FACULTY OF COMMERCE DEPARTMENT OF BANKING AND FINANCE INTERNATIONAL BANKING AND FINANCE CODE: BF03 State and explain 5 ways of financing international trade Factoring Countertrade Banker's acceptance Letter of Credit Forfaiting Factoring Factoring it is a transaction in which a company, the exporter in this case, sells its accounts receivable at a discount to a 3rd party financial institution, or factor, for immediate payment instead of waiting 30, 60, or 90 days until payment is due from its customer, the importer. It therefore helps in accelerating cash flow for the exporter, thus providing them with working capital to continue trading The accounts receivables are discounted in order to allow the factor to make a profit upon settlement of the debt. It is a common financial practice used in the trade financing industry that can be applied to both domestic and international sales. Since the factor must bear the cost and risk of assessing the credit worth of each receivable, the cost of factoring is usually quite high. It is more than borrowing at the prime rate plus points. The relationship that a business has with the factor can be a very successful, and long sustaining one. If the business wants, they can sell their accounts receivable to their factor every month for as long as they, and the factor, are both in business. When it comes to the contract between the business and the factor, both parties can negotiate if the contract should be recourse or non-recourse. Recourse factoring means that if the factor is not able to collect the full amount on the invoice , the factor can give back receivables that are not collectable. Non-recourse factoring means that if the factor is not able to collect the full amount on the invoice, the factor will absorb any and all losses. The factor charges a commission to cover the non-recourse risk, plus interest deducted as a discount from the initial proceeds. Thus factoring is when specialized firms, known as factors, purchase receivables at a discount on either a non-recourse or recourse basis. Countertrade It is a form of international trade in which goods or services are exchanged for other goods or services, rather than for hard currency It is more common among developing nations with limited foreign exchange or credit facilities. For example in 2000, India and Iraq agreed on an "oil for wheat and rice" barter deal, subject to United Nations approval under Article 50 of the UN Persian Gulf War sanctions, that would facilitate 300,000 barrels of oil delivered daily to India at a price of $6.85 a barrel while Iraq oil sales into Asia were valued at about $22 a barrel. In 2001, India agreed to swap 1.5 million tonnes of Iraqi crude under the oil-for-food program. Countertrade ensures a country with limited domestic resources has access to much needed items and raw materials A monetary valuation can however be used in countertrade for accounting purposes. Countertrade can be classified into three broad categories: Barter: It is the direct exchange of goods between two parties in a transaction. The principal exports are paid for with goods or services supplied from the importing market. Counterpurchase: The sale of goods and services to a company in another country by a company that promises to make a future purchase of a specific product from the same company in that country. Offset: Agreement that a company will offset a hard-currency purchase of an unspecified product from that nation in the future. Agreement by one nation to buy a product from another, subject to the purchase of some or all of the components and raw materials from the buyer of the finished product, or the assembly of such product in the buyer nation. Banker's acceptance When an exporter receives an order from an unknown importer (or with which it has little credit history) in another country, the importer can apply for a banker's acceptance with their bank, which substitutes the bank's credit for the importer's credit. The banker's acceptance is a negotiable instrument or document that allows the bank to guarantee payment to the exporter for the shipped goods. A banker’s acceptance refers to a financial instrument that represents a promised future payment from a bank. Upon acceptance from the bank, the liability transfers from the issuer of the banker’s acceptance and becomes an obligation of the bank. As such, the credit rating of a banker’s acceptance is generally the same as that of the bank that promised the payment. A banker’s acceptance essentially serves the same purpose as time drafts and postdated checks. A time draft is a form of payment that is guaranteed by an issuing bank but is not payable in full until a specified amount of time after it is received and accepted. The key difference is that a banker’s acceptance can be traded in the secondary market before maturity and is thus seen as an investment tool. How it works The financial institution promises to pay the exporting firm a specific amount on a specific date, at which time it recoups its money by debiting the importer’s account. A banker’s acceptance works much like a post-dated check, which is simply an order for a bank to pay a specified party at a later date. If today is Jan. 1, and a check is written with the date "Feb. 1," then the payee cannot cash or deposit the check for an entire month. Perhaps the most critical distinction between a banker's acceptance and a post-dated check is a real secondary market for banker's acceptances; post-dated checks don't have such a market. For this reason, banker's acceptances are considered to be investments, whereas checks are not. The holder may choose to sell the BA for a discounted price on a secondary market, giving investors a relatively safe, short-term investment. BAs are frequently used in international trade because of advantages for both sides. Exporters often feel safer relying on payment from a reputable bank than a business with which it has little, if any, history. Once the bank verifies, or “accepts,” a time draft, it becomes a primary obligation of that institution. The importer may turn to a banker’s acceptance when it has trouble obtaining other forms of financing, or when a BA is the least expensive option. The advantage of borrowing is that the importer receives the goods and has the opportunity to resell them before making payment to the bank. Letter of Credit Forfaiting: Medium- and Long-Term Financing It is a specialized technique to eliminate the risk of nonpayment by importers in instances where the importing firm and/or its government is perceived by the exporter to be too risky for open account credit. The name of the technique comes from the French à forfait, a term that implies “to forfeit or surrender a right.” In factoring, once a business sells its accounts receivables to a factor, they are selling 100% of the invoice. While in forfaiting, when a business gives up the right to trade receivables to international trade finance companies, they are giving up 100% of their claim on it to the forfaiter. Unlike factoring, the time periods within the forfaiter are usual longer Where there could be recourse or nonrecourse in factoring, forfaiting is conducted without recourse. Although forfaiters do like to have some type of guarantees in place from the buyer, they are still assuming all the risk if the buyer does not pay. They also cannot come back to the business, asking them to chip in any monetary compensation. When a forfaiter purchases the exporter’s receivables directly from the exporter then it is referred to as a primary purchase. The receivables technically then become a form of debt instrument that can be sold on the secondary market as bills of exchange or promissory notes, this is known as a secondary purchase. In depth dive The essence of forfaiting is the non-recourse sale by an exporter of bank guaranteed promissory notes, bills of exchange, or similar documents received from an importer in another country. The exporter receives cash at the time of the transaction by selling the notes or bills at a discount from their face value to a specialized finance firm called a forfaiter. All political and commercial risk of nonpayment by the importer is carried by the guaranteeing bank. The forfaiter can either hold the notes until full maturity as an investment or endorses and re-discounts them in the international money market. Such subsequent sale by the forfaiter is usually without recourse. In effect, the forfaiter will be dividing the discounted notes into appropriately sized packages and resells them to various investors having different maturity preferences.
