Trade Finance

What you need to know to get going

Yudy Yunardy
 Sometimes getting a bigger slice of the market
means needing more cakes
 Having the right contacts in new markets is

crucial for those first steps

Objectives

 The importance of Trade Finance

 Distinction between Trade Finance and
regular lending
 Various sources of Trade Finance
 Various instruments of Trade Finance
 Challenges facing various stake holders in
need of Trade Finance
Trade Finance Background
 Trade finance is more than regular lending. It refers to innovative
financial products and services that assist importers and
exporters to fulfill their financing needs
 Trade Finance is a source of working capital for many traders in
need of financing to procure, process or manufacture products
before sale in future
 Trade finance is also important for individual traders and firms
trading internationally, because it can shape competitiveness of
their contract terms
 Trade finance is therefore important for any country as it
facilitates international trade. As international trade increases, so
does the importance of trade finance
Trade Finance Background
 Absence of an adequate trade finance infrastructure is, in effect,
equivalent to a trade barrier
 Importers facing difficulties in accessing trade finance, have
limited chance to offer competitive terms to their suppliers the
like of advance payment terms, Sight letters of credit, Bills
avalized etc.
 Conversely, exporters with limited supply of trade finance, will
have difficulties in penetrating the market, because while
importer may prefer to buy on open account, or on deferred
terms, the supplier may not be in position to accept/offer such
terms.
Sources of Trade Finance

 Commercial Banks
 Trading Partners (exporter/importer)
 Specialized house or institutions
 Government and related institutions
Commercial Banks
 Commercial Banks are the main source of trade
finance
 They provide pre-export financing (O/D, Term Loans)
 They help in the collection process
 They issue and confirm letters of credit
 They book acceptance and discounting drafts
 They offer fee-based services such as providing credit
and country information on buyers
 Other roles played by commercial banks include
 Taking foreign exchange risks (spot, forward, swap etc)
 Taking market risks (options)
 Commercial Banks

Loans
Overdraft, Term Loans

Settlement
Take currency
(Terms of payments, Commercial risks (Spot, Swap,
Open A/C, Advance
payments, Collections, Banks forward, Options)
L/C)

Take market risks (Price

risk options, future, forward)
Commercial Banks
Summary of trade finance sources from Commercial Banks:
 Loans facilities, which may take the form of Working capital or
overdraft and Term loan facilities
 Off balance sheet financing:
 Issuing performance, bid, custom, advance payment bonds etc

 Opening letters of credit

 Accepting and confirming letters of credit

 Bills Avalisation

 Discounting documents under letters of credit

 Advance under red clause letters of credit

 Structured Finance
Trading Partners (exporter/importer)

 Supplier may offer credit to a buyer by releasing goods to a

buyer against bills of exchange, by which a seller can get an
undertaking from the buyer to pay at a specified future date
 Alternatively may decide to release the goods against
promissory notes, in which a buyer promises to pay at a future
date, but which offer less legal protection as compared to the bill
of exchange
 Under counter trade arrangements valued goods are
exchanged at an agreed value without cash or credit terms,
involving a barter-exchange, counter-purchase, or buy-back
Specialized house or institutions

 Specialized house or other trading institutions

may under forfaiting arrangement purchase
from exporters receivables without recourse
at a discounted rate to allow exporter access
financing before maturity of the bill. In this
case the receivable becomes a tradable
security
Government and related institutions

 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 underdeveloped
Government and related institutions
 Establish scheme of guarantees to support
exporters
 Establish floating line of credit to support imports
for and exports from specific sectors, e.g.
confirmation line
 Establish guarantees schemes for SME, Micro
group
 Embark on support policies, e.g. tax deferral for
export
Instruments of Trade Finance
 Letters of Credit (Documentary Credit)
 Bank Guarantees
 Pre and Post shipment finance loan facilities
 Buyers and Sellers credit
 Bills Acceptance and Avalisation
 Structured Finance
 Leasing
 Factoring and Forfaiting
 Countertrade
Letters of Credit - Definition

A Letter of Credit is a conditional undertaking issued

by a bank, at the request of one of its customers, to
pay a named beneficiary a specified amount of
money upon presentation of documents that
comply with the terms and conditions stated therein
Letters of Credit – Types

 Import letter of credit/Documentary Credit

Import
 Import letter of credit off-shore issuance
 Export letter of credit/Documentary Credit
Export
 Commitment to pay/accept negotiate
 Bank to bank reimbursement
 Reimbursement undertaking
Letters of Credit – Types

Import Letter of Credit

 Import Letter of Credit is a term used to

describe a Documentary Credit Import

(Commercial Letter of Credit) from the point
of view of the importer and the issuing bank
 LCs may be payable at sight or at a date in

the future
Letters of Credit – Types

Documentary Credit Import

 A documentary credit is an irrevocable undertaking

issued by a bank, at the request of one of its

customers, to pay a named beneficiary a specified
amount of money upon presentation of documents
in compliance with the terms and conditions stated
in the Letter of Credit
 An Import Documentary Credit constitutes a credit

exposure on the customer

Letters of Credit – Types

Import Letter of Credit Off-Shore Issuance

 A variant in the processing of the Import LC is the
Offshore Issuance. This is an efficient way of issuing
LCs, which eliminates the use of multiple banks in
the transaction
 The bank requests its foreign branches, mostly in
the country of the beneficiary, to issue LCs directly
to the beneficiary
 The client-facing branch carries the credit risk of the
buyer
Letters of Credit – Types

Export Letters of Credit

 Export LC is a term used by an exporter to

describe a Documentary Credit Export that is

a Commercial LC
 Export LCs may be payable at sight or at a

date in the future

Letters of Credit – Types

Documentary Credit Export

 A documentary credit is an irrevocable

undertaking issued by a bank, at the request

of one of its customers, to pay a named
beneficiary a specified amount of money
upon presentation of documents in
compliance with the terms and conditions
stated in the LC
Letters of Credit – Types

Confirmed Letters of Credit

 A confirmation to a Credit constitutes a definite

undertaking of the Confirming Bank, in addition to

that of the Issuing Bank, provided that the stipulated
documents are presented to that Confirming Bank
and that the terms and conditions of the LC are
complied with
 An export LC only constitutes a credit exposure on

the bank if the credit is confirmed

Letters of Credit – Types

Commitment to Pay/Accept Negotiate

 A variant of the advising of the LC is the
Commitment to Pay/Accept Negotiate. This is
also known as a silent confirmation
 This represents a commitment by the bank to
an exporter to pay or negotiate or accept
documents on a without recourse basis,
provided the terms and conditions of the LC
have been complied with
Letters of Credit – Types

Bank to Bank Reimbursement/Clean

Reimbursement
 This is a reimbursement service offered to branches
or other banks, whereby the bank administers
processes and settles claims made under Letters of
Credit issued by such other branches or banks
 There is no commitment issued by the bank, but the
bank has the obligation to process and pay a claim if
previously authorised by the LC issuing bank,
provided sufficient funds or cover are available
Letters of Credit – Types

Reimbursement Undertaking
 This is a reimbursement service offered to branches
or other banks, whereby the bank administers
processes and settles claims made under LCs
issued by such other branches or banks
 The Undertaking is an irrevocable commitment
issued by the bank but the bank has the obligation
to process and pay a claim if previously authorised
by the LC issuing bank
Standby Letters of Credit

 Do not cover the direct purchase of merchandise

 Based on the underlying principle of LC that payment is made against

presentation of documents, not necessarily shipping documents but
whatever docs the applicant, beneficiary, and issuing bank may agree to

 The party requesting a bank to issue an SBLC (the applicant) need not be
involved in a commercial transaction at all

 SBLC are payable against the presentation of documents as simple as a

certificate from the beneficiary stating that the applicant has not
performed some act, has not complied with a specific contract or other
agreement, or has defaulted either in payment for certain goods and
services or in making repayment on a loan
Guarantee

Guarantees are Legal transactions that are unrelated to the underlying transactions

Individual commitment from Issuing Bank to pay a specified amount to the

beneficiary with the conditions set out in the guarantee

Bank that issues the guarantee may not take into objections raised either by
principal or a third party when performing its payment obligation

In the case of disputes - unless otherwise stipulated- the law of the issuer’s country
shall prevail in the matters that are not regulated in the wording of the guarantee

In the event that the contracting parties are unable to agree on the selection of the
law applicable to the bank guarantee, the solution may be to use a so called
standby letter of credit (regulated by ISP98 or UCP500)
Guarantee

Bid Bond/Tender Bond

To participates in international public tenders, Company usually has to

submit a bid bond along with its offer

This ensures payment of the guaranteed amount in the event of :

 the bid being withdrawn before the due date

 the contract not being accepted by the party submitting the bid
after the contract has been awarded

 the bid bond not being replaced by a performance bond after the
contract has been awarded
Guarantee

Performance Bond

The Bank undertakes to pay the beneficiary the

guaranteed amount at the request of the
seller in the event that the supplier does not
fulfil his contractual delivery obligations or
does not fulfil them as per the terms of the
contract
Guarantee
Payment Guarantee

This is used especially with deliveries against open

account payment and can be issued to secure the
full payment of the delivery of the goods or
services.

The beneficiary can claim the guarantee by declaring

in writing that he delivered the goods but had not
received payment by the due date
Guarantee
Advance Payment Guarantee

The payment conditions for large export orders often stipulate that the
buyer has to pay for the raw materials and the manufacturing
costs in advance

However, prepayment of this kind is only made after the buyer has
received an Advance payment guarantee, which stipulates that
the prepayment will be reimbursed in the event of the seller not
meeting his contractual delivery obligations and or/not providing
the agreed services
Trade Finance

Post Import Finance

Financing provided for settlement of purchase under Letters of Credit

Pre-Export Finance
Financing provided for processing of goods/shipping
It may be based on Purchase Order or Letters of Credit (given up to 90% of LC)

Post-Export Finance
Financing provided after submission of export bills
- Collection (D/P and D/A)
- LC (sight and usance)
* Discrepant
Post Import Financing
IMPORT EXPORT
Buyer LC Application LC Advising Supplier

LC Issuance Export Bills

Checking Bills Checking Bills

Request PIF Send Bills

R
E
Q Release Docs
U
E Settlement LC
S
T

Issuing Bank Negotiating Bank

$$
Post Export Financing
IMPORT EXPORT
Buyer LC Application LC Advising Supplier

LC Issuance Export Bills

Checking Bills Checking Bills

Settlement Send Bills

Release Docs Post Export Finance

SETTLE FINANCING

Issuing Bank Negotiating Bank

$$
Avalisation
The Bank adds our guarantee (aval) to a draft accepted by a
buyer. This relates to transaction conducted under
documentary collection (document against acceptance)

This is similar to our acceptance in LC

Avalisation

Buyer Supplier
DOCUMENTS
AVAL
BANK
BUYER
BANK
ADD
ACCEPT
OUR
SENT
TO PAY
AVAL
AND
FROM
TO:
OBLIGATION
SUPPLIER
ENDORSED
SUPPLIER
TOTO
ON
BUYER
BoE
PAY ON
THROUGH
MATURITY BANKS
DATE
SWIFT CONFIRMATION
BoE SENT TO SUPPLIERS BANK

AVALISATION LIMIT
IS REQUIRED
RISK IS THE SAME AS
BILL ACCEPTANCE

Collecting Bank $$ Payment Bank

L
AVA
SWIFT Confirmation - AVAL
Structured trade finance
 Structured Trade Finance (STF) is a specialised activity dedicated to
the financing of high-value supply chains, especially upstream financing
of cross-border commodity flows and limited recourse trade finance.
Every loan is bespoke with each facility tailored to the specific needs of
client, transaction and jurisdiction. STF facility structures can provide
short term working capital or longer term funding with loans of up to five
years or more
Funding requirements
The tools and techniques of STF are used extensively in the commodity-
related sectors for the benefit of producers, processors, traders and
industrial end-users alike to meet a diverse range of funding requirements
which include:

Upstream Financing Downstream Financing

 Pre-export finance (including  Warehouse finance (for inventories
Contract Pre-payment) of exchange traded commodities)
 Tolling and processing  Receivables finance (for trade and
 Funding investment in capital other receivables)
equipment or production assets  Borrowing Base finance (funding a
 Development or refurbishment of revolving asset base)
production facilities (with or without  Provision of payment guarantees
project risk) for sellers of crude oil and refined
products
Leasing

 A lease or tenancy is the right to use or

occupy personal property or real property
given by a lessor to another person (usually
called the lessee or tenant) for a fixed or
indefinite period of time, whereby the lessee
obtains exclusive possession of the property
in return for paying the lessor a fixed or
determinable consideration (payment)
Factoring
Factoring is a form of commercial finance whereby a business sells
its accounts receivable (in the form of invoices) at a discount.
Effectively, the business is no longer dependent on the
conversion of accounts receivable to cash from the actual
payment from their customers, which takes place on typical 30-
to-90-day terms. Businesses benefit from the acceleration of
cash flow by obtaining cash from the factor equal to the face
value of the sold accounts receivable, less a factor's fee.

Factoring is considered off balance sheet financing in that it is not a

form of debt or a form of equity. This fact makes factoring more
attainable than traditional bank and equity financing.
Factoring

There are usually three parties involved when an

invoice is factored:

 Seller of the product or service who originates the

invoice.
 Debtor is the customer of the seller (i.e., the
recipient of the invoice for services rendered who
promises to pay the balance within the agreed
payment terms).
 Factor (the factoring company)
Forfaiting

Forfaiting is the discounting of international

trade receivables on a without recourse basis
Forfaiting

Forfaiting, or Medium-Term Capital Goods

Financing, means selling a bill of exchange,
at a discount, to a third party, the forfaiter,
who collects the payment from an,
essentially, overseas customer, through a
collateral bank(s), and, thus, assuming the
underlying responsibility of exporters and
simultaneously providing trade finance for
importers by converting a short-term loan to a
medium term one
Countertrade

 Countertrade is exchanging goods or

services that are paid for, in whole or part,
with other goods or services
Countertrade - Types
There are five main variants of countertrade:

 Barter: Exchange of goods or services directly for other goods or services

without the use of money as means of purchase or payment

 Switch trading: Practice in which one company sells to another its obligation to
make a purchase in a given country

 Counter purchase : Sale of goods and services to a country by a company that

promises to make a future purchase of a specific product from the country

 Buyback : Export of industrial equipment in return for products produced by that

equipment

 Offset : Agreement that a company will offset a hard - currency purchase of an

unspecified product from that nation in the future
Challenges
 Lack of Security/Collaterals
 Absence of counter party willing to offer financing
alternatives outside the banking system
 Promissory notes, Bill of Exchange, Counter trade,
Forfeiting, Suppliers credit etc
 High costs of borrowing to compensate banks for
credit risks (Interest rates, application fee, facility
fee)
 Regulatory issues
 Difficulties for importers and banks to comply with
regulatory requirements e.g. Foreign currency controls
 Compliance to terms of Trade
 Documentations
Challenges

 Absence of reliable Market information about

Counter party risks and trading requirements
 Missing link to buyers and sellers (Financial
institutions link)
 Infrastructure gap
 Transportation, Storage, Clearing & forwarding
 especially commodities
 Price Volatility for export
Challenges
 Poor negotiations skills for some
importers/exporters which have caused them
to become victims of unfavorable terms in
international trade
 Overseas supplier insist on Advance payments,
while Exporters are forced to accept Open
account terms
 While overseas suppliers require L/C’s confirmed
by first class bank, few of the L/C’s in favour of
suppliers in Tanzania will request for confirmation
 Bank charges are not shared equally
LC - UPAS (Usance Paid at Sight)
LC allows for beneficiary to claim payment at sight, even though LC is
issued as Usance LC

Benefit (to beneficiary) :

Provide flexibility to applicant and beneficiary

Risk involved :
Issuing Bank : Applicant risk of non payment (on maturity)

Mitigation :
Provided selectively
UPAS – Usance paid at sight
IMPORT EXPORT
Buyer LC Application LC Advising Supplier

LC Issuance Export Bills

Checking Bills Checking Bills

BoE Send Bills
Acceptance

Release Docs

Settlement LC

Issuing Bank Negotiating Bank

$$
Transferable LC

APPLICANT BENEFICIARY

Country Industry BENEFICIARIES

Risk Risk

Trading
Risk

Currency Bank
Risk Transfer Risk Transfer
able LC LC LC

LC Issued LC
LC received & transferred
Without Recourse

 An individual who endorses a check or

promissory note using the phrase without
recourse specifically declines to accept any
responsibility for payment. By using this phrase,
the endorser does not assume any responsibility
by virtue of the endorsement alone and, in
effect, becomes merely the assignor of the title
to the paper
Off Balance Sheet

 Off balance sheet usually means an asset or

debt or financing activity not on the
company's balance sheet. It could involve a
lease or a separate subsidiary or a contingent
liability such as a letter of credit. It also
involves loan commitments, futures, forwards
and other derivatives, when-issued securities
and loans sold
Bill of Exchange - Sample
Promissory Note - Sample
Distribution Channel/Client Group
Combination
Delivery Channels
The delivery channels used for these products
are:
 Max Trad

 SWIFT

 Fax
Product Risks

The following tools are used to assess product

related risks:
 AIM policies and standards

 Business cases

 Product Approval Committee

 Operational Risk Assessment Procedure

 Risk Self Assessment

 Audit reports
Product Risks
The following product risks are subject to Risk Management methods (if
applicable):
 Customer risk
 Country risk
 Credit risk
 Information Technology risk
 Insourcing risk
 Liquidity risk
 Market risk
 Operational risk
 Outsourcing risk
 Reputation risk (as part of the product integrity)
 Strategic Business risk (a.o. sustainability, effects on the bank's
results/equity)