TRADE FINANCE

Prof. B. B. BhattacharyyaDean, Banking

Questions

1. Terms of a sale contract provides shipment of goods ‘FOB’. Who will bear cost of freight – Seller or Buyer?

2. ‘A ’ in Mumbai sells goods to ‘B’ in Kolkata. How will payment be settled?

3. Who would approach bank for issuing a Letter of Credit – Seller or Buyer?

Questions

4. Name three important documents used in Trade Finance.

5. What is UCPDC?6. What is FEDAI?7. What is DGFT?

8. What is Post-Shipment Finance?

9. What is Buyer’s Credit?10.What are risks in Trade Finance?

Trade Transaction consists of

• Movement of Goods• Movement of Documents• Movement of Funds

s

Highest risk to exporter

Documents against Acceptance

Open Account

Advance Payment

Unconfirmed L/C

Documents against Payment

Confirmed L/C

Least risk toimporter

Least risk toExporter

Highest risk toimporter

International Chamber of Commerce

• Objectives : Promotion of trade and investment, opening of markets and free flow of capital

• Associations with more than 130 countries• ICC International Court of Arbitration – the

world’s leading body for resolving international commercial disputes by arbitration.

• UCPDC (originally in 1933 ) and the latest one UCPDC 600 effective from 01.07.2007

• First nine Incoterms published in 1936.Incoterms 2000 came into force on 01.01.2000

Risks in International Trade Finance

• Country Risks– Political Stability, Economic Environment, Legal system, Forex transactions

• Forex Risks• Commercial Risks – Dependability,

Trade disputes

Buyer’s Credit

• Financial arrangement where a Financial Institution in the exporter’s country or other country extends credit directly or indirectly to a foreign buyer to finance purchase of goods and services from the exporting country.

Various ways of payment in international trade

Clean PaymentsBills for Collection – D/P, D/ADocumentary Credit – is a written undertaking by the Importer’s Bank on behalf of its customer, promising to effect payment to exporter upto a stated sum of money within a prescribed time limit and against stipulated documents.

What is an L/C ?

LC is an arrangement whereby a bank acting at the request of the customer undertakes to pay a third party by a given date according to agreed stipulations and against presentation of documents the counter-value of goods and services supplied

BANKS DEAL ONLY IN DOCUMENTS AND NOT IN GOODS

Credit vs. Contracts

• Credits are separate transactions from the sales or other contracts on which they may be based and banks are in no way concerned with or bound by such contracts. An Issuing bank should discourage any attempt by the applicant to include, as an integral part of the credit, copies of the underlying contract.

Parties to the L/C

Applicant Issuing BankBeneficiarySecond beneficiaryAdvising BankConfirming BankNegotiating Bank

Types of Credit

• Confirmed • Sight / Usance• Back-to-Back• Transferable• Red Clause• Standby

Common documents used in Documentary Credit

• Bill of Lading• AirWay Bill• Certificate of Origin• Combined Transport Document• Draft / Bill of Exchange• Insurance Policy• Packing List• Inspection Certificate

IMPORTERBUYER

APPLICANT

CONTRACT

EXPORTERSELLER

BENEFICIARYSHIP

GOODS

TAKEDELIVERY

OFGOODS

APPLYL/C

RELEASEDOCUMENTS

AGAINSTCASH OR

T/R

ISSUINGBANK

NEGOTIATIONOF EXPORT

BILLS

PREPARE& PASS

DOCUMENTS

ADVISE L/C

MAKEPAYMENT

SENDDOCUMENTS

L/C

ADVISING BANK /CONFIRMING BANK

ORNEGOTIATING

BANK

1

5

11

2

107 4

6

8

3

9

DIAGRAMATIC EXPLANATION OF VARIOUS STEPS IN THE OPERATION OF A L/C

ULTIMATEBUYER

APPLICANTOF MASTER LC

MASTER LCISSUING BANK

ADVISINGBANK

MIDDLEMANBENEFICIARY OF

MASTER LCAPPLICANT OF

B/B LC

B/B LCISSUING BANK

ADVISING BANK /NEGOTIATING

BANK

SUPPLIERBENEFICIARY

OF B/B L/C

1

152 3

13 12 4

11 10 5

9 8 6

7

14

GOODS

DIAGRAMMATIC EXPLANATION OF THE OPERATION OF A BACK TO BACK CREDIT

USA SINGAPORE

INDIA

Risks associated with opening of Import L/C

• Importers’ Credit Risk• The goods• The status of the exporter• Country Risk• Foreign Exchange Risk

Flow Chart of an L/C

The importer signs a purchase contract for buying certain goods.

The importer requests his bank to open an LC in favour of the exporter.

The importer’s bank opens an LC as per the application.

The opening bank will forward the original LC to the advising bank in the exporter’s country.

The advising bank, after satisfying itself about the authenticity of the credit, towards the same to the exporter.

Flow Chart of an L/C

The exporter scrutinizes the LC to ensure that it conforms to the terms of the contract.

In case of any terms are not as agreed, the importer will be Asked to make the required amendments to the LC.

In case the LC is as required, the exporter proceeds to makeArrangements for the goods.

The exporter will effect the shipment of goods.

The exporter will prepare export documents and submit to his bank.

Flow Chart of an L/C

The exporter’s bank (negotiating bank) verifies all the documents with the LC

If the documents are in conformity with the terms of LC and allOther conditions are satisfied, then the bank will negotiate the bill

The exporter receives the payment in his bank account if he wants Post-shipment finance.

The LC issuing bank receives the bill and documents from the Exporter’s bank.

The importer receives the bill from the LC issuing bank and checksthe documents. He then accepts/pays the bill. On acceptance/payment,

he gets the shipping documents covering the goods purchasedby him.

Flow Chart of an L/C

The LC issuing bank reimburses the amount to the negotiating bank, if the documents are found in order.

Exporter receives the payment upon realisation, if he has notavailed post-shipment finance.

Trade Finance

• Pre-Shipment and Post-Shipment Finance

• PRE-SHIPMENT FINANCEPacking Credit, Advances against receivables from Govt., etc., Advance against cheques/drafts etc

• Packing credit in Indian Rupee• Packing credit in Foreign Currency

Features of Packing Credit in Rupees (PC)

The banks extend packing credit (PC) to exporters on production of either a letter of credit (LC) or a confirmed order.

a) The packing credit availed against an LC / order will be adjusted by the bank from out of the proceeds of the export made against that LC/order.

Features of Packing Credit in Rupees

b) Running account facility : This facility granted to exporters with goods track record to avail PC without lodging an

LC/order. The liquidation of PCs outstanding in the running account is done on a ‘first in first’ basis out.

c) A packing credit is normally given for a period not exceeding 180 days.

Features of Packing Credit in Rupees

d) PC is granted at a concessional rate of interest. The prime lending rate is not applicable to export finance.

e) Refinance can be available by banks from the Reserve Bank against the packing credit granted to the exporter.

Features of Packing Credit in Rupees

f) PC is available for both cash exports and deemed exports.

Features of Pre-shipment Credit in Foreign Currency (PCFC)

The Foreign Currency loans granted to exporters by the banks are known as PCFC.

a) PCFC is available only for cash exports in foreign currency.

b) The interest rate is less in PCFC, compared to that of packing credit in rupees, exporters may not prefer PCFC when they expect a fall in the value of rupees.

Features of Pre-shipment Credit in Foreign Currency (PCFC)

d) PCFCs can be maintained as running accounts.

e) PCFC is self-liquidating in nature and is liquidated by purchasing/ discounting of bills.

f) Refinance from the Reserve Bank is not available to banks against PCFC.

Post-Shipment Finance

Post-shipment credit is defined as any loan or advance granted by a bank to an exporter of goods from the date of extending the credit after the shipment of goods to the date of realisation of the export proceeds. Post-shipment finance is extended in the following manner :-

a) Negotiationb) Purchasec) Discount of export bill under confirmed order/export

contractsd) Advances against export bills sent on collection basis.

Features of Pre-shipment Credit in Foreign Currency (PCFC)

c) For lending under the PCFC scheme, banks can use the foreign currency balances available with them, in Exchange Earners Foreign Currency (EEFC) account/Resident Foreign Currency (RFC) accounts, Foreign Currency Non-resident (FCNR) account, Bank’s account etc.

Regulatory Requirements

• Trade Control Policy• Exchange Control Policy• UCPDC guidelines• ISBP 2002• FEDAI Guidelines• Bank’s Internal rules and Regulations

• Post-Shipment Finance-EBP/EBDEBNAdvance against Export bills sent under collection basisAdvance against Duty Drawback

INCOTERMS

EXW FOB CFR CIF

a) Packing Exp Exp Exp Exp

b) Carriage to Port (only a) (a to d) (a to e) (a to e)

c) Port Dues

d) Customs entry Imp Imp Imp Imp

e) Freight (b to i) (e to i) (f to i) (f to i)

f) Insurance

g) Imp duties

h) Port costs

i) Carrying from port

Thanks