by International trade financing is required specially to get funds to carry out international trade operations. Depending on the types and attributes of financing, there are five major methods of transactions in international trade.
An importer of goods can make payments in variety of ways through the banking system. But whatever method is used, the net effect will be to reduce the foreign currency balances of a domestic bank or to increase the rupee balances of an overseas (foreign) bank.
If, for instance, the customer asks his bank for a draft in American bank, so that when the draft is eventually presented for payment at the American bank by the supplier of the goods, the Indian bank’s account will be debited.
The Indian bank would have charged its customer in rupees for the draft at the appropriate rate of exchange, at the time the draft was issued. A bank can replenish its stocks of foreign currencies by buying from its customers (normally exporters), claims against foreign banks and, if these are insufficient, can buy currencies in the foreign exchange market.
International Trade Payment Methods
Letter of Credit
A Letter of Credit is a letter from a bank that guarantees that the payment due by the buyer to a seller will be made timely and for the given amount. In case the buyer cannot make payment, the bank will cover the entire or remaining portion of the payment.
Prepayment
Prepayment occurs when the payment of a debt or installment payment is done before the due date. A prepayment can include the entire balance or any upcoming part of the entire payment paid in advance of the due date. In prepayment, the borrower is obligated by a contract to pay for the due amount. Examples of prepayment include rent or loan repayments.
Consignment
It is an arrangement to leave the goods in the possession of another party to sell. Typically, the party that sells receives a good percentage of the sale. Consignments are used to sell a variety of products including artwork, clothing, books, etc. Recently, consignment dealers have become quite trendy, such as those offering specialty items, infant clothing, and luxurious fashion items.
Drafts
Sight Draft: It is a kind of bill of exchange, where the exporter owns the title to the transported goods until the importer acknowledges and pays for them. Sight drafts are usually found in case of air shipments and ocean shipments for financing the transactions of goods in case of international trade.
Time Draft: It is a type of foreign check guaranteed by the bank. However, it is not payable in full until the duration of time after it is obtained and accepted. In fact, time drafts are a short-term credit vehicle used for financing goods’ transactions in international trade.
Open Account
Open account is a method of making payments for various trade transactions. In this arrangement, the supplier ships the goods to the buyer. After receiving and checking the concerned shipping documents, the buyer credits the supplier’s account in their own books with the required invoice amount.
The account is then usually settled periodically; say monthly, by sending bank drafts by the buyer, or arranging through wire transfers and air mails in favor of the exporter.
Export Credit and Guarantee:
The Export Credit and Guarantee Corporation Ltd. (ECGC) is a Government of India concern, established to provide insurance on a commercial basis for exporters. It is not the function of ECGC to provide finance for exporters; it provides only insurance cover for exports.
However, the fact that exports have been insured in this way gives an inducement to financial institutions, particularly the banks, to provide the necessary finance for exports in cases where they would otherwise not be willing to do so.
The Export Credit & Guarantee Dept. of U.K. also performs a similar function. It not only provides guarantees which help to bring forth finance for the exporter, but such guarantees may take the form of financial guarantees to banks and other financial institutions to cover loans direct to overseas buyers, to enable them to buy goods and services from Britain which they might otherwise be unable to finance.
Six types of guarantees have been evolved:
(a) Packing Credit Guarantee
(b) Post Shipment Export Credit Guarantee
(c) Export Finance Guarantee
(d) Export Production Finance Guarantee
(e) Export Performances Guarantee
(f) Transfer Guarantee.
Covers issued by ECGC can be divided broadly into the following categories:
(i) Standard policies issued to exports to protect them against the risk of not receiving payments while trading with overseas buyers on credit terms;
(ii) Policies designed to protect Indian firms against the risk of not receiving payments in respect of
(a) Service rendered to foreign parties and
(b) Construction works undertaken abroad
(c) Financial guarantees issued to banks against the risks involved in providing credit to exporters
(d) Special policies.
Trade Finance Methods
The most popular trade financing methods are the following:
Banker’s Acceptance
A banker’s acceptance (BA) is a short-term debt instrument that is issued by a firm that guarantees payment by a commercial bank. BAs are used by firms as a part of the commercial transaction. These instruments are like T-Bills and are often used in case of money market funds.
BAs are also traded at a discount from the actual face value on the secondary market. This is an advantage because the BA is not required to be held until maturity. BAs are regular instruments that are used in international trade.
Accounts Receivable Financing
It is a special type of asset-financing arrangement. In such an arrangement, a company utilizes the receivables the money owed by the customers as a collateral in getting a finance.
In this type of financing, the company gets an amount that is a reduced value of the total receivables owed by customers. The time-frame of the receivables exert a large influence on the amount of financing. For older receivables, the company will get less financing. It is also, sometimes, referred to as “factoring”.
Letters of Credit
As mentioned earlier, Letters of Credit are one of the oldest methods of trade financing.
Working Capital Finance
Working capital finance is a process termed as the capital of a business and is used in its daily trading operations. It is calculated as the current assets minus the current liabilities. For many firms, this is fully made up of trade debtors (bills outstanding) and the trade creditors (the bills the firm needs to pay).
Forfaiting
Forfaiting is the purchase of the amount importers owe the exporter at a discounted value by paying cash. The forfaiter that is the buyer of the receivables then becomes the party the importer is obligated to pay the debt.
Countertrade
It is a form of international trade where goods are exchanged for other goods, in place of hard currency. Countertrade is classified into three major categories; barter, counter-purchase, and offset.
- Barter is the oldest countertrade process. It involves the direct receipt and offer of goods and services having an equivalent value.
- In a counter-purchase, the foreign seller contractually accepts to buy the goods or services obtained from the buyer’s nation for a defined amount.
- In an offset arrangement, the seller assists in marketing the products manufactured in the buying country. It may also allow a portion of the assembly of the exported products for the manufacturers to carry out in the buying country. This is often practiced in the aerospace and defense industries.
