INTERNATIONAL TRADE FINANCE

– Letter of Credit• Uniform Customary and Practices for Documentary Credits

– Standby Letters of Credit

– Alternative Methods of Guaranteeing Performance

– Alternative Methods of Financing• Seller

• Buyer

• Government Programs

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LETTERS OF CREDIT

• Letters of Credit a commercial bank guarantee of either payment by the buyer or performance by the seller.– Purposes

• Guarantees payment by the buyer (letter of credit) or to guarantee performance by seller (standby letter of credit.

• Once letter of credit is issued, the seller can use instrument to finance production of goods.

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LETTERS OF CREDIT

• Functions of Letters of Credit– Payment Instrument

• In absence of letter of credit, sight or time drafts used. No Guarantee of Payment.

– Letters of Credit Involves Bank in Transaction.

– Performance Guarantee• In Documentary Transaction no guarantee of performance.

– Payment by bank would not be released until goods and document conforms to specifications on letter of credit.

– Finance Instrument• Seller can use letter of credit as collateral to finance

production and exportation of good.

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LETTERS OF CREDIT

• Types of Letters of Credit– Irrevocable Letter of Credit-bank cannot revoke letter

of credit. To change letter of credit, must get written agreement.

• Most Popular in International Commercial Transaction

– Revocable Letter of Credit-bank can revoke letter of credit.

• Very Seldom Used.

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LETTERS OF CREDIT

• Letter of Credit Transaction• After formation of contract, buyer arranges for bank to open

letter of credit.• Buyer’s bank prepares irrevocable letter of credit.• Buyer’s bank sends irrevocable letter of credit to a US bank

for confirmation.• US bank prepares a letter of confirmation to exporter along

with irrevocable letter of credit• Exporter arranges for freight forwarded to deliver goods.

Freight Forwarder prepares documents.• Exporter presents document to Bank indicating full

compliance. Bank bound by “rule of strict compliance”• Bank reviews documents and authorizes payment

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UNIFORM CUSTOMS AND PRACTICES FOR DOCUMENTARY CREDITS

• Uniform Customs and Practices for Documentary Credits are rules and procedure published by International Chamber of Commerce– Provisions

• Care should be taken in specifying expiration dates

• The applicant must specify if the letter of credit is transferable.

• The applicant must specify that the letter be confirmed

• The currency of the letter of credit should be designated using ISO currency code.

• The applicant should designate the nominating bank

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UNIFORM CUSTOMS AND PRACTICES FOR DOCUMENTARY CREDITS

• Uniform Customs and Practices for Documentary Credits-provisions continued.– Applicant must specify clearly whether the letter of

credit will be available for partial shipment.

– The letter of credit should provide transport details

– Under “rule of strict compliance”, banks are authorized to reject documents if there are any discrepancies.

• Facial Compliance Rule-bank only required to review documents.

• Banks are not required to investigate trade customs or usage

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UNIFORM CUSTOMS AND PRACTICES FOR DOCUMENTARY CREDITS

• Uniform Customs and Practices for Documentary Credits-provisions continued– Description of the Goods should be clear and brief as

possible.– In the listing of documents, should list the contents of

each document.– Transportation Documents must be clear.– Insurance Documents must be clear.– Time periods for presentation of documents must be

specified.– Title of Letter of Credit should specify irrevocable.

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STANBY LETTER OF CREDIT

• Standby Letter of Credit is a letter of credit that represents an obligation to the beneficiary on the part of the issuer– International Standby Practices– Standby Letters of Credit secures contractual

obligations in construction contracts, service contracts, warranties, counter-trade trade obligations, secures international loans and supplies.

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ALTERNATIVE METHODS OF GUARANTEEING PERFORMANCE

• Alternative Methods of Guaranteeing Performance– Types

• Performance Bond-a guarantee from an insurance company to pay insured in case of default.

• Bid Bond-insure against the risk that a bidder may not honor its bid.

• Credit Surety-guarantees the repayment to a bank or lender who finances an export transaction or development project. Exim Bank of World Bank

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ALTERNATIVE METHODS OF GUARANTEEING PERFORMANCE

• Types-Continued– Retention Fund-in large or government

projects, a percentage is deducted from each payment due to the supplier or contractor and is retained in a fund pending completion of project.

– Demand Guarantee secures performance of a non-monetary obligation.

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SOURCES OF TRADE FINANCE

• Commercial Banks – Export Financing

• Borrowing against trade documents

• Factoring-exporter transfers title to its account receivable to a factoring company at a discount.

• Forfaithing-selling at a discount, of longer term receivables or promissory notes to a foreign buyer.

• Transferable Credit-suppliers accept part of the letter of credit that seller receives from buyer in export transaction.

• Back to Back Letter of Credit-buyer makes arrangements with third bank to make loan.

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SOURCES OF TRADE FINANCE

• Government Assistance Programs– Eximbank in United States-

– Arranges loans, guarantees, working capital and insurance

– Foreign Corporation Insurance Agency– Protects against default on exports sold under open

accounts

– Overseas Private Insurance Corporation– Offers performance bonds

– Small Business Administration– Revolving line of credit

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