Forfaiting and factoring


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Forfaiting and factoring

  1. 1. Factoring and forfaiting International financial settlements 2
  2. 2. Lecture outline Factoring as trade finance method Forfaiting as trade finance method International financial settlements 3
  3. 3. Factoring  Factoring is a transaction where the exporter sells its receivables to an institution  The factoring institution buys the receivables without recourse  Due to increased risk factors demand discount on the receivables International financial settlements 4
  4. 4. Types of factoring  Maturity factoring- the factor pays the exporter at maturity of the accounts receivable  Advance factoring- the factor pays the exporter in advance a specified share of the receivables International financial settlements 5
  5. 5. The mechanism of factoring  The factoring transaction involves three parties:  The seller-the exporter  The debtor-the importer  The factor International financial settlements 6
  6. 6. The mechanism of factoring  The receivables sold are usually invoices for the delivered products Factoring can take place with or without notification of the debtor In the case of notification the factor carries out the collection, in the case of lack of notification the exporter carries out the collection International financial settlements 7
  7. 7. Advantages Factoring is advantageous for exporters because this way they can obtain cash This can especially beneficial if companies struggle with liquidity problems  In some industries factoring is the historic method of finance e.g. in textiles or apparel branches International financial settlements 8
  8. 8. Advantages  Factoring enables risk-free export sales  The exporter can offer more attractive transaction terms  Exporters are relieved from administration duties International financial settlements 9
  9. 9. When to use factoring?  Factoring is more expensive than a bank loan  In fact it is not a loan  It can happen that banks would refuse a loan to an exporter to provide him with cash but a factor would buy his receivables  The factor checks the creditworthiness of the debtor and not of the seller  Especially beneficial for small exporters International financial settlements 10
  10. 10. Would factors always buy the receivables? The credit history of the debtor is a crucial condition The current creditworthiness of the debtor Usually even average credit rating of the debtor is refused by factors International financial settlements 120881-1165 11
  11. 11. Is the debtor affected by factoring?  Some types of debtors- usually large firms or governments have specified procedures when it comes to transferring the payment from the seller to debtor  This matters especially due to the obligation of the factor to perform the collection  The distinction between assignment of the responsibility to perform the work and the assignment of funds to the factor influences largely the debtor’s processes  Sometimes the debtor wants the seller to perform the collection International financial settlements 12
  12. 12. Forfaiting (1)  A transaction where a forfaiting institution buys withoutrecourse the debt resulting from a trade contract which is due in the future Forfaiting is usually aimed at medium-term capital goods financing The subject of forfaiting transactions are usually fixed assets As this type of goods are usually expensive the financing period may account for several years International financial settlements 13
  13. 13. Forfaiting (2)  Exporters are not willing to finance importers over such a long period  This is why the debt of the importer is sold to forfaiters (usually banks)  Forfaiting financing usually refers to transactions exceeding 500000 USD  For larger transaction more than one forfaiting institutions can be involved International financial settlements 14
  14. 14. Forfaiting (3)  The forfaiting institution takes over the risk of the sales transaction.  The exporter is liable for the quality and reliability of the project  The forfaiter has an unconditional payment obligation International financial settlements 15
  15. 15. The forfaiting process Source: E. Bishop, op. Cit. 16
  16. 16. Does the bank always agree to forfaiting?  The bank needs a guarantee that the debt will be paid off  The debt should be freely transferable  The forfaiting bank requires the debt purchased to be secured by a credible bank guarantee or the importer to be a prime buyer, e.g. government agency or a multinational company International financial settlements 17
  17. 17. Required documents The guarantee can take the form of:  promissory notes  bills of exchange,  book receivables  deferred payments under a letter of credit International financial settlements 18
  18. 18. Forfaiting paper  All documents guarantying the transaction e.g. bills of exchange and promissory notes become the property of the forfaiter  The documents are called forfaiting papers  They are liquid assets with comparatively high yields International financial settlements 19
  19. 19. What are the costs of forfaiting?(1) The forfaiting institution demands cash for buying the debt The value of the debt is discounted at a specified rate, The forfaiting institution demands also a risk premium on the transaction  International financial settlements 20
  20. 20. What are the costs of forfaiting? (2) The discount margin is the one of the principal costs of forfaiting Besides the discount margin the bank charges a commitment fee The discount can be computed as straight discount or discount to yield basis International financial settlements 21
  21. 21. Advantages of forfaiting for the exporter  Conversion of a credit transaction into a cash transaction Increase of liquidity  Risk elimination (market, transaction and political risks)  Relieve of administration duties International financial settlements 22
  22. 22. Advantages of forfaiting for the importer The flexibility to pay for his goods Deferred payment Fixed interest cost International financial settlements 23
  23. 23. Summing up  Factoring and forfaiting can be beneficial methods of trade finance  Both allow to transfer credit transactions into cash transactions  Factoring serves financing short term transactions while forfaiting medium term transactions International financial settlements 24
  24. 24. Discussion Factoring and forfaiting are withoutrecourse methods of trade finance. Is this always beneficial? Name examples when recourse financing would be more beneficial. International financial settlements 25
  25. 25. Literature E. Bishop, Finance of international trade, Chapter 10. Publication available via Science Direct Database International financial settlements 26