, or handle other financial transactions for another financial institution. Cor ...
s. Bill of exchange- is used i international trade to bind one party to pay a fixed amount of money to another party on demand date or at certain point in future. Priority payment- in this method funds are being transmitted through secure inter- bank computer network known as
SWIFT Swift or SWIFT most commonly refers to: * SWIFT, an international organization facilitating transactions between banks ** SWIFT code * Swift (programming language) * Swift (bird), a family of birds It may also refer to: Organizations * SWIFT, ...
(Society for Worldwide Inter- bank Financial Telecommunication) or by fax.


See also

*
Supply chain engineering Supply chain engineering is the engineering discipline that concerns the planning, design, and operation of supply chains. Some of its main areas include logistics, production, and pricing. It involves various areas in mathematical modelling such ...
*


References


External links


"Trade Finance Guide: A Quick Reference for U.S. Exporters"
International Trade Administration, U.S. Department of Commerce
Federation of International Trade Associations
{{Trade, state=expanded Business terms International trade International finance Working capital management