Trade finance post and pre shipmentDocument Transcript
Indian Institute of Tourism and Travel Management
(Ministry of Tourism, Government of India)
Program: PGDM (International Business)
Roll No: 2094001
I would like to express my gratitude to Faculty of Business
Research Methodology (Mrs. Sareeta Pradhan), for
guiding and providing us with valuabl e feedback throughout
this project and providing the vital information and
knowledge of this topic.
Furthermore, I would also like to acknowledge my friends
and relatives, with whom I have worked side -by-side during
the entire process
Finally, my sincere thanks goes to the entire respondent
for sharing their valuable time and voicing their opinions
and for scribing idea, without whose co -operation the
research would have bee n impossible.
IMPORTANCE OF TRADE FINANCE
Trade Finance is a specific topic within the financial services industry. It‟s
much different, for example, than commercial lending, mortgage lending
or insurance. A product is sold and shipped overseas, therefore, it takes
longer to get paid. Extra time and energy is required to male sure that
buyers are reliable and creditworthy.
In addition, foreign buyers are just like domestic buyers prefer to delay
payment until they receive and resell the goods. Due diligence and careful
financial management can mean the difference between profit and loss on
Trade Finance provide alternative solution that balance risk and payment.
In this overview, we‟ll outline the two broad categories of trade finance:
Pre-shipment Financing to produce or purchase the material
and labor necessary to fulfill the sales order.
Post-shipment Financing in order to generate immediate cash
while offering payment to buyers.
The following factors and considerations apply to financing in general:
Financing can make the sale
In some cases, favorable payment terms make a product more
competitive. If the competition offers better terms and has a similar
product, a sale can be lost.
In other cases, the exporter may need financing to produce the goods or
to other aspects of sale, such as promotion and selling cost, engineering
modification, and shipping cost. Various financing source are available to
exporters, depending on the specifics of the transaction and the
exporter‟s overall financing needs.
The costs of borrowing, including interest rates, insurance and fees will
vary. The total cost and its effects on the price of the product and profit
from the transaction should be well understood before a pro-forma invoice
is submitted to the buyer.
Costs increase with the length of terms. Different methods of financing
are available for short, medium, and long terms. Exporters need to be
fully aware of financing limitations so that they secure the right solution
with the most favorable terms for seller and buyer.
The greater the risk associated with the transaction, the grater the cost.
The creditworthiness of the buyer directly affects the probability of
payment to an exporter, but it is not the only factor of concern to
potential lender. The political and economic stability of the buyer‟s
country are also taken into consideration.
Banks/Lenders are generally concerned with two questions:
Can the exporter perform? They want to know that the exporter
can produce and ship the product on time, and that the product will
be accepted by the buyer.
Can the buyer pay? They want to know that the buyer is reliable
with the good credit history. They will evaluate any commercial or
If a lender is uncertain about the exporter‟s ability to perform, or if
additional credit capacity is needed, government guarantee programs are
available that may enable the lender to provide additional financing.
FEATURES OF TRADE FINANCE PRESPECTIVES
Trade Finance generally refers to the financing of individual transaction or
a series of revolving transactions. In addition, trade finance loans are
often self liquidating that is the lending bank stipulates that all sales
proceeds are to be collected, and then applied to payoff the loan. The
remainder is credited to the exporter‟s account.
The self-liquidating feature of trade finance is critical to many small,
undercapitalized businesses. Lender who may otherwise have reached
their lending limits for such businesses may nevertheless finance
individual export sales, if the lenders are assured that the loan proceeds
will be first be collected by them before the balance is passed on to the
Given the extent of the control lenders can exercise over such transaction
and existence of guaranteed payment mechanisms unique to or
established for international trade, trade finance can be less risky for
banks/lenders then general working capital loans.
Working Capital Loans
For exporters, working capital loan programs are normally associated with
pre-shipment financing. Many small businesses need pre-export financing
to cover the operating costs related to a sales order or contract. Loans
proceeds are commonly used to finance three different areas:
Labor: The people needed to built or but the export product.
Material: The raw material needed to produce the export product.
Inventory: The costs associated with buying the export product.
Term Financing for Foreign Buyers
Frequently, foreign buyers don‟t have the cash on hand to pay for major
purchase. So the buyers ask for extended credit terms and/or financing.
Few exporters can manage the cash flow dilemma or commercial or
political risk caused by these long term contracts.
Exporting country‟s government institutions often back buyer credit
programs. Under this program, the exporting country‟s financial
institution lend credit to the foreign buyer in order allow the foreign
importer to pay the exporter immediately. The payment is usually made
directly to the exporter.
This is an effective solution that benefits the exporter, their buyer and
commercial lender providing the loans. The exporter benefit because
they‟re paid cash on delivery and acceptance of the product or service.
The foreign buyer benefit because they get extended credit terms at
market rate or better.
The lender benefits because guarantees, many backed by the respective
governments, means fully repayment of loan and a reasonable return of
IMPORTER AND EXPORTER?
Through the Pre-shipment and Post-shipment finance options offered to
importers and exporters are fundamentally similar, their perspectives
might be different.
Export Trade Finance
Exporters, using pre and/or post shipment finance, may improve their
cash flow by utilizing trade finance to fund their purchase and/or
manufacturing of goods pending receipt of payment form their buyer. An
exporter is also able to offer advantageous credit terms to buyers as te
repayment is usually made after the goods were sold.
Import Trade Finance
Importers may use pre and post shipment finance to improve their cash
Post-shipment trade finance can allow time for goods to be sold prior to
the payment being made. It also enables importers to offer payment at a
sight basis to the supplier, rather than utilizing supplier terms(prices are
often increase to cover supplier terms). This provides a importer with a
negotiating advantage in realizing a potentially lower price.
Pre-shipment trade finance enables an importer to pay for goods prior to
shipment, when the method of payment agreed upon with the exporter is
‘Pre-payment by Clean Remittance’
PRE-SHIPMENT TRADE FINANCE
Pre-shipment finance is credit granted to the exporters by a financial
institution. Pre-shipment credit is a part of working capital finance. The
main objectives behind pre-shipment finance are:
Procure raw materials.
Carry out manufacturing process.
Provide a secure warehouse for goods and raw material.
Process and pack the goods.
Ship the goods to the buyers.
Meet other financial costs of the business.
TYPES OF PRE-SHIPMENT FINANCE
Advance against receivables from government, like duty drawback
Advance against cheques/drafts etc., representing advance
payment pre-shipment finance is extended in the following forms:
Packing credit in Indian Rupee.
Packing credit in Foreign Currency (PCFC).
REQUIREMENT FOR GETTING PACKING CREDIT
This facility is provided to an exporter who satisfies the following criteria:
Exporter should have a ten-digit importer-exporter code number
allotted by DGFT.
Exporter should not be in the caution list of RBI.
If the goods to be exported are not under OGL (Open General
License), the exporter should have the required license/quota
permit to export the goods.
Packing credit facility can be provided to an exporter on production of
following evidences to the bank:
1. Formal application for realizing the packing credit with undertaking
to the effect that the exporter would ship the goods within
stipulated due date and submit the relevant shipping document to
the bank within prescribed time limit.
2. Firm order or irrevocable L/C or original Cable/Fax/Telex message
exchange between the exporter and the buyer.
3. License issued by DGFT if the goods to be exported fall under the
restricted or canalized category. If the item falls under quota
system, proper quota allotment proof needs to be submitted.
The confirmed order received from the overseas buyer should reveals the
information about the full name and address of the overseas buyer,
description, quantity and value of goods (FOB or CIF), destination and last
date of payment.
Pre-shipment credit is granted to an exporter who has the export order or
LC in his own name. the exporter is the person or the company who
actually delivers the goods to the importers/buyers.
However, as an exception, financial institution also grant credit to the
third-party manufacturer or supplier of goods who does not have export
orders or LCs in their name, but some of the responsibilities of meeting
the export requirement have been out sourced to them, by the main
In cases where the export order is divided between more than one
exporter, pre-shipment credit can be shared between them.
Quantum of Finance
There is no fixed formula to determine the quantum of finance that is
granted to an exporter against a specific order/LC or an expected order.
The only guiding principle is the concept of Need-Based-Finance.
Banks determine the percentage of margin, depending on factor such as:
The nature of order.
The nature of the commodity.
The capability of exporter to bring in the requisite contribution.
DIFFERENT STAGES OF PRE-SHIPMENT FINANCE
Appraisal and sanction of limits
1. Pre-shipment finance or packing credit is essentially a working capital
advance made available for the specific purpose for
procuring/processing/manufacturing of goods meant for export. All costs
before shipment would be eligible for being financed under the packing
credit. Packing credit advance should be liquidated from export proceeds
While considering credit facilities for export activities, banks look
specifically into the aspects of product profile, country profile and the
commodity profile. The bank also look into the status report of the
prospective buyer, with whom the exporter proposes to do business. In
order to get the status report on foreign buyer, service of the institutions
like ECGC or international consulting agencies like Dun and Brad Street
etc may be utilized.
The Bank extends the packing credit facilities after ensuring the following:
The exporter is a regular customer, a bona-fide exporter and has a
good standing in the market.
The exporter has the necessary licenses and quota permits.
Whether the country with which the exporter wants to deal is under
the list of Restricted Cover Countries (RCC).
Disbursement of Packing Credit Advance
2. After proper sanctioning of the limits, the bank ensures that the
exporter has executed proper documents. On the basis of these
documents, disbursements are normally allowed.
There are special types of export activities that may be seasonal in
nature, in which the exporter may not be able to produce the export order
at time of availing Packing Credit. In these cases, the bank may provide a
special packing credit facility, known as Running Account Packing Credit.
Before disbursing, the bank specifically checks for the following particulars
in the submitted documents:
a) Name of the Buyer.
b) Commodity to be exported.
d) Value (either CIF or FOB).
e) Last date of shipment/negotiation.
f) Any other terms to be compiled with.
The quantum of finance is fixed based on the FOB value of contract/LC or
on the domestic value of goods, whichever is lower. Normally insurance
and freight charges are considered at later stage, when the goods are
ready to be shipped.
Disbursals are made only in stages and preferably, not in cash. The
payments are made directly to the suppliers by drafts/Banker‟s cheques.
The period for which the packing credit is provided is decided by the bank
depending upon the time required by the exporter for procuring and
manufacturing/processing the goods.
Normally the Packing Credit period should not exceed 180 days. The bank
may provide a further 90 days extension on its own discretion, without
referring to RBI.
Follow-up of Packing Credit Advance
3. Exporter needs to submit stock statement reporting the stocks, which
are under pledge or hypothecation to the bank for securing the Packing
Credit Advance. The bank decides frequency of submission of the stock
statements at the time of sanctioning the Packing Credit.
The authorized dealer (Banks) also physically inspect the stock at regular
Liquidation of Packing Credit Advance
4. Packing Credit Advance will always be liquidated with export proceed of
the relevant shipment. At this stage, the pre-shipment credit will be
converted into post-shipment credit will be converted into post-shipment
Packing Credit Advance can also be liquidated with proceeds of payment
receivable from Government of India. This payment includes the duty
drawback, payment from the Market Development Fund (MDF) of the
Central Government or from any other relevant source. For any reason, if
the export does not take place at all, the entire advance is recovered at
commercial interest rate plus a penal rate as decided by the bank.
5. If the borrower fails to liquidate the packing credit on the due
date/extended due date, the bank considered it an overdue.
In case of overdue position persists, the bank takes steps to realize its
dues as per usual recovery procedures. Nursing programme may be
initiated, if found feasible.
Packing Credit to sub-supplier
1. Packing Credit may be shared between an Export Order Holder (EOH)
and the manufacturer of goods on the basis of a disclaimer issued by EOH
to the effect that he has not availed/is not availing credit facility against
the portion of the order transferred in the name of the manufacturer.
This disclaimer may preferably be countersigned by the banker of EOH.
The banker of EOH may open an inland L/C specifying the goods to be
supplied by the sub-supplier to the EOH as part of the export transaction.
On the basis of such an L/C, the sub-supplier‟s bank may grant a packing
credit to the sub-supplier to manufacture the components required for
exports. On supply of goods, the L/C opening bank will pay to the sub-
supplier‟s bank against the inland documents received on the basis of
inland L/C opened by them.
The EOH is finally responsible for exporting the goods as per export order
and any delay in the process will subject him to penal provisions issued
from time to time. The scheme is intended to cover only the first stage of
production cycle, and is not to be extended to cover supplies of raw
material etc. Running account facility is not granted to the sub-suppliers.
In case the EOH is a trading house, the facility is available commencing
from the manufacturer to whom the order has been passed by the trading
house. Banks however, ensure that there is no double financing and the
total period of packing credit does not exceed the actual cycle of
production of the commodity.
Running Account Facility
2. Banks have been authorized to grant pre-shipment advances for export
of any commodity without insisting on prior lodgment of L/C or firm
export order under „Running Account‟ facility. The bank may extend the
facility provided the exporter has a good track record and the need for
„Running Account‟ has been established by the exporter to the satisfaction
of the bank.
In case where this facility has been provided, the exporter should produce
L/C or firm export order within a reasonable period of time. Banks mark
off the individual export bill as and when they are received for
negotiation/collection against the early outstanding pre-shipment credit,
on a “First In First Out” (FIFO) basis.
Pre-shipment Credit in Foreign Currency (PCFC)
3. with the objective of making credit available to the exporters at
internationally competitive rates , Authorized dealers have been permitted
to extend Pre-shipment Credit in Foreign Currency(PCFC) to exporters.
This is an additional window available to Indian exporters, along with the
existing INR packing credit. Under this scheme credit is provided in
foreign currency in order to facilitate the purchase of raw material,
components etc. required to fulfill the export order. The procurement of
raw material, components etc. may be made from the international
market or from the domestic market.
Packing Credit Facilities to Deemed Exports
4. Deemed exports made to multilateral funds aided projects and
programmes, under order secured through global tender for which
payment will be made in foreign exchange, are eligible for concessional
rate of interest facility both at pre and post supply stages.
Packing Credit Facilities for Consulting Services
5. In case of consultancy services, exports do not involve physical
movement of goods out of Indian Custom Territory. In such cases, pre-
shipment finance can be provided by the bank to allow the export to
mobilize resource like technical personnel and training them.
Advance Against Cheques/Drafts received as Advance Payment
6. Where exporters receive direct payments from abroad by means of
Cheques/Drafts etc. the bank may grant export credit at concessional rate
to the exporter of good track record, till the time of realization of the
proceeds of the cheques or drafts etc. The banks, however, must satisfy
themselves that the proceeds are against an export order.
POST-SHIPMENT TRADE FINANCE
Post-shipment finance is a loan, advance or any other credit provided
by an institution to an exporter of goods from India. This finance is
granted from the date of extending the credit after shipment of the goods
to the realization date of the export proceeds.
The features of post-shipment finance are:
Purpose of Finance
Post-shipment Finance is meant to finance export sales receivables
after the date of shipment of goods to the date of realization of
exports proceeds. In case of deemed exports, it is extended to
finance the receivables against supplies made to designated
Basis of Finance
Post-shipment finance is provided against evidence of shipment of
goods or supplies made to the importer or any other designated
Form of Finance
Post-shipment finance can be secured or unsecured, Since the
finance is extended against evidence of export shipment and banks
obtain the document of title of goods, the finance is normally self
liquidating. In case that involve advances against undrawn balance,
it is unsecured in nature.
Further, the finance is mostly a funded advance. In few cases, such
as financing of project exports, the issue of guarantees (retention
money guarantees) is involved, the financing is non funded in
Quantum of Finance
Post-shipment finance can be extended upto 100% of the value of
goods. However, where the domestic value of goods exceeds the
value of the export order or the invoice value, finance for the price
difference can also be extended if such a price difference is covered
by receivables from the government. This form of finance is not
extended at the pre-shipment stage.
Banks can also finance undrawn balance. In such cases banks are
free to stipulate margin requirements as per their usual lending
Period of Finance
Post-shipment finance can be short term or long term, depending
on the payment term offered by the exporter to the overseas
buyer. In case of cash export, the maximum period allowed for
realization of exports proceeds is six months from the date of
shipment. Banks can extend post-shipment finance at lower rate
up to normal transit period/notional due date, subject to maximum
of 180 days.
In case of deferred payment exports, requiring prior approval of
the Authorized dealer, RBI or EXIM Bank, post-shipment finance
can be extended at non-concessional rates up to the approved
FINANCING FOR VARIOUS TYPES OF EXPORTS
Post-shipment finance can be provided for three types of exports:
In case of physical exports, post-shipment finance is provided to
the actual exporter or to the exporter in whose name the trade
documents are transferred.
In case of deemed exports, finance is forwarded to the supplier of
the goods. These goods are supplied to the designated agencies.
Capital Goods and Project Exports
In case of export of capital goods and project exports, finance is
sometimes extended in the name of overseas buyer. The disbursal
of money is directly made to the domestic (Indian) exporter.
As seen in the case of capital goods and project exports, credit is
sometime extended directly to the foreign buyer.
Buyer‟s Credit is a financial arrangement whereby a financial institution in
the exporting country, or another country, extends a loan directly or
indirectly to a foreign buyer to finance the purchase of goods and services
from the exporting country. This arrangement enables the buyer to make
payment due to the supplier under the contract.
Finance extended by supplier to buyers in their own name is referred to
as Supplier‟s Credit. Hence, Supplier‟s Credit is a financing agreement
under which an exporter extends credit to the buyer in the importing
country to finance the buyer‟s purchases.
TYPES OF POST-SHIPMENT FINANCE
The post-shipment finance can be classified as :
1. Export Bills purchased/discounted.
2. Export Bills negotiated.
3. Advance against export bills sent on collection basis.
4. Advance against export on consignment basis.
5. Advance against undrawn balance on exports.
6. Advance against receivables from Government of India.
Export Bills Purchased/Discounted (DP & DA Bills)
1. Export bills (Non-L/C Bills) representing genuine international trade
transactions, strictly drawn in terms of sale contract/live firm
contract/order may be discounted or purchased by the banks. Proper limit
has to be sanctioned to the exporter for the purchase of export bill
facility. If the export is not covered under L/C, risk of non-payment may
arise. The risk is more pronounced in case of documents under
Export Bills Negotiated (Bills under L/C)
2. Letter of Credit is a secure mode of trade transaction, since the issuing
bank guarantees payment, subject to the condition that the beneficiary
meets the terms and condition of the L/C, hence the risk of payment is
low. Also, if a reputed bank guarantees the payment by confirming the
L/C, the risk is reduced further.
Due to this inherent security provided by this mode, banks are often
ready to extend finance against bill under L/C. However, it is to be noted
that the bank still faces two major risk in this case. First is the risk of non
performance by the exporter, wherein case the exporter is unable to meet
his terms and conditions, the issuing bank would not honor the L/C.
Secondly, the bank also faces the documentary risk, wherein if the issuing
bank notices some discrepancy in the document supplied, it may refuse to
honor the commitment. Hence it becomes extremely important for the
negotiating bank, and the lending bank to thoroughly scrutinize the terms
and conditions of the L/C and the document submitted by the beneficiary
in support of the same.
Advance Against Export Bills Sent on Collection Basis
3. At times, the exporter might have fully utilized his bills limit and in
certain cases the bills drawn under L/C may have some discrepancies. In
such cases, the bills will be sent on collection basis. In some cases, the
exporter himself may request the bill to be sent on collection basis,
anticipating the strengthening of foreign currency.
Banks may allow advance against these collection bills to an exporter.
Concessional rates of interest can be charged for this advance until the
transit period in case of DP Bills and transit period plus usance period in
case of Usance Bills, depending upon the type of drawing. For computing
the Eligible Transit Period, the period commences from the date of
acceptance of the export documents at the bank‟s branch for collection
and not from the date of advance.
Advance Against Export on Consignment Basis
4. Goods are exported on consignment basis at the risk of the exporter.
Eventual remittance of sale proceeds is made by agent/consignee. The
overseas branch/correspondent of the bank is instructed to deliver the
documents against trust receipt.
Advances granted against export bills covering goods sent on
consignment basis are liquidate from remittance of the sale proceeds
within 6 months from the date of shipment, conforming to relevant RBI
guidelines. In case of exports through approved Indian owned
warehouses abroad, the time limit for realization is 15 months.
Advance Against Undrawn Balance on Exports
5. In certain lines of export trade, it is common practice to leave a certain
amount as undrawn balance. Adjustments are made by buyer for
difference in weight, quality etc. ascertained after arrival and inspection of
goods. Authorized Dealer (Banks) can handle such bills provided the
undrawn balance is in conformity with the normal level of balance left
undrawn in the particular line of export trade, subject to the maximum of
10% of the full export value.
The export has to give an undertaking that he shall surrender or account
for the balance of the proceeds within a period prescribed realization,
such advance can be provided at concessional rate up to a maximum
period of 90 days.
Advance Against Receivables from Government of India
6. where the domestic cost of production of goods is higher in relation to
international price, the exporter may get support from the government so
that he may compete effectively in the overseas market. Just as in the
case of various foreign governments. The Government of India and other
agencies provide support to exporter under the Export Promotion
Scheme. This can be in the form of refund of Excise and Custom duty,
known as Duty Drawback.
Banks can grant advances to exporters against their entitlement under
this category at lower rate of interest at maximum period of 90 days.
These advances being in the nature of unsecured advances cannot be
granted in isolation. These are granted only if other types of export
finance are also extended to the exporter by the same bank.
After the shipment, the exporter lodge their claims, supported by relevant
documents to the relevant government authorities. These claims are
processed and eligible amount is disbursed. These advance are liquidated
out of the settlement of claims lodged by the exporters. It has to be
ensured that the bank is authorized to receive the claim amount directly
from the concerned government authorities.
CRYSTALLIZATION OF OVERDUE EXPORT BILLS
If the export bill purchased /negotiated/discounted is not realized on due
date (in case of Demand Bills within Normal Transit Period and in case of
Usance Bills on notional due date), exporter‟s foreign exchange liability is
converted into Rupee liability on the 30th
day after the expiry of NTP in
case of DA bills, at prevailing TT selling rate ruling on the day of
crystallization, or the original bill buying rate, whichever is higher.
However, if the exporter want to crystallize the overdue export bills
earlier he apply in writing to the AD even before the 30th
day after the
notional due date. If the crystallized export bill realizes subsequently,
conversion of foreign exchange will be made at the market rate prevailing
on the day of the payment. In this case, the exchange profit/loss is borne
by the exporter.
EXPORT BILLS ARE RE-DISCOUNTED FACILITY (EBRD)
This is an additional window available to exporters, along with the existing
financing scheme at post-shipment stage. The facility is available in all
convertible currencies. The scheme covers export bills up to 180 days
from the date of shipment (inclusive of normal transit period and grace
period, if any applicable).
Under the scheme of Ads rediscount the export bills in overseas market
by arranging with an overseas agency/bank by way of line of credit or
banker‟s acceptance facility or any other similar facility at rates linked to
6 month LIBOR rates. Spread between borrowing and lending is left to the
discretion of the bank concerned. Ultimately, the cost to the exporter
should not exceed 0.75% above 6 month LIBOR/EURILIBOR/EURIBOR,
excluding withholding tax.
In case of re-discounting of export bills on without – recourse basis, the
credit limits of the exporter are restored immediately. ADs have been
permitted to utilize the on-shore foreign exchange funds available with
them by way of balances in Exchange Earner‟s Foreign Currency account
(EEFC), Resident Foreign Currency Account and Foreign Currency (non-
resident) account schemes. Exporters can also directly arrange for
rediscounting facilities abroad without prior permission from the RBI,
subject to compliance of guidelines prescribed by the Reserve Bank.
OPTIONS FOR THE EXPORTER
Having gone through the detail of various pre-shipment and post-
shipment Trade Finance options, we see that the exporter has the
following financing options:
1. Pre-shipment credit and post-shipment credit in rupees.
2. Pre-shipment in Rupees and post-shipment under export bill re-
discounting in foreign currency, EBRD.
3. Pre-shipment in Foreign Currency (PCFC) and post-shipment under
export bill re-discounting in foreign currency, under EBRD.
An exporter may avail any facility in a denominated foreign currency,
depending on the premium/discount factor of the currency in which he
has got exposure. For example, if the exporter has got an exposure in
Euro and this currency is at a premium, the exporter may not want to
avail any facility in foreign currency. Instead, the exporter may prefer to
avail a Rupee loan and try to earn the premium factor of the foreign
FORFAITING AND FACTORING
Factoring has a long and rich tradition, dating back 4,000 years to the
days of Hammurabi. Hammurabi was the king of Mesopotamia, which gets
credit as the “cradle of civilization”. In addition to many other things, the
Mesopotamians first developed writing, put structure into business codes
and government regulation and came up with the concept of factoring.
The first widespread, documented use of factoring occurred in the
American colonies before the revolution. During this time, cottons, furs
and timber were shipped from the colonies. Merchant bankers in London
and other parts of Europe advanced fund to the colonist for these raw
materials, before they reached the continent. This enabled the colonist to
continue to harvest their new land, free from the burden of waiting to be
paid by their European customer.
These were not banking relationships, as they exist today. If the colonist
had been forced to use modern banking services in eighteenth century
England, the process would have been much slower. The bank would have
waited to collect from the European buyers of the raw material before
paying the seller of these goods. This was not practical for anyone
involved. So, just as today, the “factors” of colonial times made advances
against the accounts receivable of clients.
With the advent of Industrial Revolution, factoring become more focused
on the issue of credit, although the basic premise remained the same. By
assisting clients in determining the creditworthiness of their customers
and setting credit limits, factors could actually guarantee payment for
approved customer. This is known as factoring without recourse (or non-
recourse factoring) and is quite common in business today. Today, factors
exist in all shapes and sizes as division of large financial institution or, in
large numbers, as individually owned and operated entrepreneurial
Forfaiting and Factoring
Forfaiting and factoring are similar services that serve to provide better
cash flows and risk mitigation to the seller. It may be mentioned that
factoring is for short term receivables (under 90 days) and is more
related to receivables against commodity sales. Forfaiting can be for
receivables against which payments are due over a longer term, over 90
days and even up to 5 years. The difference in the risk profiles of
receivables is the fundamental difference between factoring and forfaiting,
which has implications for the cost of services.
Both factoring and forfaiting are like bill discounting, but the bill
discounting is more domestic-related and usually falls within the working
capital limit set by the bank for the customer.
Forfaiting is a mechanism of financing exports:
By discounting export receivables.
Evidence by bills of exchange or promissory notes.
Without recourse to the seller (such as exporter).
Carrying medium to long term maturities.
On a fixed rate basis (discount).
Up to 100% of the contract value.
In a forfaiting transaction, the exporter surrenders his rights to claim for
payment on goods delivered to an importer, in return for immediate cash
payment from a forfaiter. As a result, an exporter can convert a credit
sale into cash sale, with no recourse either to him or his banker.
FORFAITING – OPERATING PROCEDURE
1. Exporter initiates negotiations with prospective overseas buyer,
finalizes the contract and open an L/C through this bank.
2. Exporter ships the goods as per the schedule agreed with the buyer.
3. The exporter draws a series of bills of exchange and send them
along with the shipping documents, to his banker for presentation
to importer for acceptance through latter‟s bank. Bank returns
avalised and accepted bills of exchange to his client (the exporter).
4. Exporter informs the Importers bank about assignment of proceeds
of transaction to the forfaiting bank.
5. Exporter endorses avalised Bill of Exchange (BOE) with a word
“without re-course” and forwards them to the Forfaiting Agency
(FA) through his bank.
6. The FA effects payments of discounted value after verifying the
Aval‟s signature and other particulars.
7. Exporter‟s bank credits Exporter‟s A/C.
8. On maturity of BOE/Promissory notes, the Forfaiting Agency
presents the instruments to the Aval (Importer‟s Bank) for
In case of Indian exporters availing Forfaiting facility, the forfaiting
transaction is to be reflected in the following three documents associated
with an export transaction, in the manner suggested below:
Invoice: Forfaiting discount, commitment fees, etc. need to be
shown separately, instead, these could be built into the FOB price,
stated on the invoice.
Shipping Bill and GR form: Details of the forfaiting costs are to be
included along with the other details, such as FOB price,
commission insurance, normally included in the “Analysis of Export
Value” on the Shipping Bill. The claim for duty drawback if any is to
be certified only with reference to the FOB value of the export
stated on the shipping bill.
BENEFIT TO EXPORTER
100% Financing – Without recourse and not occupying exporter‟s
credit line. That is to say once the exporter obtains the financed
fund, he will be except from the responsibility to repay the debt.
Improved Cash Flow – Receivables become current cash inflow
and it is beneficial to the exporter to improve financial status and
liquidation ability so as to heighten further the fund raising
Reduced Administration Cost – By using forfaiting, the exporter
will spare from the management of the receivables. The relative
costs, as a results are reduced greatly.
Advanced Tax Refund – Through Forfaiting, the exporter can
make the verification of export and get tax refund in advance just
after financing .
Risk Reduction – Forfaiting business enables the exporters to
transfer various risks resulted from deferred payment, such as
interest-rate risk, currency risk, credit risk and political risk to the
Increased Trade Opportunity – With forfaiting, the export is able
to grant credit to his buyer freely, and thus, be more competitive in
FEE TYPE DESCRIPTION
This is payable to the forfaiter for his commitment to execute a specific
forfaiting transaction at a firm discount rate within a specified time. It
ranges between 0.5% to 1.5% per annum of the unutilized amount to be
forfaited and is charged for the period between the date the discounting
takes place or until the validity of the forfait contract, whichever is earlier.
This is the interest cost payable by the exporter for the entire period of
credit involved and is deducted by the forfaiter from the amount paid to
the exporter against the availed promissory notes or bills of exchange.
BENEFIT TO BANK
Forfaiting services provide the bank with the following benefits:
Banks can provide an innovative product range to clients, enabling
the client to avail 100% finance, as against 80-85% in case of other
Banks gain fee-based income.
Lower credit administration and credit follow up.
Factoring is a continuing arrangement between a financial institution (the
Factor) and a business concern (the Client), selling goods or services to
trade customers. The Factor purchases the client‟s book debt (account
receivables) either with or without recourse to the client.
The purchase of book debts or receivables is central to the functioning of
factoring. The supplier submits invoices arising from contracts of sale of
goods to the factor.
The Factor performs at least two of the following services:
Financing for the seller, by way of advance payments.
Maintenance of accounts relating to the account receivables.
Collection of account receivables.
Credit protection against default in payment by the buyer.
The buyer is informed in writing that all payment of receivables should be
made to the Factor.
DIFFERENT MODELS OF FACTORING
Export Factoring can be done based on two distinct models:
1. Two-Factor System.
2. Direct Factoring.
1. A TWO-FACTOR SYSTEM
It essentially involves an export factor in the country of the seller
(exporter) and its correspondent factor (import factor) in the country of
the debtor (importer). The correspondent factor typically performs a
mutually agreed set of services for the export factor. It could be any one
or both the below mentioned services:
A. Credit Guarantee Protection: The import factor undertakes to
pay the export factor in the event the importer fails to pay by a
specified period after due date. The import factor sets up limits on
buyers present in that country and the export factor discounts
invoices for its customers based on these limits. The credit
guarantee protection cover insolvency/protracted default of buyer,
However it does not cover trade disputes.
B. Collection Services: The import factor undertakes to follow up
with debtors for payment and in cases where payment is not
forthcoming they would be in a position to detect early indications
as they would be based in the same location and would be familiar
with local business intelligence as well as practices.
The factoring quotes given by various import factors would differ
depending on their location and comfort regarding the overseas
buyer. In this situation, the export factor would need to monitor its
correspondent relation with various import factors across the globe.
Also the possibility of undertaking any factoring business by the
export factor would be depend on the response of the import factors
for each transaction.
2. DIRECT FACTORING
Factoring can also be offered by availing credit insurance for the entire
factoring portfolio. Credit insurance will cover insolvency/protracted
default by the buyer as well as country risk but it would not cover trade
disputes. The credit insurer will set up limits on overseas buyers and
based on these limits export bills would be discounted.
Thereafter, detail of the invoice would be passed on to the collection
agency that will follow up for payment with the overseas buyer. In case
the overseas buyer does not respond, the collection agent can monitor
potential default cases, so that credit insurer can be informed in advance.
Using services of a collection agency could reduce significantly the delays
and to some extent the uncertainty in payments from overseas buyers.
BENEFITS OF FACTORING
Turnover Linked Finance – So as an exporter, you can finance a
higher level of sales than before and plan growth more effectively.
Flexible Cash Flow – To finance working capital requirements and
No Collateral/Security – So availing the financing is comparatively
More Time for Core Business – Since sales ledger management and
collections are handled by the factor.
Credit Protection – Reduces the incidence of bad-debts.
Pre-assessments – So buyers‟ creditworthiness is checked
Regular MIS Report – MIS reports from Factors reduce the time
spend on reconciliation of outstanding.
FACTORING: OPERATING PROCEDURE
For the factoring operation, the pre-requisite is the establishment of a
factoring relationship between the client and the factor. On the basis of
credit evaluation, the factor fixes limits for individual customers of the
client indicating the extent to which, and the period for which the Factor
is prepared to accept the client‟s receivables for such customers.
1. The client (seller) sells the goods to the customer (buyer) and
invoices him in the usual way inscribing a notification to the effect
that the debt due on the invoice is assigned to and must be paid to
2. The client offers the assigned invoices to the Factor under cover of a
schedule of offer accompanied by copies of invoices and receipted
3. The Factor provides immediate prepayment up to 80% of the value
of the assigned invoices and notifies the customer sending a
statement of account.
4. Factor follows up with the customer and sends him the statement.
5. The customer makes the payment to the Factor.
6. When the customer makes the payment for the invoice, the Factor
will pay the balance 20% of the invoice value.
The prominent features of the arrangement are:
1. The drawings in the client‟s account will be regulated on the basis of
the drawing eligibility available from time to time, against the debt
so purchased by the Factor, less the amount of retention money.
2. The client will be free to draw funds at any time up to the drawing
eligibility, which will be adjusted for: New debts factored, Factored
debts collected, charges debited.
3. The Factor will send age-wise statements of accounts to the client
at the agreed periodicity.
FEE TYPE DESCRIPTION
Finance charge is computed on the pre-payment outstanding in export‟s
account at monthly intervals.
Service charge is a nominal charge levied at monthly intervals to cover
the cost of services, For example collection, sales ledger management and
periodical MIS reports. It ranges from 0.1% to 0.3% on the total value of
invoices factored/collected by the bank.
Guarantees are given by bank on behalf of its customer regarding specific
performance/obligation by the customer to the other party. The
guarantees ensure payment to the party the bank‟s customer is doing
business. Under a bank guarantee/surety bond arrangement, the bank
acts as guarantor of a claim or obligation in lieu of the debtor. The bank
cannot be held liable in the event that the debtor fails to “perform”. The
banks obligation is limited to its pledge to pay a maximum specified
amount on fulfillment of the term of commitment.
A bank guarantee/surety bond may only be issued if the customer has
been granted a line of credit. In certain cases, the bank may require
adequate collateral. One may note that even though in both Letter of
Credit and Bank Guarantee ensure that the issuing bank guarantees
payment, the difference lies in that fact that while L/C is a „positive action‟
instrument, BG is a non-performance instrument. Hence, payment is
released under L/C as and when all the terms of the underlying trade
transaction are met. On the other hand, payment is released under BG if
and when the term of underlying transactions are not compiled with.
TYPES OF BANK GUARANTEES
In principle, there are two types of guarantee:
1. Direct Guarantee
A Direct Guarantee occurs when the client instructs the bank to
issue a guarantee directly in favor of the beneficiary.
2. Indirect Guarantee
Within an Indirect Guarantee, a second bank is involved. The
second bank usually a foreign bank with a head office in the
beneficiary‟s country of domicile, is requested by the initiating bank
to issue a guarantee in return for the latter‟s country-liability and
In this case, the initiating bank will cover the guaranteeing (foreign)
bank against the risk of any losses that it may incur in the event
that a claim is made under the guarantee. It formally pledges to
pay the amount claimed under the guarantee upon first demand by
the guaranteeing bank.
Depending on the purpose of the Guarantee, the Bank Guarantees may
be classified as under:
1. Tender Bond
This type of bank guarantee is also known as bid bond. The purpose
of a tender bond is to prevent a company from submitting a tender,
winning the contract and then declining to accept it on the grounds
that the deal is no longer lucrative. Tender bonds offer buyers
security against dubious or unqualified bids. They are often
mandatory for public invitations to tender.
2. Performance Bond
This is also known as performance guarantee. A performance
bond/guarantee provides security for any costs that may be
incurred by the bond beneficiary on non-performance of a
contractually agreed service and/or non-compliance with the
3. Credit Guarantee
Borrowers are often required to provide collateral for a credit line or
a loan. A third party may also provide collateral. A bank guarantee
is one of the options creditors have to ensure that a loan will be
repaid.(On the condition that the lending and guaranteeing banks
are not identical.)
4. Payment Guarantee
A payment guarantee, or payment default guarantee, provides
security against default for the goods to be delivered, for example.
If the debtor fails to make payment when due, and beneficiary has
fulfilled his or her contractual obligations , e.g. goods have been
delivered and/or services have been provided in accordance with
the contract, a written declaration to this effect is generally
sufficient to redeem payment from the guaranteeing bank.
This instrument can be used instead of a Letter of Credit if, for
example, the buyer does not require or demand proof of delivery by
means of the usual original delivery documents.
5. Confirmed Payment Order
This is an irrevocable obligation on the part of the bank to pay a
specified sum at a specified time to the beneficiary (creditor) on
behalf of the customer.
6. Advance Payment Guarantee
The advance payment guarantee is intended to bind the supplier to
use the advance payment for the purpose stated in the contract
between the buyer and the supplier. An advance payment provides
the supplier with funds to purchase equipment or components.
In general, the advance payment guarantee should contain a
reduction clause that automatically reduces the amount in
proportion to the value of the (partial) delivery(ies). The advance
payment guarantee should only become effective once the advance
payment has been received.
7. B/L Letter of Indemnity
This is also called a Letter of Indemnity. Individual bill of lading or
the full set can go missing or be held up in the mail. Carriers may
be liable for damages if they deliver the consignment before
receiving the original bill of lading. A bank guarantee in the carrier‟s
favor for 100-200% of the value of the goods enables them to
delivers the goods to the consignee without presentation of the
8. Rental Guarantee
This a guarantee of payment under a rental contract. The guarantee
is either limited to rental payments only, or includes all payments
due under the rental contract. (e.g. including cost of repairs on
termination of the rental contract).
9. Credit Card Guarantee
In a certain circumstances, credit card companies will not issue a
high value credit card without a bank guarantee. Such kind of
guarantee extended by a bank is known as a Credit Card
CLAIM (GUARANTEE UTILIZATION)
If the beneficiary under the guarantee considers that the supplier has
violated the supplier‟s contractual obligation, the former may utilize the
guarantee. Claims must be made during the period of validity and strictly
in accordance with the guarantee conditions.
The RBI has issued some general guidelines for bankers to follow while
doing the guarantee business. The Authorized Dealer/EXIM Bank have
been authorize to furnish (without prior permission of Reserve Bank), bid
bonds/tender guarantees and advance payment/performance guarantees
in cases where the RBI has been authorized to approve proposals of
As per the recent guidelines, the Authorized Dealers/EXIM Bank/Working
Group may consider and approve project export proposal/service
contracts abroad. These may involve all types of guarantees to be
furnished in connection with execution of projects/contract abroad. In
order to get the latest updates on these guidelines, one should refer to
relevant circulars of RBI, available at RBI‟s website:
While issuing guarantees on behalf of customers, the following safeguards
In the case of Financial Guarantees, banks should ensure that the
customer would be in a position to reimburse the amount in case
the bank is required to make the payment under the guarantee.
In the case of Performance Guarantees, banks should exercise due
caution and should know the customer sufficiently well, to satisfy
themselves that he has the necessary experience, capacity and
means to perform the obligations under the contract and is not
likely to commit any default.
Banks should normally refrain from issuing guarantees on behalf of
customers who do not enjoy credit facilities with them.
Banks should ideally guarantee shorter maturities, and leave longer
maturities to be guaranteed by other institutions. A Bank Guarantee
should ideally not have tenure for more than 10 years.
A Bank should ensure that 20% of its outstanding unsecured
guarantees plus the total of its unsecured outstanding unsecured
advances should not exceed 15% of its total outstanding advances.
DOMESTIC TRADE FINANCE
Fundamentally, the trade finance business is the domestic arena is similar
to the trade finance business on an international level. However, since no
multi-currency or cross country transactions occurs, hence the regulatory
framework is much simpler. The goods do not require customs clearance
and the remittance do not need to be reported to the Forex regulatory
bodies. Naturally, export/import licenses are not required and export
quota restrictions do not limit growth.
Also, since both the buyer and the seller operates within the same legal
and administrative framework, and are often known to each other, the
level of mutual confidence is higher.
Modes of transactions in domestic trade within national boundaries are
basically similar to the modes of transaction in International Trade. These
Open A/C transactions.
Delivery against payment.
Delivery against acceptance.
It is natural that due to higher degree of confidence enjoyed by the
buyers and sellers within the same regulatory and administrative
boundaries, the easier to carry out and less documentation intensive
trade option like clean payments and documentary collections are used
Most of the Trade Finance options available in International Trade are also
available in domestic trade. However, some financing options that are
specifically more relevant in domestic trade.
Through channel financing, Dealers are able to leverage their relationship
with reputed companies in sourcing low cost funds with support from their
counterparts. Channel Financing is a product that extends working capital
finance to dealer having business relationships with large companies in
India. This may be in the form of either cash credit facilities or as a bill
discounting line of credit.
Under this, the bank can extend:
Discounting of trade bills drawn by the reputed supplier and
accepted by the dealer/distributor.
Limited overdraft facility to the dealer/distributor for his business
dealing with large corporate.
By providing short term lending to clients utilizing qualified receivables
and improved control of the sales/distribution channels. In addition,
payables discounting serves to add value by improving supplier
relationships and enhancing cash-flow management.
Vendors can leverage their relationship with reputed companies by
sourcing low cost bill discounting line of credit. Vendor Financing is a
product to extend working capital finance to vendors having business
relationships with large corporate in India. Herein the bank undertakes to
discount bills drawn by the supplier/vendor and accepted by the
CHALLENGES BEFORE TRADE FINANCE SERVICE
Traditional standardized trade finance products are outdated and belong
to a bygone era. Traditionally, Trade Finance services have been suited to
meet the needs of the industrial age, wherein disparate parties engaged
in trade of goods. The competitive advantage and profitability of the
company was determined by its strength relative to the strength of the
next member of the supply chain. The trade was transaction specific and
each deal could be looked at and dealt with independently.
In the information age, it is not the companies that compete with each
other rather it‟s the “Networks” that compete with each other networks.
In this context, a “Networks” can be loosely described as the summation
of the entire supply chain, commencing from raw material procurement,
through various stage of value addition, and finally to the end user. In
knowledge industries, a network can be defined as the summation of
organizations that create, process and distribute information to serve a
In such a scenario, the survival/growth of each member in the networks
depends on the strength of the network as a whole and vice-versa. As a
result, the relationship between various member of the supply chain
changes from a „Buyer-Seller‟ relationship to that of a „partner-in-growth‟
It is to be noted that an organization can be a member of more than one,
sometimes rival „networks‟. However, a combination of all the member of
the network would make a unique supply chain structure, usually
dominated by one dominant member that competes with other networks.
Such „networks‟ are already becoming dominant in the International
market. E.g. Dell Computers, Microsoft, Oracle, Ford Motor Company, GM,
Toyota, GE, Boeing, Wal-Mart etc. are all examples wherein all the
members of the network operates in tandem with each other through
careful information processing and Supply Chain Management by sharing
critical data on a continuous basis.
Domestic and International trade has experienced dramatic changes due
to the introduction of supply chain management techniques that have
reduced the dollar size of individual shipments. In 2001, the average
value of an international shipment was 42% of what it was in the 1970s.
Managing the supply chain carefully reduces inventory and brings
companies close to just-in-time production.
This change has had a tremendous impact on the trade finance business,
because traditional trade finance solutions such as letters of credit are far
less relevant to this new reality of international trade business.
THE WAY AHEAD
The challenge before the banks is to provide solution that are „network‟
specific and not just transaction specific. Just putting an “e” before a “LC”
(Letter of Credit) won‟t make the e-LC a killer app.
Moving traditional Trade Finance tools to the internet is not the answer.
New age trade finance solutions should strive to achieve 2 goals:
1. Move from a transaction focus solution to network management
2. Customize and package solutions that are relevant to a particular
Most banks operating in the trade finance business have moved their
trade features online, for reason of efficiency and cost reduction, either
via proprietary solutions or by outsourcing the operation to another
institution. Even if this move has created efficiencies, reduced costs, and
fulfilled clients‟ needs, it has failed to address the issue of today‟s trade
finance business. This step is very similar to integrating third-party
solutions, which cannot alone completely address customer needs.
The real added value to customer in the trade business today stems from
the merger of trade finance with supply chain and cash management, and
packaging and providing the information on real-time basis to the
customer in an easily accessible manner. As Businesses move towards
operating in a more integrated manner across political boundaries, so
would their supporting financial structures. This would require banks to
provide for internationally integrated financial solutions, like Global cash
management solutions and integrated multinational treasury solutions.
The underlying principal towards all future growth would be integration –
integration of markets leading to integration of services, further leading to
integration of processes and databases.
PRACTITIONERS‟ BOOK ON TRADE FINANCE
INTERNATIONAL TREASURY MANAGEMENT