Chapter 11: Trade Finance Flashcards
• What is the difference between letter of credit and documentary collection –
○ Both under banks, documentary collection- bank doesn’t monitor payment and shipment, but just watch the documents.
• What are they payment methods
Open Account Documentary Collections Documentary letters of credit confirmed documentary letters of credit sight or term payments
• Steps to a letter of credit.
§ Agreement between buyer and seller to do business
§ Buyer goes to buyers bank and requests application for a letter of credit
§ Buyers bank calls sellers bank and tells them about the details of the deal and application checked out - so there is an issuance of the letter of credit
§ Sellers bank advices the seller
§ Seller ships the product.
§ Buyer presents documents to prove that they have received the product
§ Buyers bank forwards presented documents to the sellers bank.
Release of payment by sellers bank to seller
Four pillars of finance
- Payment Facilitation
- Financing
- Risk Mitigation
- Provision of Information
Four pillars of finance : 1. Payment Facilitation
across borders and jurisdictions, in timely manner (use of electronic remmitence)
Four pillars of finance : 2. Financing
to several parties in a deal, available at nearly every stage of a transaction, from pre-shipment to post-delivery
○ The availability of numerous mechanisms to provide financing to one or more parties in a trade transaction
○ Need for financing can appear at any point in the trade, so have sufficient funds.
Four pillars of finance :3. Risk Mitigation
covering everything from revolutions and military coups to economic crises, to commercial default or bankruptcy, civil unrest
○ Not only is this critical in terms of assuring successful conclusion of business, but it is also very important in reducing the overall risk profile of a transaction, and therefore, the cost of that transaction.
○ Example: letters of credit
○ Risk mitigation can be provide by financial insitutions working in partnership with government
○ Risk to be managed:
§ Commercial risk - risk associated with the trading partner (insolvency)
§ Bank risk- financial health of the trading parnter
§ Sovereign or country risk - economic or political risks
§ Currency or foreign exchange risk- risk associated with changes in relative values of currencies.
Four pillars of finance :4. Provision of Information
- about the status of shipment, and the status of financial flows
- Timely, accurate and detailed information about every aspect of the trade.
Payment methods : Open Account
- Transfers of funds to the account of the exporter and may be effected prior to shipment or on delivery.
- Used between very stable and secure markets (well established relationship and trust)
- Payment in advance
- Payment on delivery
Payment methods : Documentary Collections
- Banks act as intermediaries between the importer and exporter, agreeing to facilitate payment to the exported only once a set of shipping documents have been prepared and presented to the intermediary bank.
- Documentary collections afford some degree of incremental protection to both parties
Payment methods : Documentary letters of credit
- Most secure trade finance- instrument available in terms of protecting the interest of both parties.
- Banks act as intermediaries.
- Difference is that banks are required to verify that the terms and conditions of payment specified in a documentary credit have been full complied with by the exporter. This involves
- Detailed documents presented by the exporter
- Requires a review of elements such as the shipment date, the deception of goods and the presentation of carious inspection certificates.
- Documents of transport should be verified, including negotiable bills of lading
- This method provides a high degree of comfort for both parties.
Payment methods : confirmed documentary letters of credit
• If exporter is not trusting of importers bank, they can ask for the letter of credit to be confirmed
This means another bank steps in, one that the exporter trusts, this bank adds its own separate and
Payment methods : sight or term payments
- Payment undertaking under collections or documentary letters of credit may be at sight or could be term payments
- Payment at sight refers to payment immediately upon recipt of documents that are presented as per the collection of the letter of credit
- Term payments, are future-dated, as agreed upon between buyer and seller.
Other forms of finance and trade facilitation
- medium term financing
- long term financing
- buyer credit
- supplier credit
- forfeiting
- countertrade
- leasing
- project financing
Medium- and long-term financing
○ Medium term financing arrangements are structured for repayment periods of up to five years
○ Long term financing arrangements can range between 5-15
