Finance function

Finance Function
The finance function involves the acquiring and utilization of funds necessary for
efficient operations. Finance is the lifeblood of a business without it things wouldn’t run
smoothly. It is the source to run any organization, it provides the money, it acquires the
money.
Finance Function involves
o Ensure enough funds at reasonable cost.
o Ensure safety of funds.
o Ensure efficient effective and profitable utilization of funds.
o Ensure that finance funds don’t remain idle.

Financial Institutions In Foreign Trade
o World Bank Group(WBG)
o International monetary Fund
o SDR
o Regional Development Banks

WORLD BANK GROUP
WBG
IBRD
IDA
IFC
MIGA
ICSID

Introduction To World Bank Group
o The World Bank group is a multinational financial institution established at the end
of World War II (1944) to help provide long-term capital for the reconstruction and
development of member countries.
o The World Bank functions as an international organization that fights poverty by
offering developmental assistance to middle-income and low-income countries. By
giving loans and offering advice and training in both the private and public sectors,
the World Bank aims to eliminate poverty by helping people help themselves.

INTERNATIONAL BANK FOR RECONSTRUCTION
AND DEVELOPMENT (IBRD)
o The International Bank for Reconstruction and Development (IBRD) is a global
development cooperative owned by 189 member countries.
o As the largest development bank in the world, it supports the World Bank Group’s
mission by providing loans, guarantees, risk management products, and advisory
services to middle-income and creditworthy low-income countries, as well as by
coordinating responses to regional and global challenges.
o Generally, the IBRD lends money to a government for the purpose of developing that
country’s economic infrastructure such as roads and power generating facilities

INTERNATIONAL DEVELOPMENT ASSOCIATION
(IDA)
o The International Development Association (IDA) is the part of the World Bank that
helps the world’s poorest countries. Overseen by 173 shareholder nations, IDA aims to
reduce poverty by providing loans (called “credits”) and grants for programs that boost
economic growth, reduce inequalities, and improve people’s living conditions.
o IDA complements the World Bank’s original lending arm—the International Bank for
Reconstruction and Development (IBRD).
o IDA is a multi-issue institution, supporting a range of development activities that pave
the way toward equality, economic growth, job creation, higher incomes, and better living
conditions. IDA's work covers primary education, basic health services, clean water and
sanitation, agriculture, business climate improvements, infrastructure, and institutional
reforms.

INTERNATIONAL FINANCE
CORPORATION(IFC)
o IFC is the member of the World Bank Group and the largest global development
institution focused exclusively on the private sector in developing countries.
o IFC is a member of the World Bank Group and is headquartered in Washington,
D.C. in the United States. It was established in 1956, as the private-sector arm of
the World Bank Group, to advance economic development by investing in for-profit
and commercial projects for poverty reduction and promoting development.
o IFC has focused on sustainable agriculture opportunities, improve healthcare and
education, increase access to financing for microfinance and business clients,
advance infrastructure, help small businesses grow revenues, and invest in climate
health.

THE MULTILATERAL INVESTMENT
GUARANTEE AGENCY (MIGA)
o The Multilateral Investment Guarantee Agency (MIGA)promotes cross-border investment in
developing countries by providing guarantees (political risk insurance and credit enhancement) to
investors and lenders.
o The guarantees protect investments against noncommercial risks and can help investors obtain
access to funding sources with improved financial terms and conditions.
o The agency derives its unique strength from the World Bank Group and from its structure as an
international organization whose shareholders include most countries of the world. This enables
MIGA to provide an umbrella of deterrence against government actions that could disrupt projects,
and assist in the resolution of disputes between investors and governments.
o MIGA offers clients extensive knowledge of emerging markets and international best practices in
environmental and social management.

INTERNATIONAL CENTRE FOR SETTLEMENT OF
INVESTMENT DISPUTES (ICSID)
o The International Centre for Settlement of Investment Disputes (ICSID), an institution
of the World Bank Group based in Washington D.C, United States, was established in
1966 pursuant to the Convention on the Settlement of Investment Disputes between
States and Nationals of Other States (the ICSID Convention or Washington Convention).
As of May 2011, 157 countries had signed the ICSID Convention.
o ICSID has an Administrative Council, chaired by the World Bank's President, and a
Secretariat.
o It provides facilities for the conciliation and arbitration of investment disputes between
member countries and individual investors.
o The expenses of the ICSID Secretariat are financed out of the Bank's budget, although
the costs of individual proceedings are borne by the parties involved.

INTERNATIONAL MONETARY FUND(IMF)
o The International Monetary Fund (IMF) is an organization of 189 countries, working to
foster global monetary cooperation, secure financial stability, facilitate international
trade, promote high employment and sustainable economic growth, and reduce poverty
around the world.
o Created in 1945, the IMF is governed by and accountable to the 189 countries that make
up its near-global membership.
o The IMF's primary purpose is to ensure the stability of the international monetary
system—the system of exchange rates and international payments that enables
countries (and their citizens) to transact with each other. The Fund's mandate was
updated in 2012 to include all macroeconomic and financial sector issues that bear on
global stability.

SPECIAL DRAWING RIGHTS(SDR)
o Special drawing rights (SDR) refer to an international type of monetary reserve
currency created by the IMF in 1969 that operates as a supplement to the existing
money reserves of member countries.
o SDR is created in response to concern about the limitations of gold and dollars as
the sole means of settling international accounts, SDRs augment international
liquidity by supplementing the standard reserve currencies.
o An SDR is essentially an artificial currency instrument used by the IMF, and is built
from a basket of important national currencies. The IMF uses SDRs for internal
accounting purposes.

Regional Developmental Banks
Asian Development Bank
o ADB is a financial institution established in 1966 to reduce poverty in the
Asia-Pacific region. The bank is headquartered in Manila, Philippines and
consists of 61 member countries.
o ADB promotes economic growth and international development in the Asia-
Pacific region of the world. It finances its activities with bonds and works
closely with the International Monetary Fund and the World Bank toward
accomplishing its goals. Its two largest shareholders are the United States and
Japan.

REGIONAL DEVELOPMENTAL BANKS
African Development Bank(AFDB)
o The African Development Bank (AfDB) Group’s mission is to help reduce
poverty, improve living conditions for Africans and mobilize resources for the
continent’s economic and social development.
o AFDB aims at assisting African countries – individually and collectively - in
their efforts to achieve sustainable economic development and social progress.
Combating poverty is at the heart of the continent’s efforts to attain sustainable
economic growth.
o The Bank seeks to stimulate and mobilize internal and external resources to
promote investments as well as provide its regional member countries with
technical and financial assistance.

Non Resident Accounts
o Non-Resident bank accounts are those, which are maintained by Indian
nationals and Persons of Indian origin resident abroad, foreign nationals
and foreign companies in India.
o Bank branches can open ordinary non-resident accounts in the names of
private individuals provided initial deposits for opening the accounts are
received from abroad in an approved manner or the initial amount is
tendered in foreign currency while on a visit to India or transfer of funds
from the existing non-resident account of the same person.

Repatriable And Non-repatriable Bank
Accounts
The two types of NRI( Non Resident Indian ) accounts are non-repatriable accounts and
repatriable accounts.
1.Repatriable Accounts : Legally Indian rupees can be transferred back to foreign
currency, that is money can be converted to any foreign currency.
o NRE Account ( Non-resident External Account ) – : Savings, Current & Time Deposits
o FCNR-B Account ( Foreign Currency Non-resident Bank Deposits)
2.Non-Repatriable Accounts : Money cannot be converted to any foreign currency.
o Non-Resident (Non-Repatriable) Rupee Deposit Accounts (NRNR Accounts)
o Non-Resident (Special) Rupee Accounts (NRSR Accounts).
Note : With effect from 01/04/2002, both NRSR and NRNR deposit schemes have been
discontiuned by RESERVE BANK OF INDIA.

5 Types Of Non Resident Accounts
1.Ordinary Non-Resident Rupee Accounts (NRO Accounts)
o NRO Accounts are Rupee denominated non-repatriable accounts(the right to take
the money outside India is known as ‘Repatriation Right’) and can be in the form of
savings, current recurring or fixed deposits.
o These accounts can be opened jointly with residents in India. When an Indian
National / PIO resident in India leaves for taking up employment, etc. outside the
country, his bank account in India gets designated as NRO account.
o The deposits can be used to make all legitimate payments in rupees. Interest
income, from NRO accounts is taxable. Interest income, net of taxes is reportable.

2.Non-Resident (External) Rupee Accounts (NRE Accounts)
o These are again rupee accounts. The NRE account can be opened only with money
received from abroad and not from local rupee sources. There can be joint holder to the
account but not with residents. The joint account holder should also be a non resident.
o The funds held in the account can be freely repatriated outside India without limit and
without any approval from RBI. Since the account is maintained in rupee, for
repatriation purpose the Rupee will be converted into the desired foreign currency at the
prevailing rate of exchange.
o Interest earned on the account is free from income tax. The account can be maintained
as savings bank account, fixed deposit, recurring deposit, etc.

3. Foreign Currency (Non –Resident) Accounts (Banks) (FCNR (B) Accounts)
o FCNR Accounts are Term Deposit Accounts. They can be maintained in four im-
portant currencies, viz., US Dollar, Pound Sterling, and Japanese Yen. Presently it
can be maintained in the new European Currency “Euro” also. They can be
maintained for period ranging from one year to 3 years.
o These accounts are now known as FCNR (B) Accounts. ‘B’ stands for Banks. Since
the account is maintained in foreign currency and paid back in the same currency,
there is no conversion of currency takes place when balance is repatriated outside
India.

4. Non-Resident (Non-Repatriable) Rupee Deposit Accounts (NRNR Accounts)
o These accounts are opened by transfer of freely convertible foreign currency funds from abroad, or
from NRE / FCNR accounts.
o Non-residents can open joint accounts with other Non-Residents (except Pakistan and
Bangladeshi nationals) or resident close relatives in India. Deposits can be held jointly with a
resident.
o Deposits can be for a period from 6 months to 3 years, and can be renewed further. Accounts may
also be opened by transfer of funds from the existing NRE/FCNR accounts of the non-resident
accounts holders.
o The principal is non-repatriable; interest can be repatriated. There is no income tax on the interest
o Reserve Bank has withdrawn this scheme since April 1, 2002. Hence, new accounts cannot be
opened after April 2002.

5. Non-Resident (Special) Rupee Accounts with banks in India
o NRIs/PIOs presently have the facility of maintaining bank accounts and undertaking
financial transactions in India subject to certain exchange control regulations.
o In order to simplify the procedures and to provide greater freedom to NRIs/PIOs for
putting through financial transactions in India, NRIs and PIOs are now permitted to
open bank accounts in India, which will be at par with rupee accounts, maintained by
residents. They can now open Non-Resident (Special) Rupee Accounts with banks in
India which will have the same facilities and restrictions as are applicable to rupee
accounts maintained in India by residents relating to repatriation of funds held in these
accounts and/or income/interest earned on them. The procedure for opening such
accounts is the same as that of domestic accounts of resident individuals.

NRI’S Significance To Indian Economy
o Improves the standard of living
o Increases purchasing power
o Increase in demand and supply boosts the market development
o Boosts the GDP of the country
o Major source of Direct Foreign investment
o Helps in new technology and knowledge transfers
o Contributes to education, healthcare, charity and other social projects.

Methods Of Trade Settlement
1.Open Account
o Open account is a payment method in international trade where exporters
first ship the goods to the importers and then they will be receiving the
payment from the importers some time after the shipment.
o Exporters will receive their payment in most cases 30 days, 60 days or 90
days after bill of lading date.
o This is the most risky payment type for the exporters because as soon as
shipment completed exporters send all documents to the importers so that
the control over the goods passes to the importers before payment
initiated.

2.Cash in Advance
Cash in Advance is a pre-payment method in which, an importer the payment for the items
to be imported in advance prior to the shipment of goods. The importer must trust that the
supplier will ship the product on time and that the goods will be as advertised. Cash in
Advance methods of payment is usually done when-
o The Importer has not been long established.
o The Importer's credit status is doubtful or unsatisfactory.
o The country or political risks are very high in the importer’s country.
o The product is in heavy demand and the seller does not have to accommodate an
Importer's financing request in order to sell the merchandise.

3.Documentary Credits
o Documentary Credits are also known as Letters of Credit.
o Documentary credits are one step more secure payment methods than documentary
collections as banks give the payment guarantee to the exporters.
o Usually some form of securities or cash as a collateral is required by the bank for issuing
a letter of credit, and charge a service fee, typically as a percentage of the value of the
L/C.
o Documentary credits have two weaknesses. They are expensive and complicated.
o This payment option is suitable for medium to big amount transactions.

4.Documentary collection
o Documentary collection are also known as “Cash Against Documents”.
o Exporters ship the goods to the importers and then they collect the shipment
documents and give them to their bank. Exporter bank sends the documents to the
importers bank who gives the documents to the importers against payment or payment
guarantee.
o Money will be send back to the exporter throughout the banks; from importer’s bank to
exporter’s bank and finally from exporter’s bank to the exporter.
o If importers do not pay or accept to pay money for the documents banks will not be held
liable under documentary collections which makes this payment method weak in terms
of risk issues.

Exporter
Importer
Consignment
Consignment
Open Account
Open Account
Documentary Collections
Documentary Collections
Letters of Credit
Letters of Credit
Cash in Advance
Cash in Advance
Methods Of Payment

Types Of Letter Of Credit
1. Standby Letter of Credit – With this LC, the bank will cover the full or remaining amount of the payment if the buyer
fails to fulfill payment obligations to the seller.
2. Irrevocable Letter of Credit – A letter of credit where it cannot be modified unless all parties agree to the
modifications.
3. Revocable Letter of Credit – Opposed to the irrevocable L/C, the bank can modify the L/C under the buyer’s
permission without the consent of the seller. Once it is revoked, the bank is no longer liable to pay the seller.
4. Confirmed Letter of Credit – This L/C involves a bank other than the issuing bank guaranteeing the letter of credit.
The second bank is the confirming bank, usually the seller’s bank. The confirming bank would honour the L/C if the
issuing bank defaults.
5. Back-to-Back Letter of Credit – Used when an intermediary such as a broker is involved between the buyer and the
seller, or when the seller must first purchase the goods from a supplier that would be sold to the buyer. This L/C
consists of two letter of credits to finance a transaction.

Types Of Letter Of Credit
6.Transferable Letter of Credit – A letter of credit that allows the seller to assign a portion of the L/C
to other party/parties. This L/C comes in handy when the seller is not the sole manufacturer of the
goods and require purchasing from other suppliers, since it doesn’t require multiple L/Cs anymore.
7.Deferred Payment Letter of Credit – a letter of credit where payment is delayed to a fixed date
stated in the L/C.
8.Red Clause Letter of Credit – A letter of credit where the seller requests a portion of the L/C to be
paid before goods have been shipped and documents have been submitted.
9.Payment at Sight Letter of Credit – Payment is made immediately (maximum within seven days)
after the required documents have been submitted.
10.Revolving Letter of Credit – a single letter of credit that can be used for multiple shipments over a
period of time. It is used for regular shipments of the same commodity to the same buyer.

Parties Involved In The Letter Of Credit
1. Applicant : The buyer finalises the terms and conditions of a purchase transaction and submits a
request in the prescribed format to his bank for issuing a letter of credit in favour of the seller.
The applicant is also called the ‘opener’ of the credit.
2. Beneficiary : The beneficiary of the letter of credit is the person in whose favour the LC has
been issued. Generally, the LC is issued favouring the seller of the goods and services.
3. Opening/Issuing Bank : On receipt of the application from its customer, the bank examines the
proposal and opens a letter of credit in favour of the beneficiary with the stipulated terms and
conditions. This bank is known as the opening/issuing bank.
4. Advising Bank : Advising bank, as a part of letter of credit takes responsibility to communicate
with necessary parties under letter of credit and other required authorities. The advising bank is
the party who sends documents under Letter of Credit to opening bank.

Parties Involved In The Letter Of Credit
5.Confirming Bank :Confirming bank is one of the other parties involved in Letter of Credit. Confirming
bank as a party of letter of credit confirms and guarantee to undertake the responsibility of payment or
negotiation acceptance under the credit.
6. Negotiating Bank : Negotiating Bank negotiates documents delivered to bank by beneficiary of LC.
Negotiating bank is the bank who verifies documents and confirms the terms and conditions under LC on
behalf of beneficiary to avoid discrepancies.
7.Reimbursing Bank: The issuing bank of the LC may arrange with another bank to reimburse the amount
under the LC to the negotiating bank that has made payment to the beneficiary. Such banks are known as
reimbursing banks.
8.Second Beneficiary : Second beneficiary who represent the first beneficiary or original beneficiary in their
absence, where in the credits belongs to original beneficiary is transferable as per terms.

MECHANISM OF LETTER OF CREDIT
1. Buyer and seller agree to conduct business. The seller wants a letter of credit to guarantee payment.
2. Buyer applies to his bank for a letter of credit in favor of the seller.
3. Buyer's bank approves the credit risk of the buyer, issues and forwards the credit to its correspondent
bank (advising or confirming). The correspondent bank is usually located in the same geographical
location as the seller (beneficiary).
4. Advising bank will authenticate the credit and forward the original credit to the seller (beneficiary).
5. Seller (beneficiary) ships the goods, then verifies and develops the documentary requirements to
support the letter of credit. Documentary requirements may vary greatly depending on the perceived risk
involved in dealing with a particular company.

MECHANISM OF LETTER OF CREDIT
6.Seller presents the required documents to the advising or confirming bank to be processed for payment.
7.Advising or confirming bank examines the documents for compliance with the terms and conditions of the letter of
credit.
8.If the documents are correct, the advising or confirming bank will claim the funds by:
-Debiting the account of the issuing bank.
- Waiting until the issuing bank remits, after receiving the documents.
- Reimburse on another bank as required in the credit.
9. Advising or confirming bank will forward the documents to the issuing bank.
10. Issuing bank will examine the documents for compliance. If they are in order, the issuing bank will debit the buyer's
account.
11. Issuing bank then forwards the documents to the buyer.

Illustration Of A Letter Of Credit Transaction
A buyer from France decides to buy goods of USD 5000.00 from a seller in
Malaysia by documentary letter of credit. The buyer asks his bank i.e. the issuing
bank to issue a letter of credit in the name of the seller.
1. Issuing bank issues a documentary letter of credit in the name of the seller
and keeps the seller’s bank as advising bank.
2. Seller manufactures and ships the goods to the buyer and prepares all the
documents.
3. The seller submits the documents to the advising bank, who checks the
documents for discrepancies, and if no discrepancies are found, they send the
documents to the issuing bank.
4. Issuing bank checks the documents and if found satisfactory, intimates the
buyer of the same.

Illustration Of A Letter Of Credit
Transaction
5. The buyer makes complete payment of USD 5000.00 plus the bank charges to the
issuing bank. After receiving the payment, the issuing bank gives the documents to the
buyer.
6. The buyer clears the goods from the shipping line through these documents.
7. The issuing bank transfers full payment of USD 5000.00 to the advising bank.
8. Advising bank deducts its own service charge and transfers the remaining payment to
the seller.
Thus the transaction is complete.

Finance function

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