International Trade Finance

Lecture Notes on International Trade Finance Introduction International Trade Finance refers to those activities that provide funds and control over international trade and commerce. In this aspect several instruments and products are provided so that the importers and the exporters are able to reduce risk, complete transactions, and finance international business respectively. As the markets globalize, such mechanisms are required to enable trade in goods and services across national boundaries. Key Concepts of International Trade Finance 1. Importance of Trade Finance - Provides risk mitigation for both importers and exporters. - Enhances liquidity and funding of the global undertakings. - Controls the risks of payment arising from international trade transactions. 2. Main Parties Involved - Exporter (Seller):Agent – Country, or investor in commercial and service activity. - Importer (Buyer): Purchaser of goods or services rendered. - Financial Institutions (Banks):arrange financing to their clients and offer guarantees to both opposing parties. - Insurers: Provision of cover where payment default or political clauses are incurred. 3. Risks in International Trade - Commercial Risk: The buyer will become insolvent or refuses to pay for instances of commercial activity. - Country Risk: Economic or political development in the country of the buyer may render sanction. - Currency Risk: Self-explanatory – changes in foreign exchange rates while conducting the transaction. - Transport Risk:Goods may be lost or damaged in the process of transport. Trade Finance Instruments 1. Letters of Credit (LCs) - It is a most common trade finance instrument, which involves a bank making a commitment to pay on account of the importer. - Types of Letters of Credit: - Irrevocable LC: All involved parties have to provide consent prior any amendments or cancellation. - Confirmed LC: Payment risk is Shareable by Issuing and an additional bank that pays the ier with extra assurance to the exporter. - Standby LC: It is a second layer payment to be made in case the importer does not pay up in the terms agreed. 2. Bills of Exchange - Is an order in writing from one Person (the-drawer) to another ( the-drawee) requiring that a given sum of money be paid either on presentation of the order or at a future stated period. 3. Documentary Collections - The bank of the exporter delivers the goods to the buyer or their agent on behalf of the bought documentary evidence or title documents that enable possession of the goods until payment is made. 4. Trade Credit Insurance - Relates to the cover, which reimburses exporters, to title and or sell goods Willing to explore payment Default Risk from the importer. - Usually extended so as to include political risks cover such as war and or embargoes, and commercial risks cover such as the buyer going bankrupt. 5. Factoring and Forfaiting - Factoring: Exporter sells the accounts receivable to a third party called factor at a discount for cash. - Forfaiting: Exporters assign or sell their medium to long term receivables more than 90 days on credit at a discount to forfaiters. 6. Bank Guarantees - The bank undertakes that the other party (generally the importer) performs his obligations in favor of the exporter. 7. Open Account and Advance Payment - Open Account: The exporter is ready for risk by accepting payment after shipment of goods by the importer. - Advance Payment:The payment is received before the goods are dispatched to the importer, hence taking risks to the exporter rather than the importer. Process of Trade Finance 1. Pre-Shipment Finance - Assists in the purchase of raw materials, production of goods, and readiness of products for shipment. 2. Post-Shipment Finance - This refers to the money extended after goods have been shipped to help in waiting for the payment after the shipment reachers the destination country. - Example: Discounting of Bills of Exchange or Letters of Credit. Current Trends in International Trade Finance 1. Digitization - Digitization Out to paperless trade financing processes is fast being adopted attributable to the need to cut costs, increase efficiency and accelerate the duration of transactions. - Exploration has been done on the application of blockchain technology and smart contracts in minimizing fraud with improved transparency in document exchanges. 2. Sustainability in Trade Finance - More Emphasis is being placed on the development of these trade finance products which are socially and ecologically responsible in aiding green businesses and industries.. - Such trade finance transactions in particular, have been market-ed by financial institutions in line with the United Nations Sustainable Development Goals (SDGs). 3. Impact of Geopolitical Risks - Increasingly trade finance is playing a more important role in countering risks that arise out of geopolitical factors like trade wars or sanctions. 4. Covid-19 and Trade Finance - The Crisis revealed the risks of globalization, domestic economies were cut off from international trade, causing disruptions of supply chains and increasing the risks of businesses - The financial institutions reacted by developing more liberal trade finance packages where borrowers were offered longer repayment periods and more liquidity support was extended. In understanding how the global credit market had changed, different financial instruments took shape.