Basics of Trade Services and Trade Finance January 1999

Basics of Trade Services
and Trade Finance

January 1999
Global Corporate Bank
Training and Development
Basics of Trade Services

and Trade Finance
Warning
This workbook is the product of, and

copyrighted by, Citibank N.A. It is solely for
the internal use of Citibank, N.A., and may
not be used for any other purpose. It is
unlawful to reproduce the contents of these
materials, in whole or in part, by any
method, printed, electronic, or otherwise; or
to disseminate or sell the same without the
prior written consent of Global Corporate
Bank Training and Development – Latin
America, Asia / Pacific and CEEMEA.
Please sign your name in the space below.
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Table of Contents
TABLE OF CONTENTS
TABLE OF CONTENTS
Introduction
Overview...................................................................................................................ix
Course Objectives.....................................................................................................ix
The Workbook ......................................................................................................... x
Unit 1: The Trade Environment
Introduction ............................................................................................................ 1-1
Unit Objectives....................................................................................................... 1-1
Overview................................................................................................................ 1-2
Political Issues............................................................................................ 1-2
Business Issues ......................................................................................... 1-3
Social Issues .............................................................................................. 1-3
Legal Issues ............................................................................................... 1-3
Factors That Restrict Global Trade ........................................................................ 1-3
Tariffs ......................................................................................................... 1-4
Nontariff Barriers ........................................................................................ 1-4
Quotas........................................................................................................ 1-5
Factors That Promote Global Trade....................................................................... 1-5
Trade Agreements...................................................................................... 1-6
European Community .................................................................... 1-6
North American Free Trade Agreement (NAFTA)........................... 1-8
MERCOSUR ................................................................................... 1-9
Pacto Andino (Andean Pact) ........................................................ 1-10
Trade Agreements / Organizations........................................................... 1-10
General Agreement on Tariffs and Trade (GATT) ........................ 1-11
Asociación Latino-Americana de Integración (ALADI) .................. 1-12
Export Credit and Multilateral Agencies.................................................... 1-12
Export Credit Agencies (ECAs)..................................................... 1-13
Multilateral Agencies..................................................................... 1-13
World Bank Group ............................................................... 1-14
World Bank Affiliates ............................................................ 1-15
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Unit 1: The Trade Environment (Continued)
Overseas Private Investment Corporation (OPIC) ............... 1-15

Regional Development Banks.............................................. 1-16
Unit Summary ...................................................................................................... 1-17
Progress Check 1 ................................................................................................ 1-19
Unit 2: Trade Services

Introduction ............................................................................................................ 2-1
Unit Objectives....................................................................................................... 2-1
Establishing Terms Between Buyers and Sellers................................................... 2-2
Payment Options ................................................................................................... 2-3
Cash in Advance ........................................................................................ 2-4
Open Account ............................................................................................ 2-6
On Consignment ........................................................................................ 2-9
Documentary Collections.......................................................................... 2-12
Advantages and Risks to the Buyer, Seller, and Citibank............. 2-15
Summary .................................................................................................. 2-18
Progress Check 2.1 ............................................................................................. 2-19
Letters of Credit (L/C) .......................................................................................... 2-31
Parties to a Letter of Credit ...................................................................... 2-31
Revocable or Irrevocable Letter of Credit................................................. 2-32
Basic Letter of Credit Components .......................................................... 2-32
Commercial and Standby Letters of Credit .......................................................... 2-33
Commercial Letters of Credit.................................................................... 2-34
Settlements Under a Letter of Credit ............................................ 2-36
Types of Irrevocable Commercial Letters of Credit ....................... 2-37
Special Features of Commercial Letters of Credit ........................ 2-39
Advantages and Risks of Commercial Letters of Credit................ 2-42
Import Letter of Credit and Export Letter of Credit........................ 2-46
Standby Letters of Credit ......................................................................... 2-47
Standby Letter of Credit: Guarantee Type................................... 2-48
Standby Letter of Credit: Payment Type...................................... 2-49
Advantages and Risks of Standby Letters of Credit ..................... 2-51
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TABLE OF CONTENTS iii
Unit 2: Trade Services (Continued)

Other Legal Forms of Guarantee ............................................................. 2-54
Summary .................................................................................................. 2-56
Progress Check 2.2 ............................................................................................. 2-59
Financial and Commercial Transaction Documents ............................................. 2-73
Financial Documents................................................................................ 2-73
Check ........................................................................................... 2-73
Draft / Bill of Exchange ................................................................. 2-73
Promissory Note ........................................................................... 2-74
Commercial Documents ........................................................................... 2-75
Commercial Invoice ...................................................................... 2-75
Bill of Lading ................................................................................. 2-75
Insurance Document / Policy ........................................................ 2-76
Other Documents.......................................................................... 2-77
Unit Summary ...................................................................................................... 2-78
Progress Check 2.3 ............................................................................................. 2-81
Unit 3: Trade Finance

Introduction ............................................................................................................ 3-1
Unit Objectives....................................................................................................... 3-1
Extension of Credit ................................................................................................ 3-2
Establishing Creditworthiness .................................................................... 3-2
Identifying Risks ......................................................................................... 3-3
Setting Interest Rates................................................................................. 3-4
Establishing Credit Terms .......................................................................... 3-5
Determining the Type of Financing ............................................................ 3-6
Short Term Loan............................................................................. 3-7
Medium Term Loan......................................................................... 3-7
Line of Credit .................................................................................. 3-7
Syndication ..................................................................................... 3-8
Booking Transactions................................................................................. 3-8
Managing the Credit ................................................................................... 3-9
Purposes for Trade Financing................................................................................ 3-9
Unit 3: Trade Finance (Continued)
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iv TABLE OF CONTENTS
Pre-Export Financing................................................................................ 3-11

Export Financing ...................................................................................... 3-13
Import Financing....................................................................................... 3-13
Inventory (Warehouse) Financing ............................................................ 3-13
Summary .................................................................................................. 3-14
Progress Check 3.1 ............................................................................................. 3-15
Types of Export Financing ................................................................................... 3-23
Commercial Financing.............................................................................. 3-23
Banker’s Acceptance .................................................................... 3-25
Application of Bankers’Acceptances ................................... 3-25
Pricing .................................................................................. 3-26
Eligible and Ineligible Banker’s Acceptance......................... 3-27
Risks .................................................................................... 3-28
Forfaiting....................................................................................... 3-29
Advantages of Forfaiting ...................................................... 3-34
Disadvantages of Forfaiting ................................................. 3-35
Required Documentation ..................................................... 3-35
Summary .................................................................................................. 3-36
Progress Check 3.2 ............................................................................................. 3-37
Types of Export Financing (Continued) ................................................................. 3-41
Export Credit Agency-Supported Financing ............................................. 3-41
ECA Guarantee and Insurance ............................................ 3-42
Cash Payment Requirement......................................................... 3-42
Sourcing from Multiple Countries .................................................. 3-42
Local Costs Financing .................................................................. 3-43
Funding Mechanisms.................................................................... 3-43
Interest Rates: Floating and Fixed ............................................... 3-44
Insurance Coverage ..................................................................... 3-46
Transaction Structures: Buyer Credit and Supplier Credit ............ 3-47
Buyer’s Credit Financing ...................................................... 3-47
Supplier’s Credit Financing .................................................. 3-48
Multilateral Agency (MLA)-Supported Financing........................... 3-50
Unit 3: Trade Finance (Continued)
Private Insurance-Supported Financing ................................................... 3-51
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TABLE OF CONTENTS v
Export Finance: Structuring the Deal .................................................................. 3-52

Option One – Buyer’s Credit Combined with Insurance
or ECA Guarantee ........................................................................ 3-54
Option Two – Forfait Market ......................................................... 3-54
Summary .................................................................................................. 3-55
Correspondent Banking ....................................................................................... 3-55
Relationship Among Banks ...................................................................... 3-56
Products ................................................................................................... 3-56
Letter of Credit Confirmation......................................................... 3-57
Nonsovereign Funding.................................................................. 3-57
Participations ................................................................................ 3-59
Unit Summary ...................................................................................................... 3-60
Progress Check 3.3 ............................................................................................. 3-63
Unit 4: Risk and Compliance

Introduction ............................................................................................................ 4-1
Unit Objectives....................................................................................................... 4-1
Risks for the Bank.................................................................................................. 4-2
Credit Risk.................................................................................................. 4-3
Lending Risk ................................................................................... 4-3
Counterparty Risk ........................................................................... 4-3
Country (Political and Cross-Border) Risk .................................................. 4-4
Political (Sovereign) Risk ................................................................ 4-5
Transfer Risk .................................................................................. 4-5
Convertibility Risk ........................................................................... 4-6
Other Risks................................................................................................. 4-7
Image Risk...................................................................................... 4-7
Product Risk ................................................................................... 4-7
Operational / Systems Risk............................................................. 4-8
Legal and Regulatory Risk.............................................................. 4-8
Documentation Risk........................................................................ 4-8
Unit 4: Risk and Compliance (Continued)

Performance Risk ........................................................................... 4-9
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vi TABLE OF CONTENTS
Risks in a Trade Finance Transaction ........................................................ 4-9

Risk Management ................................................................................................ 4-10
Allocating Cross-Border Risk.................................................................... 4-10
Risk Transfer ....................................................................................................... 4-12
Risk Transfer Through Syndication .......................................................... 4-12
Investors in Risk Transfer Transactions ................................................... 4-14
Banks............................................................................................ 4-14
Insurance Companies ................................................................... 4-14
Export Credit Agencies (ECAs)..................................................... 4-16
Other Investors – Forfaiting .......................................................... 4-17
Example of Risk Transfer / Risk Management.............................. 4-18
Option One........................................................................... 4-19
Option Two........................................................................... 4-19
Option Three ........................................................................ 4-20
Advantages of Risk Transfer .................................................................... 4-20
Summary ............................................................................................................. 4-21
Progress Check 4.1 ............................................................................................. 4-23
Compliance Issues............................................................................................... 4-33
US Sanctions ........................................................................................... 4-34
Sanction Administration in the US ................................................ 4-35
Reporting Requirements ............................................................... 4-36
Penalties....................................................................................... 4-36
US Anti-Boycott Laws and Regulations.................................................... 4-36
Penalties....................................................................................... 4-37
Discovering Noncompliance Issues .............................................. 4-38
US Export Controls................................................................................... 4-39
Penalties....................................................................................... 4-40
Anti-Money Laundering ............................................................................ 4-41
The Money Laundering Process ................................................... 4-41
Unit 4: Risk and Compliance (Continued)

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TABLE OF CONTENTS vii
Avoiding Problems........................................................................ 4-42

Unit Summary ...................................................................................................... 4-43
Progress Check 4.2 ............................................................................................. 4-45
Unit 5: Identifying Customers’Needs and Pricing Solutions

Introduction ............................................................................................................ 5-1
Unit Objectives....................................................................................................... 5-1
The Information Gathering Process ....................................................................... 5-2
Existing Customers .................................................................................... 5-2
New Customers.......................................................................................... 5-3
Key Pricing Benchmarks........................................................................................ 5-9
Minimum Return on Cross-Border Risk ...................................................... 5-9
Expected Return on Assets...................................................................... 5-10
Revenue-to-Expense Ratio ...................................................................... 5-11
Market Quotations for Similar Risks ......................................................... 5-11
Pricing Guidelines ................................................................................................ 5-12
Risk Identification ..................................................................................... 5-12
General Guidelines................................................................................... 5-13
Documentary Collections, Transfers, and Payment Orders .......... 5-13
Import Letters of Credit ................................................................. 5-14
Export Letters of Credit................................................................. 5-15
Trade Finance............................................................................... 5-16
Selling Trade Paper ...................................................................... 5-18
Presenting the Offer to the Customer .................................................................. 5-19
Unit Summary ...................................................................................................... 5-25
Progress Check 5 ................................................................................................ 5-27
Appendices
Appendix A — Glossary......................................................................................A-1
Appendix B – Index.............................................................................................B-1
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INTRODUCTION
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INTRODUCTION
OVERVIEW
“Trade” is the movement of goods and services that develops from a business transaction
between a buyer and a seller. Facilitating trade is one of the most important activities in
a bank. Because of the large number of legal, political, and business issues and risks
involved in any trade transaction, Citibank has developed many different products to
accommodate its customers’ trade needs. This workbook is designed as
an introduction to Citibank trade services and finance.
In the following pages we examine the global trade environment, discuss the trade
services and products that are available to Bank customers, and analyze the risks and
benefits of these products and services to the Bank. We then identify several compliance
issues that are essential to the safe and effective provision of trade services, and outline
the process of pricing customer solutions.
COURSE OBJECTIVES
When you complete this workbook, you will be able to:
• Understand the global trade environment
• Recognize trade agreements, organizations, and other factors that

facilitate / restrict global trade
• Recognize the documents required for trade transactions
• Identify Citibank trade products and services
• Understand the role of correspondent banks and export credit agencies

in providing trade products and services
• Identify the risks involved in trade transactions and understand how

Citibank transfers risk
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x INTRODUCTION
• Recognize trade compliance issues and key regulations / legislation
• List and describe factors for analyzing customer needs and trade
opportunities
THE WORKBOOK
This workbook is designed to give you complete control over your own learning. The
material is divided into workable sections, each containing everything you need to master
the content. You can move through the workbook at your own pace and go back to review
ideas that you didn’t completely understand the first time. Each unit contains:
Objectives – which point out important elements in the

lesson that you are expected to learn.
Text – which is the “heart” of the workbook. This

section explains the content in detail.
Key Terms – which also appear in the Glossary. They

appear in bold face the first time they
appear in the text.
Instructional terms or phrases in the left margin which

Mapping – highlight significant points in the lesson.
þ Progress Checks – which do exactly what they say — check

your progress. Appropriate questions are
presented at the end of each unit, or within
the unit in some cases. You will not be
graded on these by anyone else; they are
to help you evaluate your progress. Each
set of questions is followed by an Answer
Key. If you have an incorrect answer, we
encourage you to review the corresponding
text and find out why you made an error.
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INTRODUCTION xi
In addition to these unit elements, the workbook includes:
Appendix A, Which contains definitions of all key terms

Glossary – used in the workbook.
Appendix B, Which helps you locate glossary items in the

Index – workbook.
Each unit covers an aspect of trade services and trade finance. The units are:
UNIT 1 – The Trade Environment
UNIT 2 – Trade Services
UNIT 3 – Trade Finance
UNIT 4 – Risk and Compliance
UNIT 5 – Identifying Customers’ Needs and Pricing Solutions
Since this is a self-instructional course, your progress will not be supervised. We expect
you to complete the course to the best of your ability and at your own speed. Now that
you know what to expect, please begin with Unit 1. Good luck!
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xii INTRODUCTION
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Unit 1
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UNIT 1: THE TRADE ENVIRONMENT
INTRODUCTION
At Citibank, we strive to be the most competent, profitable, and innovative financial

service organization in the world. To accomplish this goal, we must continually assess
the environment in which we operate, offer trade solutions that best meet our customers’
needs, and measure the risks associated with conducting business.
We begin this unit by examining the global trade environment and the factors that enable
or restrict the flow of goods and services. We then describe the European Community
and discuss three agreements that affect trade in the Latin American region as well as two
multinational agreements / organizations that promote trade. A description of the export
credit agencies in several countries and the multilateral agencies that facilitate
international commerce completes our study of the trade environment.
UNIT OBJECTIVES
When you complete Unit 1, you will be able to:
n Recognize issues and identify factors that restrict / promote global trade
n Recognize trade agreements in Latin America and Europe that promote
regional trade
n Recognize two multinational organizations that promote international trade
n Identify government support programs for national exports
n Distinguish between export credit agencies and multilateral agencies
n Recognize the role of the World Bank, its affiliates, and regional
development banks in promoting international trade
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1-2 THE TRADE ENVIRONMENT
OVERVIEW
In the past, trade was conducted directly between countries. Today,

countries have grouped themselves into trading blocks to:
n Reinforce their individual strengths
n Strengthen their positions in the trade environment
Each block of countries has its own set of rules and regulations for
domestic, intrablock, and global trade.
To support the global interests of their customers, banks either have

a multiblock presence or they have special arrangements with other
banks operating in a region. These special arrangements, called
correspondent relationships, are discussed in Unit 3.
Factors restrict Political, business, social, and legal issues affect the global trade
or promote environment. As trade officers, we need to carefully analyze all
flow of goods
aspects of the environments in which our customers conduct their
business.
Political Issues
Political issues (e.g. civil wars, riots, political unrest, and

revolutions) occur in all parts of the world and affect global trade.
For example, many political changes are taking place in China
today. We must monitor China’s adherence to the International
Chamber of Commerce (ICC) rules in order to act as trade advisors
to our customers.
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THE TRADE ENVIRONMENT 1-3
Business Issues
Basic differences in the business philosophies of eastern and

western countries also must be considered. In western countries,
companies tend to focus on shareholders first and then on
customers and employees. In eastern countries, these priorities
are usually reversed – the customer and his/ her needs are most
important.
Social Issues
When conducting business in the world marketplace, we must

acknowledge cultural traditions, social welfare, social behaviors,
and the influence of religion on consumption behavior.
Legal Issues
Legal issues that affect business include licensing arrangements,

ownership questions, and local laws. Other legal concerns are tariffs
and quotas.
As we mentioned earlier, political, business, social, and legal issues

affect the global trade environment. Factors related to these issues
may restrict or promote global trade. Let’s first examine those
factors that limit global trade.
FACTORS THAT RESTRICT GLOBAL TRADE
Most countries appear to conform to international principles

of free trade. However, some countries impose trade-restricting
measures such as tariffs, nontariff barriers, and quotas on trading
partners.
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Tariffs
Taxes on Tariffs are taxes that are placed on imported goods to:
imported goods
n Protect domestic businesses from foreign competition
n Discriminate, if they apply unequally to products of

different countries
n Retaliate, if they are designed to compel another country to

remove artificial trade barriers
Example The tariff imposed on Japanese motorcycles is an example of a

protective tariff. In 1983, Harley-Davidson, a US manufacturer, was
having difficulty competing with the heavyweight bikes imported
from Japan by Honda and Kawasaki. The US Government imposed
a five-year tariff on Japanese bikes imported into the United States.
This gave Harley-Davidson management time to reorganize the
company and become competitive again — without pressure from
the Japanese imports. By 1987, Harley-Davidson had regained its
share of the market in the heavyweight class of bikes and requested
that the tariff be lifted a year early.
Nontariff Barriers
Import- Nontariff barriers consist of a variety of measures that restrict

restricting imports. These measures include testing, certification, or
measures
bureaucratic hurdles.
Example An interesting example of bureaucratic hurdles occurred in France
in 1983. The French government decided to reduce the importation
of foreign video recorders and mandated that all recorders had to
be sent to the customs station at Poitiers — which was far from the
normal transportation routes. Because the station was understaffed,
operated only a few days per week, and each individual package
had to be opened, the import of video recorders was effectively
stopped. Meanwhile, the French were able to assert their adherence
to international agreements.
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Quotas
Restrictions Quotas are restrictions on the quantity of specific products that can
on quantity be imported and exported. Sometimes import quotas are imposed
of imports
to prevent damage to a domestic industry, e.g. clothing and textiles.
and exports
Occasionally, this action has unexpected results.
Example For example, in the early 1970s, quotas placed on tuna fish packed
in oil from Japan prevented the tuna from entering the US market.
This forced the Japanese to concentrate on packing tuna in water
even though, at that time, only 7% of tuna was packed in water.
The Japanese became quite successful and created a niche for
themselves in the tuna-packed-in-water market.
Export quotas are set for reasons of national defense, economic

stability, and price support. For example, it is United States
government policy to control the export of weapons and high
technology that may have an adverse effect on national security.
Tariffs, nontariff barriers, and import and export quotas all function
to restrict or limit foreign trade. There also are several methods that
serve to promote global trade.
FACTORS THAT PROMOTE GLOBAL TRADE
The current trend in international trade is to open markets that

traditionally have been protected with restrictive factors such
as quotas and tariffs. In this section, we describe:
n Trade agreements that were created to encourage

international trade (European Community, NAFTA,
MERCOSUR, and Pacto Andino)
n Trade agreements / organizations (GATT and ALADI)

that Latin American countries have joined to strengthen
their commitment to global trading
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n Government and multilateral agencies (MLAs), through

which governments provide financial assistance to support
world trade (export credit agencies [ECAs], World Bank,
and regional development banks)
Trade Agreements
A trade agreement is an agreement between two or more countries

concerning the buying and selling of each country’s goods and
services. Countries enter into trade agreements to facilitate trade
among the member countries. Their objectives are to:
n Diversify export markets
n Create or explore trade opportunities without barriers
n Protect products from other markets
n Encourage economic development of the region
While there are many trade agreements in different parts of

the world, one plays a major role in Europe (the European
Community [EC]), and three of them directly influence trade
in Latin America: North American Free Trade Agreement
(NAFTA), MERCOSUR, and Pacto Andino.
European Community
The European Community (EC) is a group of European countries

that have joined together to establish a common market which
assures the free movement of people, goods, services, and capital.
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Member States As of 1995, the EC consisted of the following 15 member states

(countries): Austria, Belgium, Denmark, Finland, Germany, Greece,
France, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain,
Sweden, and United Kingdom. Other countries are being considered
for membership.
European The European Community has established a customs union
Community vs. consisting of a common customs tariff and a customs code. It also
Free-trade Zone
has at its disposal commercial policy instruments for ensuring that
its products and services have access to third-country markets. The
EC uses instruments to ensure equal competition between itself and
third countries on the basis of anti-dumping and anti-subsidy laws.
The EC is different from a free-trade zone. The EC has a common

customs tariff and a customs code. On the other hand, in a free-trade
zone, each member country:
n Retains its own customs tariff and customs code
n Decides its national trading policy quite independently
A free-trade zone does not constitute a uniform trading bloc with

third countries.
The European Community is the largest trading power in the world –

even larger than the United States or Japan. While all three have
large domestic markets, they are not growing as rapidly as other
international markets and, as a result, the competition among the
three is intense for other international markets.
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North American Free Trade Agreement (NAFTA)
Canada, the In 1994, the North American Free Trade Agreement became
United States, effective to facilitate the flow of goods and capital between
and Mexico
Canada, the United States, and Mexico. These countries have
agreed to establish a free trade zone among their territories and to
consider products, services, and capital from any of the three
countries as if they were their own. NAFTA represents the largest
world market with 370 million consumers. Its main objectives are
to:
n Eliminate trade barriers and facilitate the cross-border flow of

goods and services among the parties
n Promote fair conditions for competition within the free trade

zone
n Significantly increase investment opportunities
n Provide adequate protection to patent holders, copyrights,

and transfers of technology — and to guarantee that all
intellectual property can be traded safely
n Create effective procedures for the implementation of this

treaty, its joint administration, and resolution for disputes
n Establish parameters and guidelines for future regional and

multilateral (involving more than two countries or parties)
cooperation to improve and expand the benefits
of NAFTA
The last objective is especially important because NAFTA is designed

for the eventual participation of other countries. Chile, for example,
is interested in joining in the near future. In addition, Canada has
expressed an interest in inviting non-Latin American countries such
as Australia and other Pacific Rim countries.
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MERCOSUR
Argentina, The Southern Cone Common Market (MERCOSUR) is an

Brazil, agreement between Argentina, Brazil, Paraguay, and Uruguay to
Paraguay, and
create a common market for the member countries. The agreement,
Uruguay
which became fully operational on January 1, 1995, has the
following objectives:
n Establish the free movement of capital, goods, services,

and people
n Create a common trade tariff structure and establish a

common policy
n Coordinate macroeconomic policies
MERCOSUR establishes an automatic progressive tariff schedule

to phase out existing tariffs in a period of three to four years and to
remove restrictions on the movement of labor, goods, and services.
The consumer and productivity potential for member countries is
significant. MERCOSUR is modeled after the European Community
(EC) and, if successful, will encompass a geographical area that is
twice the size of the EC.
Chile became an associate MERCOSUR member in early 1996. Peru,

Ecuador, Venezuela, Colombia, and Bolivia have agreed to start
talks to link the Pacto Andino with MERCOSUR.
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Pacto Andino (Andean Pact)
Peru, Ecuador, The third agreement that influences Latin American trade is the
Colombia, Pacto Andino (Andean Pact). Peru, Ecuador, Colombia, Chile,
Chile, Bolivia,
Bolivia, and Venezuela entered into this agreement to form a
and Venezuela
Latin American common market. These countries agreed to create
common rules for foreign investment and an eventual common
external tariff.
Unfortunately, the Andean Pact has not had much success in

achieving its goals. During the seventies and eighties, the Latin
American countries were affected by the external debt crisis and
forced to concentrate on their individual problems rather than on
regional matters.
Several Andean countries are trying to revive the arrangement to

serve broader regional trading objectives. In 1993, Venezuela,
Colombia, and Peru adopted a uniform tariff.
The objectives of the Andean Pact are to:
n Promote peaceful and equal development among its members
n Encourage an acceleration of growth through economic

integration
The emphasis on opening new markets brings renewed hope for

growth in the global trade environment. We now look at two
multinational organizations which enhance global competition.
Trade Agreements / Organizations
Two multinational trade agreements / organizations that promote

international trade are General Agreement on Tariffs and Trade
(GATT) and Asociación Latino-Americana de Integración
(ALADI). They encourage orderly international financial conditions
and provide advice on capital and economic development.
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General Agreement on Tariffs and Trade (GATT)
Abolishes The General Agreement on Tariffs and Trade (GATT) is an

quotas and organization with a set of trade agreements created to abolish quotas
reduces tariffs
and reduce tariffs among participating nations. It was originally
created in 1947 as a temporary arrangement, pending its replacement
by a UN agency. The UN agency was never established, and GATT
was expanded at several succeeding negotiations. It has proven to be
one of the most effective instruments for world trade liberalization.
At its international headquarters in Geneva, GATT has a secretariat,

a Council of Representatives, an annual assembly called the Sessions,
and an International Trade Center. With over 100 member countries,
GATT affects almost 90% of world trade.
The provisions of GATT include:
n A schedule of tariff concessions for each participating

nation
n Unconditional most-favored-nation clauses that

guarantee other GATT countries the extension of
any tariff concessions that have been granted to
non-GATT countries
n Elimination of quotas and other trade restrictions
n Uniform custom regulations and the obligation of each

contracting nation to negotiate for tariff cuts upon the
request of another member nation
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Asociación Latino-Americana de Integración (ALADI)
The Asociación Latino-Americana de Integración (ALADI) is an

organization established by the Treaty of Montevideo in 1980. It
began as an agreement signed in 1965 under the Asociación Latino-
Americana de Libre Comercio (ALALC). Member countries include
Argentina, Brazil, Mexico, Chile, Colombia, Peru, Uruguay,
Venezuela, Bolivia, Ecuador, and Paraguay.
Promotes ALADI’s purpose is to promote financial relationships among
financial private banking agencies. It provides its members with a mechanism
relationships
for financing for Latin American intraregional trade. ALADI allows
among private
banking for central bank payment guarantees of short and medium-term
agencies trade credits among banks of member customers.
ALADI is a clearing system between the Central Banks of the

member countries. Clearing occurs three times a year and settles
all import and export transactions under the ALADI agreement
between member countries. The settlement between the Central
Banks is in US dollars only.
ALADI’s Council of Ministers is comprised of the foreign ministers

of the member countries. The Conference of Contracting Parties
makes decisions on questions requiring a resolution of the members.
The Secretariat performs technical and administrative duties.
Export Credit and Multilateral Agencies
Direct and Commercial banks are not the only entities involved in financing
indirect world trade and economic development. Governments participate
government
in these activities, both directly through their own national
involvement
organizations (export credit agencies) and indirectly through their
membership in a variety of international economic organizations
(multilateral agencies).
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Export Credit Agencies (ECAs)
Support and Export Credit Agencies are national organizations that support and
expand local expand local exports to benefit the country’s balance of payments
exports
and, as a result, create jobs in the local market. The ECA programs
enable the Bank’s customers (exporters) to remain competitive with
businesses from other countries. Importers also benefit from access
to preferential rates and terms for loans from programs of the
exporting countries.
ECA programs ECA assistance is provided in the form of guarantees or insurance
as well as direct lending. ECA programs include:
n Insurance to national exporters and commercial banks

against commercial (credit) and/or country risks
n Payment guarantees to commercial banks involved in

export financing
n Preferential fixed interest rate loans to foreign importers
In Unit 3 we provide additional details on the different

characteristics of the ECAs.
Multilateral Agencies
Governments working together have established institutions whose

purpose is to maintain orderly international financial conditions and
to provide capital and advice for economic development, particularly
in those countries that lack the resources to do it themselves. These
institutions or multilateral agencies play an increasing role in the
financing of large export contracts and projects. We discuss first the
globally-oriented World Bank, its entities and affiliates, and then
examine the role of regional development banks.
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World Bank Group
The World Bank Group is comprised of the International

Bank for Reconstruction and Development(IBRD) and
the International Development Association (IDA) and two
affiliates, the International Finance Corporation (IFC) and
the Multilateral Investment Guarantee Agency (MIGA).
Let’s examine their specific roles.
World Bank The World Bank is a multilateral development agency. Its

purpose is to help member countries progress economically
and socially so that their people may live better and fuller lives.
The World Bank is the primary source of funding for projects

in emerging-market countries when private capital cannot be
raised. In addition to lending medium and long-term funds
directly to governments in the emerging markets, the World
Bank provides technical and financial aid to private-sector
companies for direct investments.
World Bank The term “World Bank” refers to two legally and financially
entities: IBRD distinct entities: the International Bank for Reconstruction
and IDA
and Development (IBRD) and the International Development
Association (IDA). The IBRD and IDA have three related
functions:
• Lend funds
• Provide economic advice and technical assistance
• Serve as a catalyst to investment by others
Both the IBRD and the IDA provide training and technical
advice to help developing countries address their own
problems. However, the IBRD makes market-rate loans
to newly industrialized countries (e.g. Korea, Brazil) by
borrowing in the world capital markets. The IDA extends
assistance to the poorest countries on easier terms (e.g.,
interest-free loans), largely from resources provided by its
wealthier members.
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Funds from such other sources as governments, commercial

banks, export credit agencies, and other multilateral institutions
are increasingly being paired with World Bank funds to
cofinance projects.
World Bank Affiliates
IFC and MIGA The International Finance Corporation (IFC), an affiliate of

the World Bank, is the world’s largest multilateral organization
specifically structured to provide loans to — and equity
investments in — private companies in the emerging markets.
It seeks to promote growth in the private sector of the emerging
market countries by mobilizing foreign and domestic capital to
invest alongside its own funds in commercial enterprises.
The Multilateral Investment Guarantee Agency (MIGA), also

an affiliate, encourages foreign direct investment in emerging
markets countries by providing:
• Investment guarantees against the risks of currency

transfer, expropriation, war and civil disturbance,
and breach of contract by the host government
• Advisory services to MIGA’s member countries on
means of attracting foreign investment
Overseas Private Investment Corporation (OPIC)
The Overseas Private Investment Corporation (OPIC) is

a profit-making US government agency. Its primary objective
is to insure or guarantee US investment in more than 130
developing countries throughout the world. It also offers
some export finance assistance. OPIC’s programs provide:
• Project financing through direct loans and loan

guarantees
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• Investment insurance, including coverage for medium

and long term loans from Citibank NY to its branches
and subsidiaries, against a broad range of country risks
• A variety of investor services (e.g. advisory services,
country and regional information)
OPIC’s insurance program protects investors and commercial
bank lenders against the risk of inconvertibility of a currency,
loss of investment due to expropriation, nationalization, or
confiscation by action of a foreign government or loss due
to political upheavals such as revolution or civil war. OPIC’s
insurance program does not protect commercial bank lenders
or investors from the commercial risk, i.e. credit and foreign
exchange risk.
Regional Development Banks
Regional development banks provide funding for building

infrastructures and private businesses in emerging markets
countries. Even if a project does not meet the necessary criteria
for financing from the development bank, assistance is still
available to help companies locate direct investment financing
from other sources.
The most important regional development banks are owned

by the governments of many donor countries, both from the
industrialized world and from emerging markets, and serve
mainly as central banks for local development banks. They also
offer direct financing to private sector-businesses. The most
important development banks are:
• The Inter-American Development Bank (for

Latin America)
• The Asian Development Bank (for Asia and
the Pacific)
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• The African Development Bank and Fund

(for Africa)
• The European Bank for Reconstruction and
Development (for Eastern Europe and the
Commonwealth of Independent States)
• The European Investment Bank (for the funding
of worldwide interests of the European Union)
• Corporacion Andina de Fomento (for Pacto
Andino countries)
UNIT SUMMARY
In this unit, we examined some political, business, social,

and legal conditions that promote or restrict global trade.
We considered the factors that limit global trade — tariffs,
nontariff barriers, and quotas. We introduced the trade
agreement that plays a major role in Europe and the three
agreements that encourage trade in the Latin American region,
as well as two multinational organizations created to help
countries compete in the world marketplace.
We described governments’ direct and indirect contributions

to the promotion of international trade. Export credit agencies
in the US and other countries are established by national
governments to support exports and improve the country’s
balance of payments. Multilateral agencies, such as the World
Bank and regional development banks, seek to maintain
orderly international financial conditions and provide capital
and advice for economic development.
You have completed Unit 1, The Trade Environment. Please complete the Progress Check
to test your understanding of the concepts and check your answers with the Answer Key.
If you answer any questions incorrectly, please reread the corresponding text to clarify
your understanding. Then, continue to Unit 2, Trade Services.
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þ PROGRESS CHECK 1
Directions: Determine the one correct answer to each question unless directed
otherwise. Check your answers with the Answer Key on the next page.
Question 1: Determine how the following factors affect the trade environment. Place
a P for those that promote trade and an R for those that restrict trade.
_____ Civil unrest in the country where the goods are being exported
_____ A country importing goods is a member of GATT
_____ A quota has been placed on imports of leather shoes
_____ An export credit agency will provide preferential financing rates to

foreigners who buy that country’s exports
_____ A multilateral agency guarantees repayment of a Citibank loan to a

customer from an emerging-market country who is purchasing
computers from a US firm
_____ A new trade agreement establishes a free trade zone in participating countries
_____ To protect its own bicycle market, a country places a tariff on imported bicycles
_____ An importer in an emerging-market country receives low-cost financing

from a World Bank entity.
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ANSWER KEY
Question 1: Determine how the following factors affect the trade environment. Place
a P for those that promote trade and an R for those that restrict trade.
R Civil unrest in the country where the goods are being exported
P A country importing goods is a member of GATT
R A quota has been placed on imports of leather shoes
P An export credit agency will provide preferential financing rates to
foreigners who buy that country’s exports
P A multilateral agency guarantees repayment of a Citibank loan to a
customer from an emerging-market country who is purchasing
computers from a US firm
P A new trade agreement establishes a free trade zone in participating
countries
R To protect its own bicycle market, a country places a tariff on imported
bicycles
P An importer in an emerging-market country receives low-cost financing
from a World Bank entity
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þ PROGRESS CHECK 1
(Continued)
Question 2: Which agreement establishes a free trade zone in Canada, the United States,
and Mexico?
_____ a) Pacto Andino
_____ b) ALADI
_____ c) MERCOSUR
_____ d) NAFTA
Question 3: A small country in Latin America requires the inspection of imported

toasters. The inspector’s office is open one day a week and is understaffed.
This is an example of a(n):
_____a) nontariff barrier.

_____b) import quota.
_____c) tariff.
_____d) export quota.
Question 4: One of the reasons tariffs are placed on imported goods is to:
_____ a) promote competition between domestic and foreign goods.

_____ b) encourage foreign trade.
_____ c) control imports.
_____ d) create a favorable trade climate.
Question 5: The trade agreement which creates a common market for Argentina, Brazil,
Paraguay, and Uruguay is:
_____a) MERCOSUR.
_____b) Pacto Andino.
_____c) ALADI.
_____d) HERMES.
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ANSWER KEY
Question 2: Which agreement establishes a free trade zone in Canada, the United States,
and Mexico?
d) NAFTA
Question 3: A small country in Latin America requires the inspection of imported

toasters. The inspector’s office is open one day a week and is understaffed.
This is an example of a(n):
a) nontariff barrier.
Question 4: One of the reasons tariffs are placed on imported goods is to:
c) control imports.
Question 5: The trade agreement which creates a common market for Argentina, Brazil,
Paraguay, and Uruguay is:
a) Mercosur.
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þ PROGRESS CHECK 1
(Continued)
Question 6: Which multinational agreement / organization has over 100 member

countries that account for almost 90% of world trade?
_____ a) ALADI
_____ b) NAFTA
_____ c) Pacto Andino
_____ d) GATT
Question 7: Which multinational agreement / organization provides a mechanism for

financing to its members for Latin American intraregional trade?
_____ a) ALADI
_____ b) NAFTA
_____ c) Pacto Andino
_____ d) GATT
Question 8: Which trade agreement has created the largest trading power in the world?
_____ a) NAFTA
_____ b) GATT
_____ c) ALADI
_____ d) MERCOSUR
_____ e) Pacto Andino
_____ f) European Community
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ANSWER KEY
Question 6: Which multinational agreement / organization has over 100 member

countries that account for almost 90% of world trade?
d) GATT
Question 7: Which multinational agreement / organization provides a mechanism for

financing to its members for Latin American intraregional trade?
a) ALADI
Question 8: Which trade agreement has created the largest trading power in the world?
f) European Community
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þ PROGRESS CHECK 1
(Continued)
Question 9: Export credit agencies (ECAs) are established by:
_____ a) commercial banks.

_____ b) free trade agreements.
_____ c) governments.
_____ d) multilateral agencies.
Question 10: Identify two banks that are World Bank entities.
_____ a) International Bank for Reconstruction and Development

_____ b) African Development Bank and Fund
_____ c) Inter-American Development Bank
_____ d) International Development Association
Question 11: The trade agreement that has had the least amount of success in
achieving its goals, primarily due to an external debt crisis in the
seventies and eighties is:
_____ a) ALADI.
_____ b) Pacto Andino.
_____ c) GATT.
_____ d) MERCOSUR.
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ANSWER KEY
Question 9: Export credit agencies (ECAs) are established by:
c) governments.
Question 10: Identify two banks that are World Bank entities.
a) International Bank for Reconstruction and Development

d) International Development Association
Question 11: The trade agreement that has had the least amount of success in
achieving its goals, primarily due to an external debt crisis in the
seventies and eighties is:
b) Pacto Andino.
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þ PROGRESS CHECK 1
(Continued)
Question 12: A small Guatemalan company is seeking financing to build a plant and
purchase US equipment in order to export textile to the US. The two
agencies most likely to assist with financing are:
_____ a) ECA.
_____ b) OPIC.
_____ c) MIGA.
_____ d) IFC.
Question 13: Select the statement that best describes the difference between an export
credit agency (ECA) and a multilateral agency.
_____ a) An ECA is an international organization that provides information

to local exporters and their importers. Multilateral agencies provide
funding to promote trade between emerging market countries.
_____ b) ECAs within countries support the expansion of local exports.

Multilateral agencies provide informational and financial assistance
to support export activities in countries that lack the resources to do
it themselves.
_____ c) An ECA is a local agency affiliated with the Bank to assist customers
in broadening their foreign markets. Multilateral agencies are
international insurance agencies that provide capital to emerging
market countries that compete for large export contracts.
_____ d) Multilateral agencies provide funding to local companies that are just
beginning to expand into foreign markets. ECAs provide low-cost,
variable rate financing to foreign importers.
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ANSWER KEY
Question 12: A small Guatemalan company is seeking financing to build a plant and
purchase US equipment in order to export textile to the US. The two
agencies most likely to assist with financing are:
a) ECA. (to finance the purchase of US equipment)
d) IFC. (to finance the construction of the plant)
Question 13: Select the statement that best describes the difference between an export
credit agency (ECA) and a multilateral agency.
b) ECAs within countries support the expansion of local exports.

Multilateral agencies provide informational and financial assistance
to support export activities in countries that lack
the resources to do it themselves.
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þ PROGRESS CHECK 1
(Continued)
Question 14: In emerging market countries, when private capital cannot be raised for
large infrastructure improvement projects, governments may obtain market-
rate funding from the:
_____ a) local export credit agency.

_____ b) World Bank Group’s International Development Association.
_____ c) World Bank Group’s International Bank for Reconstruction
and Development.
_____ d) Overseas Private Investment Corporation.
Question 15: Match each of the following organizations with its role in promoting
international trade.
_____ International Finance Corporation (IFC)

_____ Multilateral Investment Guarantee Agency (MIGA)
_____ Overseas Private Investment Corporation (OPIC)
_____ Regional development banks
1. Affiliate of the World Bank that provides investment guarantees

against country risks and advice to member countries on how to attract
foreign investment
2. Provides funding or assistance in locating funding for building
infrastructures and private businesses in emerging market countries
3. Affiliate of the World Bank that promotes private sector growth in
emerging market countries through direct investing and attracting
foreign and domestic investors
4. US government agency with the primary objective of protecting
US investments in developing countries against country risk
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ANSWER KEY
Question 14: In emerging market countries, when private capital cannot be raised for
large infrastructure improvement projects, governments may obtain market-
rate funding from the:
c) World Bank Group’s International Bank for Reconstruction

and Development.
Question 15: Match each of the following organizations with its role in promoting
international trade.
3 International Finance Corporation (IFC)

1 Multilateral Investment Guarantee Agency (MIGA)
4 Overseas Private Investment Corporation (OPIC)
2 Regional development banks
1. Affiliate of the World Bank that provides investment guarantees

against country risks and advice to member countries on how to attract
foreign investment
2. Provides funding or assistance in locating funding for building

infrastructures and private businesses in emerging market countries
3. Affiliate of the World Bank that promotes private sector growth in

emerging market countries through direct investing and attracting
foreign and domestic investors
4. US government agency with the primary objective of protecting

US investments in developing countries against country risk
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þ PROGRESS CHECK 1
(Continued)
Question 16: Quotas are an example of ___________ issues which affect the global trade
environment.
_____ a) political
_____ b) business
_____ c) social
_____ d) legal
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ANSWER KEY
Question 16: Quotas are an example of ___________ issues which affect the global trade
environment.
d) legal
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Unit 2
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UNIT 2: TRADE SERVICES
INTRODUCTION
In an international trade transaction involving goods or services, the buyer and the
seller negotiate details about the method and timing of both payments and delivery.
These negotiations require attention to complex details concerning credit arrangements,
transaction structuring, legal issues, and political and cross-border risks. Citibank
customers, whether buyers and/or sellers, involved in an international trade transaction
rely on the expertise of a global bank like Citibank for advice and assistance regarding
these complex details.
In the first two parts of this unit, you will learn about international payment options and
how Citibank and Citibank customers use trade services to reduce the risks associated
with trade transactions. In the third part, you will learn about the financial and
commercial documents that facilitate international trade.
UNIT OBJECTIVES
n Identify the effect of leverage in a trade transaction

n Identify five payment options for settling trade transactions
n Recognize the risks and advantages of the five payment options
to buyers and sellers, as well as the role and risks for Citibank
n Distinguish between the two major categories of letters of credit – commercial
letters of credit and standby letters of credit
n Understand the application of different types of letters of credit
to international trade transactions
n Recognize the commercial and financial documents needed for
a typical international trade transaction
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2-2 TRADE SERVICES
ESTABLISHING TERMS BETWEEN BUYERS AND SELLERS
Whenever goods are bought and sold, the buyer (importer) and the
seller (exporter) conduct negotiations to determine the terms of the
transaction. The terms of the transaction establish how much, when,
and in what form the buyer will pay the seller.
Buyer’s goals The buyer’s goals during the negotiations are to:
n Minimize the total cost of the goods which, in addition to

the agreed-upon price, may include:
• Cost of financing the goods between the time they

are purchased and the time they are converted into
cash upon subsequent resale
• Lost opportunity cost of not being able to invest
funds in the event available cash is used to pay for
the goods
• Foreign exchange costs if the deal is denominated
in a currency other than the buyer’s
n Maintain good relationships with sellers
Poor payment practices may offend suppliers of materials that

are critical to the production of the buyer’s goods. Conversely,
the relationship with a seller who offers lenient payment terms
is a valuable resource that the buyer will want to protect.
n Assure receipt of specified goods previously contracted with

the seller
Seller’s goals The seller’s goals are to establish terms that:
n Increase the attractiveness of the product. By offering lenient

trade terms to the buyer, it increases the likelihood that the
buyer can afford the product.
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TRADE SERVICES 2-3
n Maximize the price of the goods without losing the sale
Either through borrowing or through available cash, the seller

must cover the cost between the time the sale is contracted
and the final payment is received. The seller may try to build
this cost into the price of the product, but runs the risk of
making the goods less attractive.
n Assure payment from the buyer. The seller will examine all
the risks associated with the trade transaction to ensure that
—
• The buyer is able to pay

• Funds can be converted to the currency of the
seller’s country
• Funds can be transferred to the seller’s country
Leverage The party with the most business influence during the negotiations
will be more successful in dictating terms that meet the desired
objectives. In other words, the amount of leverage each party
has determines how many goals the seller and buyer will achieve.
For example, a buyer who regularly purchases 90% of a seller’s
product may be able to negotiate very favorable payment terms
with that seller.
PAYMENT OPTIONS
After establishing the terms of the deal, the two parties draw up a
contract and the buyer issues a purchase order. The buyer and seller
arrange one of five major payment options to settle the transaction:
n Cash in advance
n Open account
n On consignment
n Documentary collections
n Letters of credit
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2-4 TRADE SERVICES
In the next two sections, “Cash in Advance” and “Open Account,”

we examine the distinct characteristics of these payment options and
discuss their advantages and risks to the buyer and seller, as well
as the role and risks for Citibank.
Cash in Advance
Payment before Cash in advance is the most basic payment method for goods.
shipment The seller receives cash from the buyer before goods are shipped.
Buyer’s There are no advantages to the buyer in this transaction and there
advantages are several risks to consider. For instance:
and risks
n Lack of control over the goods
n Loss of the use of the funds paid to the seller
n Refusal or inability of the seller to ship the goods
n Political (sovereign) risk in the seller’s country until the

goods are shipped. Political (sovereign) risk, a component
of country risk, is the possibility that the actions of a
sovereign government (e.g. nationalization or expropriation)
or independent events (e.g., wars, riots, civil disturbances)
affect the ability of the seller in that country to meet its
obligations to the buyer. (We will examine political risk
in greater detail in Units Three and Four.)
n Commercial or credit risk of the seller as a result of funds

misuse, bankruptcy, or any other improper business activity
Seller’s The seller has all of the advantages in the cash-in-advance
advantages transaction and almost none of the risks. The seller can ship the
and risks
goods whenever convenient and, in the meantime, enjoy the use of
the buyer’s funds.
Citibank’s role Citibank has minimal involvement in a cash-in-advance transaction.
However, it can derive fee income from transactions associated with
funds transfer, foreign exchange (if required), and cash management.
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TRADE SERVICES 2-5
The advantages and risks of a cash-in-advance transaction and the

role of Citibank are illustrated in Figure 2.1.
CASH IN ADVANCE
The seller receives cash from the buyer prior to shipment.
Advantages Risks
BUYER n None n Buyer has no control over goods

n Buyer loses use of funds paid to
the seller
n Seller may refuse to, or be
unable to, ship the goods
n Political risk in the seller’s
country
n Seller’s commercial or credit risk
SELLER n Ships goods when n None

convenient
n Enjoys use of
buyer’s funds
CITIBANK n Has minimal involvement in this payment option. However,

it can derive fee income from transactions associated with
funds transfer, foreign exchange (if required), and cash
management.
Figure 2.1: Cash in advance: Advantages and risks for buyer and seller and the
role of Citibank
Situations Cash in advance transactions are arranged only in situations where

the seller may have significant leverage and is able to dictate the
terms of the deal — for example, when several buyers are competing
for a limited product.
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2-6 TRADE SERVICES
Open Account
Shipment A second method of paying for merchandise in an international

before payment trade transaction is the open account. The seller ships the goods,
accompanied by the title documents (legal documents, e.g.
insurance and transport documents, indicating proof of an
individual’s ownership of the goods), before receiving payment
or a written promise to pay (i.e. promissory note or draft). The
shipper does not retain control of the goods.
The flow of goods and cash in an open account payment option is

illustrated in Figure 2.2.
(2) P a y m e n t
On the
(1) Shipment agreed
of goods upon date,
amount,
Title currency
documents
The buyer may
also be the
end-user of
the imported
goods
Figure 2.2: Open account flow
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TRADE SERVICES 2-7
Buyer’s The buyer has all of the advantages and minimal risk in an open
advantages account transaction. The buyer:
and risks
n Retains control of the goods
n Has time to generate cash from the sale of the goods before
paying the seller to cover the period between the purchase
and resale of the goods. Nevertheless, lack of timely
payments may cause the facility to be discontinued.
Note: The length of time between the shipment of goods by

the seller and the payment by the buyer depends on the credit
terms previously negotiated. The purchase order issued by
the buyer or the contract of sale represents the terms and
conditions of the negotiation.
n May not have to borrow and can use available cash on

receipt of the merchandise
n May incur foreign exchange risk if the imported goods

are priced in the seller’s currency. The buyer may be unable
to pay if its currency weakens sharply against the seller’s
currency.
Seller’s The seller has none of the advantages and all of the risks in an
advantages open account transaction. The seller:
and risks
n Has no control over the goods and the buyer’s willingness
to pay for them
n Incurs cross-border risk which may prevent an otherwise

reputable buyer from sending payment. (Cross-border risk,
a component of country risk, is the risk that, due to economic
problems, political disturbances, or sovereign actions within
the buyer’s country, it may become impossible to get money
out of a country or to convert the buyer’s currency into a
foreign currency — See Unit 4 for more details on risks).
n May incur foreign exchange risk if the exported goods are

priced in the buyer’s currency
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2-8 TRADE SERVICES
n May need to borrow to cover the period between shipment

of the goods and receipt of funds. If the seller borrows at
a floating rate, the seller may incur interest rate risk (the
interest rate at which the seller borrows may rise to the
point in which the transaction may become unprofitable
for the seller).
Citibank’s role Citibank has minimal involvement in an open account transaction.

However, it can derive fee income from transactions associated with
funds transfer, foreign exchange (if required), and cash management.
Documentation for the shipment of the merchandise is handled
outside banking channels.
The advantages and risks of an open account transaction and the role
of Citibank are shown in Figure 2.3.
OPEN ACCOUNT
Buyer receives goods and pays later through
an arrangement negotiated in advance with the seller
Advantages Risks
BUYER n Retains control over goods n Foreign exchange risk

n Pays when convenient
n May not have to borrow
and can use available
cash
SELLER n None n No control over goods and

buyer’s willingness to pay
n Cross-border risk
n Foreign exchange risk
n Interest rate risk
CITIBANK n Has minimal involvement in this payment option.

However, it can derive fee income from transactions
associated with funds transfer, foreign exchange (if
required), and cash management.
Figure 2.3: Open account: Advantages and risks for the buyer and seller
and the role of Citibank
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TRADE SERVICES 2-9
Situations The typical situations in which a seller would be willing to assume

the above risks are when the contract is:
n Between parent companies and subsidiaries to facilitate

intra-company trade
n Between buyers and sellers with excellent long-term

relationships
n Between sellers and buyers, when sellers feel strong

competitive pressures, especially in domestic markets
Cash in advance and open account are relatively simple procedures,

but the risks involved are unevenly distributed between the buyer
and seller. These two payment options are not suitable in transactions
where the buyer and seller do not know each other very well, or the
seller does not want to assume the credit risk and country risk when
offering payment terms to the buyer.
The other three payment options — on consignment, documentary

collections, and letters of credit — may be more appropriate. These
options reduce the risk to the seller and buyer and simplify the cash
management aspects of the transaction. We examine these options
in detail in the sections that follow.
On Consignment
Seller ships In an “on consignment” sale, the seller ships the goods to the
goods but importer while retaining ownership of the goods. The importer is
retains
ownership
referred to as the consignee who is actually an agent responsible
for paying for the goods if and when the goods are sold.
Consignee’s The prime advantage for the consignee is that the consignee pays
advantages only as the imported goods are sold. The consignee receives a
and risks
fee for brokering the sale. There are no risks for the consignee.
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2-10 TRADE SERVICES
Seller’s The key advantages for the seller are that the seller retains
advantages ownership of the goods until sold and uses the services of the
and risks
consignee to intermediate the sale of the goods to the buyer. In
terms of risks, the seller:
n Has limited control over the goods
n Has no control over the consignee’s willingness to pay

for goods
n Receives payment only upon sale of goods
n May incur cross-border risk of the consignee’s country
n May incur foreign exchange risk
n May incur commercial or credit risk
Citibank’s role Citibank has minimal involvement in an “on consignment”

transaction. However, it can derive fee income from transactions
associated with funds transfer, foreign exchange (if required), and
cash management.
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TRADE SERVICES 2-11
The advantages and risks of an “on consignment” transaction and the

role of Citibank are shown in Figure 2.4.
ON CONSIGNMENT
The seller ships goods to the consignee, but retains ownership.
Payment is made if and when the consignee sells the goods
Advantages Risks
CONSIGNEE n Pays only as goods are n None

sold
SELLER n Retains ownership of the n Has limited control over

goods goods
n Consignee intermediates n Has no control over
sale of goods to buyer consignee’s willingness to
pay for goods
n Receives payment only
upon sale of goods
n May incur:
• Cross-border risk
• Foreign exchange risk
• Commercial or credit risk
CITIBANK n Has minimal involvement in this payment option. However,

it can derive fee income from transactions associated with
funds transfer, foreign exchange (if required), and cash
management.
Figure 2.4: On consignment: Advantages and risks for the seller and consignee
and the role of Citibank
Situations Seller should only grant consignment terms to a:
n Reputable consignee with good credit ratings
n Consignee with whom the seller has a good credit history
n Consignee whose country enjoys economic and political

stability
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Documentary Collections
Banks act upon The fourth payment option, documentary collections, is a method
instructions by which a seller is able to collect payment from an overseas buyer
received
through an intermediary bank. Banks act as intermediaries in
facilitating the flow of the title documents and in the payment of
the transaction.
Parties and There are four major parties involved: the seller, remitting bank
process (seller’s bank), buyer, and collecting / presenting bank (buyer’s
bank). There are four major steps in a documentary collection:
1. The seller, after effecting shipment, forwards to the remitting

bank (seller’s bank) the following documents covering the
shipment —
l Written collection instructions

l Draft (financial document which is a demand for
payment), and/or
l Commercial documents (e.g. commercial invoice,
transport document, and any other document
applicable to the collection transaction)
2. The remitting bank (seller’s bank), acting as an intermediary,

transcribes the sellers’ collection instructions and forwards it
to the collecting / presenting bank (buyer’s bank) along with
the draft and/or commercial documents.
3. The collecting / presenting bank, acting as an intermediary,

makes the draft and/or commercial documents available to the
buyer for inspection and only delivers the original commercial
documents in accordance with the remitting bank’s collection
instruction.
4. The buyer, after inspecting the commercial documents, has

three options: (i) to pay, (ii) to obligate itself to pay at a future
date, or (iii) to refuse either to pay or to obligate itself to pay
the accompanying draft.
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TRADE SERVICES 2-13
Seller requires If the seller requires immediate payment of a collection and is not
immediate willing to extend financing to a buyer, the seller will use a sight
payment
draft. A sight draft is an order signed by the seller directing the
buyer to pay a specified amount to the seller upon presentation of
the draft. The document and cash flow for documents against
payment is illustrated in Figure 2.5.
n After shipping the goods (1), the seller sends a sight draft
with the commercial documents (transport documents,
commercial invoice and any other document applicable to
the collection transaction) to the collecting / presenting bank
through the remitting bank (2,3).
n The collecting / presenting bank releases the commercial

documents to the buyer only upon payment of the sight
draft (4). The buyer must effect payment of this draft to
receive the commercial documents. The release of the
documents to the buyer upon payment of a sight draft is
known as documents against payment (D/P collection).
n The collecting / presenting bank forwards the payment to

the seller through the remitting bank (5,6).
Citibank
remitting bank
( 6 )$
( 2 ) Sight draft and

documents
(1) ( 3 ) Sight
(5) draft and
documents
in trust
( 4 ) Sight draft and

documents
(4)
Citibank
collecting / presenting bank
Figure 2.5: Documentary collection flow for documents

against payment (D/P collection)
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2-14 TRADE SERVICES
Seller extends If the seller extends financing to the buyer, the seller uses a time
financing draft. A time draft is an order signed by the seller directing the
buyer to pay a specified amount to the seller on a specified future
date. The document flow for documents against acceptance
(D/A collection) is illustrated in Figure 2.6.
n After shipping the goods (1), the seller sends a time draft
with the commercial documents (transport documents,
commercial invoice, and any other document applicable
to the collection transaction) to the collecting / presenting
bank through the remitting bank (2,3).
n The collecting / presenting bank releases the commercial

documents to the buyer only upon the buyer obligating itself
to pay the accompanying draft. The buyer obligates itself to
pay by placing the word accepted across the face of a draft
followed by the maturity date and the buyer’s signature. The
release of the commercial documents to the buyer upon its
acceptance of the time draft is known as documents against
acceptance (D/A collection) (4,5,6). These steps occur
simultaneously.
n The seller receives the accepted draft from the remitting

bank and holds it to maturity (7); it may then be presented
for payment under a D/P collection (Figure 2.5).
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TRADE SERVICES 2-15
Citibank
remitting
bank
(7) Accepted
returned to
draft
seller (3) Time draft
anddocuments
in trust
(2) Time draft and
(1) documents
Goods
( 4 ) Time draft for

acceptance (6) Accepted
*(5) Accepted time draft returned
draft to seller
*(5) Documents
released
upon
acceptance
Citibank collecting
/ presenting
bank
Figure 2.6: Documentary collection flow for documents against

acceptance (D/A collection)
* Please note that these steps occur simultaneously.
Advantages and Risks to the Buyer, Seller, and

Citibank
Buyer’s In a documentary collection transaction, the buyer’s advantage is

advantages that the buyer may refuse to:
and risks
n Pay for drafts and/or documents
n Accept a time draft
In terms of risks, the goods may not meet the buyer’s specifications
after payment and/or acceptance.
Seller’s For the seller, the advantage is that the seller knows that the
advantages commercial and/or financial documents are controlled by the banks,
and risks
acting as intermediaries, and are not delivered to the buyer until
payment is made or a time draft is accepted by the buyer.
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2-16 TRADE SERVICES
A bank’s control of the documents reduces the seller’s risk in

relation to the documents only; however, the seller may be
exposed to:
n Cross-border risk
n Foreign exchange risk
n Interest rate risk
n Commercial or credit risk
n Costs resulting from the buyer’s refusal to pay. In this

instance, the seller incurs the expense of storing goods in a
foreign country while finding another buyer in that country
(or in another country), or arranging for their return to the
country of origin.
n Loss of goods resulting from a time limit for holding goods in

public storage. Regulations in many countries may restrict the
number of days in which goods may be held in public storage.
After that time, the goods may be sold at auction.
Citibank’s In a documentary collection transaction, Citibank facilitates the

advantages flow of the title documents and of the payment of the transaction.
and risks
Citibank does not deal with goods and does not assume any credit
risk — it acts only as an intermediary in the collection process.
However, there are operational risks to consider:
n Citibank must follow the collection instructions issued

by the seller; otherwise it may incur a financial loss.
n Citibank must comply with US government regulations, in

the US and abroad, or it may be exposed to fines, civil and
criminal penalties, and negative publicity (See Unit 4).
n Citibank must comply with foreign government regulations

in their respective countries or it may be exposed to fines,
civil and criminal penalties, and negative publicity.
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TRADE SERVICES 2-17
n Citibank must safeguard negotiable instruments since they

can be fraudulently endorsed and are freely negotiable in
the open market. For instance, time drafts, after acceptance
by buyers, become negotiable instruments and, as such,
require safekeeping to protect Citibank from financial losses
and customer dissatisfaction.
In exchange for the risks, Citibank has an opportunity to increase

fee-based revenues and to take advantage of cross-sell opportunities
in cash management.
The advantages and risks of documentary collections for the buyer,

seller, and Citibank are shown in Figure 2.7.
DOCUMENTARY COLLECTIONS
The seller ships goods to the buyer. The seller’s draft and title
documents are presented through the intermediary banks for payment.
Advantages Risks
BUYER n May refuse to pay n Goods may not meet buyer’s

for drafts and/or specifications
documents
n May refuse to
accept a time draft
SELLER n Commercial and/or n Country, foreign exchange, interest rate,

financial and commercial risks
documents n Buyer does not pick up documents or
controlled by banks refuses to pay
n Time limit for holding goods in public
storage in the event of non-acceptance of
documents
CITIBANK n Fee-based n Not following collection instructions

revenues n Not complying with US government
regulations, in the US and abroad
n Cross-sell n Not complying with foreign government
opportunities regulations in their respective countries
n Not safeguarding negotiable instruments
Figure 2.7: Documentary collections: Advantages and risks for buyer and seller
and risks for Citibank
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2-18 TRADE SERVICES
References The Uniform Rules for Collections (UCC), a publication of the

International Chamber of Commerce (ICC), provides guidelines for
parties / participants involved in collections transactions.
Summary
In international trade, buyers and sellers have different objectives:
n The buyer wants to ensure the receipt and quality of the

goods while structuring a favorable payment schedule. As
such, buyers prefer the “open account” payment option.
n The seller wants to deliver the goods and receive payment as

quickly as possible. As such, sellers prefer cash in advance.
Citibank has minimal involvement in those trade transactions

associated with the first three payment options we discussed: “cash
in advance,” “open account,” and “on consignment.” As a result, the
Bank does not incur any direct risk. On the other hand, Citibank can
derive fee income from related transactions such as funds transfer,
foreign exchange (if required), and cash management.
In terms of the fourth payment option, “documentary collections,”

Citibank derives fee income from this payment option since it acts
as an intermediary bank in facilitating the flow of the title documents
and in the payment of the transaction. Citibank incurs operational
risks since it must deal with documents and negotiable instruments.
To check your understanding of the first four trade payment options,

please complete Progress Check 2.1 and check your answers with the
Answer Key. If you answer any questions incorrectly, please reread
the corresponding text to clarify your understanding. Then, proceed
to the next section of Unit 2 where we discuss the fifth and final
payment option, “Letters of Credit.”
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TRADE SERVICES 2-19
þ PROGRESS CHECK 2.1
Question 1: In negotiating a trade transaction, the party with the most leverage will:
_____ a) finance the seller.

_____ b) be able to dictate the terms.
_____ c) have none of the advantages.
_____ d) incur foreign exchange risk.
Question 2: In a documentary collection, the banks:
_____ a) monitor the quality of the goods shipped.

_____ b) assume the buyer’s credit risk.
_____ c) act as intermediaries in the collection process.
_____ d) verify that the number of goods shipped agrees with the title document.
Question 3: An exporter receives a purchase order and payment for 1500 pairs of shoes.
This is an example of which type of payment option?
_____ a) Documentary Collections

_____ b) Open Account
_____ c) Cash in Advance
_____ d) On Consignment
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ANSWER KEY
Question 1: In negotiating a trade transaction, the party with the most leverage will:
b) be able to dictate the terms.
Question 2: In a documentary collection, the banks:
c) act as intermediaries in the collection process.
Question 3: An exporter receives a purchase order and payment for 1500 pairs of shoes.
This is an example of which type of payment option?
c) Cash in Advance
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TRADE SERVICES 2-21

(Continued)
Question 4: The bank holds shipping documents in its custody and will only deliver
them to the buyer upon receipt of payment for the documents. If payment is
not received, the intermediary banks will look for further instructions from
the seller. This is an example of:
_____ a) documents against acceptance.

_____ b) cash in advance.
_____ c) on consignment.
_____ d) documents against payment.
Question 5: An exporter receives a purchase order for two million radios and ships the
goods and title documents directly to the buyer before receiving payment
for the goods. Which payment option is this?
_____ a) Open Account

_____ b) Documentary Collections
_____ c) On Consignment
_____ d) Cash in Advance
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2-22 TRADE SERVICES
ANSWER KEY
Question 4: The bank holds shipping documents in its custody and will only deliver
them to the buyer upon receipt of payment for the documents. If payment is
not received, the intermediary banks will look for further instructions from
the seller. This is an example of:
d) documents against payment.
Question 5: An exporter receives a purchase order for two million radios and ships the
goods and title documents directly to the buyer before receiving payment
for the goods. Which payment option is this?
a) Open Account
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TRADE SERVICES 2-23

(Continued)
Question 6: A “cash in advance” transaction gives all of the advantages to the:
_____ a) buyer.
_____ b) seller.
Question 7: Identify the payment option(s) which expose the seller to the risk of
nonpayment by the buyer. (Select all that apply.)
_____ a) Cash in Advance

_____ c) Documentary Collections
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2-24 TRADE SERVICES
ANSWER KEY
Question 6: A “cash in advance” transaction gives all of the advantages to the:
b) seller.
Question 7: Identify the payment option(s) which expose the seller to the risk of
nonpayment by the buyer. (Select all that apply.)
b) Open Account
c) Documentary Collections
d) On Consignment
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TRADE SERVICES 2-25

(Continued)
Question 8: What payment option(s) should the seller consider when his/her products
are in high demand? (Select all that apply.)

_____ b) Documents Against Acceptance
_____ d) Documents Against Payment
Question 9: Identify the risk(s) faced by the seller when collecting payment from an
overseas buyer. (Select all that apply.)
_____ a) Country
_____ b) Foreign Exchange
_____ c) Commercial
_____ d) Interest Rate
_____ e) Operational
Question 10: What payment option(s) should the seller consider when the seller is
willing to extend credit to the buyer? (Select all that apply.)

_____ c) Documents Against Acceptance
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2-26 TRADE SERVICES
ANSWER KEY
Question 8: What payment option(s) should the seller consider when his/her products
are in high demand? (Select all that apply.)
a) Cash in Advance
d) Documents Against Payment
Question 9: Identify the risk(s) faced by the seller when collecting payment from an
overseas buyer. (Select all that apply.)
a) Country
b) Foreign Exchange
c) Commercial
d) Interest Rate
Question 10: What payment option(s) should the seller consider when the seller is
willing to extend credit to the buyer? (Select all that apply.)
b) Open Account
c) Documents Against Acceptance
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TRADE SERVICES 2-27

(Continued)
Question 11: In what payment option does the seller use the services of an importer
or responsible agent to intermediate the sale of the goods to the buyer?

_____ b) Documents Against Acceptance
Question 12: In what payment option(s) do banks derive fee income when facilitating
the flow of title documents and of the payment of the trade transaction?

_____ b) Documentary Collection
_____ d) Open Account
Question 13: What is the most common type of risk incurred by banks in a documentary
collection?
_____ a) Foreign Exchange

_____ b) Country
_____ c) Operational
_____ d) Interest Rate
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2-28 TRADE SERVICES
ANSWER KEY
Question 11: In what payment option does the seller use the services of an importer
or responsible agent to intermediate the sale of the goods to the buyer?
c) On Consignment
Question 12: In what payment option(s) do banks derive fee income when facilitating
the flow of title documents and of the payment of the trade transaction?
b) Documentary Collection
Question 13: What is the most common type of risk incurred by banks in a documentary
collection?
c) Operational
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TRADE SERVICES 2-29

(Continued)
Question 14: Banks acting as intermediaries of a trade transaction can derive more fee
income from:
_____ a) documents against payment.

_____ b) documents against acceptance.
_____ c) the “on consignment” option.
_____ d) the “open account” option.
Question 15: In which of the following situations would a seller grant consignment
terms? (Select all that apply.)
_____ a) Reputable consignee who is unknown to the seller

_____ b) Between buyers and sellers with excellent long-term relationships
_____ c) Between parent companies and subsidiaries to facilitate intra-
company trade
_____ d) Consignee with whom the seller has a good credit history and
whose country faces economic and political stability
Question 16: Chemco, one of the largest Mexican producers and exporters of chemical
products, is scheduled to begin selling phosphate to QRS Chemicals, a
company recently acquired by Chemco. In arranging financing terms,
Chemco has offered its subsidiary a tenor of up to 90 days after shipment
date. What is the best payment option for this trade arrangement?
_____ a) Export Letter of Credit

_____ b) Import Letter of Credit
_____ c) Open Account
_____ e) Documentary Collection
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2-30 TRADE SERVICES
ANSWER KEY
Question 14: Banks acting as intermediaries of a trade transaction can derive more fee
income from:
b) documents against acceptance.
Question 15: In which of the following situations would a seller grant consignment
terms? (Select all that apply.)
d) Consignee with whom the seller has a good credit history and
whose country faces economic and political stability
Question 16: Chemco, one of the largest Mexican producers and exporters of chemical
products, is scheduled to begin selling phosphate to QRS Chemicals, a
company recently acquired by Chemco. In arranging financing terms,
Chemco has offered its subsidiary a tenor of up to 90 days after shipment
date. What is the best payment option for this trade arrangement?
c) Open Account
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TRADE SERVICES 2-31
LETTERS OF CREDIT (L/C)
Bank assumes The fifth major payment option covered in this unit, “letter of
obligation to pay
credit,” is an instrument issued by a bank to a named party which
substitutes the bank’s creditworthiness for that of its customer.
The letter of credit states the bank’s willingness to guarantee its
customer’s credit and the bank’s conditional obligation to pay the
party named in the letter of credit.
Parties to a Letter of Credit
Several participants are involved in a letter of credit transaction:
n The applicant is the party that arranges for the letter of

credit to be issued.
n The beneficiary is the party named in the letter of credit in

whose favor the letter of credit is issued.
n The issuing or opening bank is the applicant’s bank that

issues or opens the letter of credit in favor of the beneficiary
and substitutes its creditworthiness for that of the applicant.
n An advising bank may be named in the letter of credit to

advise the beneficiary that the letter of credit was issued.
n The paying bank is the bank nominated in the letter of

credit that makes payment to the beneficiary without
recourse, after determining that documents conform, and
upon receipt of funds from the issuing bank or another
intermediary bank nominated by the issuing bank.
n The confirming bank is the bank which, under instruction

from the issuing bank, substitutes its creditworthiness for that
of the issuing bank. It ultimately assumes the issuing bank’s
commitment to pay.
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Citibank’s role A bank may take on more than one role in a single letter of credit
transaction. At least two banks are involved in most transactions —
the bank in the applicant’s country and the bank in the beneficiary’s
country. However, it is not unusual to find three, and sometimes
four, different banks participating in one transaction. As a result
of Citibank’s global network, Citibank can assume many roles in
a single transaction. In a letter of credit transaction, banks deal only
with documents; they have nothing to do with the goods.
Revocable or Irrevocable Letter of Credit
Letters of credit are issued either as “revocable” or “irrevocable.”

Unless clearly designated revocable, a letter of credit is considered
irrevocable.
Amended or A revocable letter of credit is one that can be amended or canceled

canceled at by the issuing or opening bank at any time without prior notice to,
any time
or agreement of, the beneficiary. It is seldom used.
Cannot be An irrevocable letter of credit is one that is a definite commitment

amended or by the issuing bank to pay, provided the beneficiary complies with
canceled
the terms and conditions of the letter of credit. An irrevocable letter
of credit cannot be amended or canceled without the consent of the
issuing bank, confirming bank (if the L/C is confirmed), and the
beneficiary.
Basic Letter of Credit Components
Required A letter of credit always includes the following basic components:

information
n Revocable or irrevocable designation
n Beneficiary’s name and address
n Aggregate amount in the specified currency.

Letters of credit can be issued in any currency.
n Expiration date and place of expiration
n Payment terms and conditions
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TRADE SERVICES 2-33
Discrepancy Documents must comply with the terms and conditions of the letter
of credit and must be consistent with all documentary requirements.
A discrepancy represents any variation or difference between the
requirements of the credit (text) and what is shown on the
documents presented.
A discrepancy can void the bank’s commitment to pay. In some

cases, the bank may return the discrepant documents to the
beneficiary with instructions to re-present corrected documents. If
the beneficiary cannot re-present corrected documents, the paying
bank, on the instruction of the beneficiary, requests approval from
the issuing bank to waive the discrepancies and pay the beneficiary.
In the event that the issuing bank refuses to waive the discrepancies,
the beneficiary retains the ownership of the shipping documents and
may seek settlement outside of the letter of credit.
COMMERCIAL AND STANDBY LETTERS OF CREDIT
Payment for The characteristics that we have described so far are common to any
goods vs. letter of credit; however, there are two major categories of letters of
payment for
credit – commercial letters of credit and standby letters of credit.
performance
A commercial letter of credit is used as a payment method in
conjunction with the movement of goods. A standby letter of credit
is used as a monetary indemnification in relation to the performance
of the Bank’s customer in an underlying contractual obligation with
another party. We describe these two types of letters of credit in the
pages that follow.
References There are two publications published by the International Chamber
of Commerce (ICC) which provide guidelines for parties /
participants in letter of credit transactions: the Uniform Customs
and Practice for Documentary Credits (UCP) and the
International Standby Practices (ISP). While the UCP is utilized
for both commercial letters of credit and standby letters of credit, the
ISP is a more recent publication specifically suited and more
appropriate to use for standby letters of credit.
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2-34 TRADE SERVICES
Commercial Letters of Credit
When the beneficiary (seller or exporter) is in a position to dictate

terms that minimize risk, and the applicant (buyer or importer)
wishes to purchase goods without paying for them in advance, the
beneficiary will require the applicant to provide a commercial letter
of credit.
A commercial letter of credit is an instrument that states the bank’s

obligation to pay the beneficiary upon presentation of conforming
documents evidencing that goods have been shipped. Citibank only
pays the beneficiary if the required documents presented are in
accordance with the terms and conditions of the letter of credit.
Other terms In addition to the basic letter of credit components previously
described, the following terms and conditions are also part of a
commercial letter of credit:
n Presentation period for documents
n Latest shipment date
n Required documentation
n Merchandise description
n Origin of goods, place of shipment and destination, shipping

terms (i.e. FOB, FCA, CFR, CIF  please refer to the latest
edition of the ICC publication titled INCOTERMS 1990)
n Reimbursement instructions (for bank use only)
Transaction The typical transaction flow of a commercial letter of credit is as

flow follows:
1. The applicant (buyer or importer) initiates the request for

a letter of credit.
2. The issuing bank (opening) issues the letter of credit and

forwards it to the beneficiary directly or transmits it to the
advising bank.
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TRADE SERVICES 2-35
3. The advising bank authenticates and presents the letter of

credit to the beneficiary. If the issuing bank nominates the
advising bank to be its paying agent, the advising bank may
also become the paying bank. The issuing bank may also
request that the advising bank add its confirmation to the
letter of credit.
4. The beneficiary ships the goods.
5. The beneficiary forwards the documents required under the

terms and conditions of the letter of credit to the paying
(confirming) bank.
6. The paying (confirming) bank examines the documents to

ensure compliance with the terms and conditions of the letter
of credit. If the documents comply, the paying bank receives
funds from the issuing bank before releasing payment to the
beneficiary.
7. The paying (confirming) bank forwards the documents to the

issuing bank. Upon receipt, the issuing bank reexamines the
documents to ensure compliance with the terms and
conditions of the letter of credit.
8. The issuing bank debits the applicant’s account.
9. The issuing bank releases the documents to the applicant.
The commercial letter of credit flow is illustrated in Figure 2.8.
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2-36 TRADE SERVICES
Figure 2.8: Commercial letter of credit flow
Settlements Under a Letter of Credit
All commercial letters of credit must clearly indicate whether they

are payable by sight payment, by deferred payment, by acceptance,
or by negotiation. These are noted as formal demands under the
terms of the commercial letter of credit.
Sight payment In a sight payment, the commercial letter of credit is payable
when the beneficiary presents the complying documents and if
the presentation takes place on or before the expiration of the
commercial letter of credit.
Deferred In a deferred payment, the commercial letter of credit is payable on
payment a specified future date. The beneficiary may present the complying
documents at an earlier date, but the commercial letter of credit is
payable only on the specified future date.
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Acceptance An acceptance is a time draft drawn on, and accepted by, a banking
institution which promises to honor the draft at a specified future
date. The act of acceptance is without recourse as it is a commitment
to pay the face amount of the accepted draft.
Negotiation Under negotiation, the negotiating bank, a third party negotiator,
expedites payment to the beneficiary upon the beneficiary’s
presentation of the complying documents to the negotiating bank.
The bank pays the beneficiary, normally at a discount of the face
amount of the value of the documents, and then presents the
complying documents, including a sight or time draft, to the issuing
bank to receive full payment at sight or at a specified future date.
Types of Irrevocable Commercial Letters of Credit
There are three basic types of irrevocable commercial letters

of credit.
1. Straight letter of credit
A straight letter of credit usually involves three parties:

an applicant, the issuing bank, and the beneficiary. The
commitment of the issuing bank extends to the named
beneficiary; the beneficiary presents the documents directly
to the issuing bank or nominated paying bank for payment.
2. Negotiable letter of credit
In a negotiable letter of credit, the issuing bank assures anyone

who “negotiates” against conforming documents that it will be
reimbursed under the terms and conditions of the letter of credit.
The negotiating bank becomes a legal party to the letter of credit.
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Additional In a negotiable letter of credit, the additional party to consider

party: is the negotiating bank. This bank, usually unnamed in the letter
negotiating bank
of credit, elects to “negotiate” (purchase documents from, and
advance funds to, the beneficiary) against presentation of the
documents required by, and conforming to, the terms and
conditions of the letter of credit.
Settlement Generally, a negotiating bank negotiates documents and may
under negotiable provide advance funding to the beneficiary on a recourse basis.
letter of credit
In effect, the negotiating bank extends a loan and charges a fee.
If the issuing bank refuses to reimburse the negotiating bank for
reasons other than discrepant documents, the negotiating bank
can retrieve its funds from the beneficiary. From the beneficiary’s
perspective, a negotiable letter of credit accelerates payment.
3. Confirmed letter of credit
A confirmed letter of credit is typically used when a

beneficiary may not be willing to rely on the credit standing
(creditworthiness) of an issuing bank and/or on the political
risk of the issuing bank’s country. The risks associated with the
issuing bank’s country may affect the ability of the issuing bank
to honor its obligations.
Commitment to As a result, the beneficiary may insist not only that the issuing
pay without bank issues a letter of credit, but also may require that a bank in
recourse
the beneficiary’s country adds its commitment to pay without
recourse. This requirement is met by a letter of credit that is an
irrevocable obligation of the issuing bank (buyer’s bank) which
is confirmed by a bank in the beneficiary’s country. The bank
in the beneficiary’s country adds its commitment to that of
the issuing bank to honor drafts and documents presented in
accordance with the terms and conditions of the letter of credit.
This bank is referred to as the confirming bank.
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Confirmed, The confirming bank guarantees payment and assumes the credit
irrevocable letter and country risks of the issuing bank. A confirmed, irrevocable
of credit
letter of credit provides the best protection to the beneficiary in
provides best
protection mitigating the cross-border and commercial risks of the
to beneficiary transaction.
Special Features of Commercial Letters of Credit
Letters of credit may be structured to meet the particular

circumstances of a transaction. Some special features include:
revolving, red clause, back-to-back, transferable letters of
credit, and assignment of proceeds.
n Revolving Letters of Credit

Credit available Instead of establishing one letter of credit for each shipment
for fixed amount from the same seller, the buyer can open a revolving letter
of time
of credit which makes a fixed sum available for a specified
amount of time to cover multiple shipments from a single seller.
For example, a letter of credit with a total value of $600,000
may be structured to allow a seller to make six monthly
shipments, each valued at $100,000. The seller may draw up
to $100,000 after each shipment.
Cumulative / Revolving letters of credit may be cumulative or non-
non-cumulative cumulative. In a cumulative revolving letter of credit, the
$100,000 per month may be carried over into another month if,
for some reason, the seller does not ship. In a non-cumulative
revolving letter of credit, the $100,000 does not carry over from
month to month.
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n Red Clause Letters of Credit

Cash advance In this type of letter of credit, the buyer / applicant authorizes
(loan) to the designated bank to make a cash advance (loan) to the seller /
beneficiary
beneficiary to purchase the goods or effect shipment under the
letter of credit. The designated bank charges interest to the seller
at the local rate, unless the letter of credit terms provide
otherwise.
It is referred to as a “red clause” simply because some banks

historically printed this clause in red ink. Typically, it is used
when the applicant and the beneficiary enjoy a close business
relationship.
n Back-to-Back Letters of Credit

Possible Two letters of credit used to facilitate the purchase of the same
collateral for goods are called back-to-back letters of credit. The beneficiary
second L/C
of an irrevocable letter of credit may use it as collateral to open
a second letter of credit. This second letter of credit is issued in
favor of the ultimate manufacturer or supplier of goods needed
for shipment under the first letter of credit.
In a back-to-back letter of credit, the beneficiary of the first letter

of credit provides security for his/her supplier by procuring the
issuance, in favor of the supplier, of a second letter of credit.
A back-to-back letter of credit is an instrument seldom used

because of the credit and operational risks for the paying /
confirming bank of the first (original) letter of credit. This bank
becomes, in turn, the opening bank of the second letter of credit.
Some of the problems with this instrument are as follows:
• The credit standing of the original beneficiary must be

such to enable the original paying / confirming bank to
open the second letter of credit without requiring any
collateral dependency on the first letter of credit.
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• The terms and conditions of the first and second letters

of credit should NOT be mirrored. For instance, the
expiration date of the second letter of credit would
need to be several days less than the first letter of
credit to accommodate the two presentations of
documents.
• There are issues involving the original beneficiary. For
instance, suppose the second beneficiary presents the
documents which meet the terms and conditions of the
second letter of credit. As a result, the opening bank of
the second letter of credit must pay.
• Now, what happens if the original beneficiary does not
present the documents or goes bankrupt? What if the
original opening bank finds discrepancies with the
presented documents and refuses to pay? How will the
opening bank of the second letter of credit get
reimbursed by the opening bank of the first letter of
credit?
Whenever a “transferable” credit is necessary to execute a trade
transaction, there are other instruments available that minimize a
bank’s risk. These are transferable letters of credit and
assignment of proceeds.
n Transferable Letters of Credit

Transfers credit A transferable letter of credit involves less risk for the Bank than
to supplier to a back-to-back letter of credit. It allows the beneficiary of the
transferable letter of credit to request the nominated transferring
bank to transfer, in whole or in part, the letter of credit to one or
more second beneficiary(ies). The first beneficiary is typically
a broker or middle person in the transaction and the second
beneficiary(ies) is the ultimate supplier of the goods.
n Assignment of Proceeds
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Assignment If the letter of credit is not transferable, an assignment of

of proceeds to proceeds is another option available for the beneficiary to finance
a third party
the purchase of goods from its supplier. With assignment of
proceeds and in accordance with the provisions of applicable
law, the beneficiary can instruct the paying bank to assign,
partially
or in total, the proceeds available under a letter of credit to a
third party (assignee).
The assignment of proceeds is not, itself, a letter of credit and

the assignee is not a party to the letter of credit. The assignee
is not entitled to payment under the letter of credit unless the
beneficiary presents strictly complying documents under the
terms and conditions of the letter of credit. If the beneficiary fails
to submit complying documents, the assignee will not be paid the
amount originally agreed to under the assignment of proceeds.
Advantages and Risks of Commercial Letters of

Credit
Applicant’s The letter of credit assures the applicant (buyer) that the beneficiary
advantages (seller) will only be paid if the documents comply with the terms
and risks
and conditions stated in the letter of credit. Since banks only deal
with documents, and not with goods, the applicant still runs the risk
that the merchandise may not be as it was represented in the
documentation.
Beneficiary’s The beneficiary enjoys four major advantages with a commercial
advantages letter of credit:
and risks
1. The beneficiary is assured of payment as long as it complies
with the terms and conditions of the letter of credit. The letter
of credit identifies which documents must be presented and
the data content of those documents. The credit risk is
transferred from the applicant to the issuing bank.
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2. The beneficiary can enjoy the advantage of mitigating the

issuing bank’s country risk by requiring that the letter of
credit be confirmed by a bank in its own country. That bank
then takes on the country and commercial risk of the issuing
bank and protects the beneficiary.
3. The beneficiary minimizes collection time as the letter of

credit accelerates payment of the receivables.
4. The beneficiary’s foreign exchange risk is eliminated with

a letter of credit issued in the currency of the beneficiary’s
country.
Citibank’s risks In addition to operational risks, Citibank can incur other risks
depending on the role(s) it plays in a letter of credit transaction.
The roles and corresponding risks are as follows:
n Issuing Bank — faces a credit risk, as the bank that

substitutes its creditworthiness for that of its customer. The
issuing bank takes the full risk of the transaction until its
customer, the applicant, is able to repay the full amount of the
payment under the letter of credit.
Operational risks also are associated with the issuing bank

because the bank may misinterpret or overlook part of the
applicant’s (customer’s) instructions. For instance, when
the issuing bank opens the letter of credit, it may forget to
include a beneficiary documentation requirement that had
been specified as part of the applicant’s original instructions
to the issuing bank. As a result, the beneficiary may get paid,
but the issuing bank may not be able to be reimbursed by the
applicant because the documentation requirements do not
comply with the applicant’s original instructions.
n Advising Bank — faces operational risks such as delaying

or failing to advise the beneficiary that a letter of credit has
been issued. As a result, the letter of credit may expire or
there may be insufficient time for the beneficiary to present
the documentation under the terms and conditions of the
letter of credit. In addition, the advising bank can be liable
for failure to properly authenticate the apparent authenticity
of the letter of credit.
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n Paying Bank — faces operational risks such as paying the

beneficiary against nonconforming documents.
n Confirming Bank — faces a credit risk as the bank that

substitutes its creditworthiness for that of the issuing bank.
The confirming bank takes the full risk of the transaction
until its customer, the issuing bank, reimburses the full
amount of the payment under the letter of credit. It also faces
operational risks such as payment against nonconforming
documents, and country risk of the issuing bank’s country.
n Negotiating Bank — faces operational risks such as payment

against nonconforming documents or misplacing any
documentation that must be returned to the issuing bank.
It also faces the credit risk of the beneficiary when advancing
funds with recourse to the exporter.
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The advantages and risks of a commercial letter of credit for the

applicant, beneficiary, and Citibank are shown in Figure 2.9.
COMMERCIAL LETTER OF CREDIT

Goods are shipped to the applicant. The beneficiary’s draft and title
documents are presented through the paying / confirming / issuing
bank for payment.
Advantages Risks
APPLICANT n Assurance that n Merchandise not as

payment represented in documentation
will only be made upon
beneficiary’s
compliance with L/C
terms and conditions
n Mitigation of n Non-compliance with L/C terms
BENEFICIARY
commercial and and conditions
country risks, if credit
is confirmed
n Currency conversion
approved before
goods shipped
n Collection time
minimized
n Elimination of foreign
exchange risk for L/C
issued in currency of
beneficiary’s country
CITIBANK n Fee-based revenues n Issuing Bank – credit risk of the

n Cross-sell opportunities applicant and operational risks
(Risks may vary n Advising Bank – operational
depending on risks
bank role)
n Paying Bank – operational
risks
n Confirming Bank – credit risk
of the issuing bank, operational
risks, and country risk of the
issuing bank’s country
n Negotiating Bank – operational
risks; credit risk of the
beneficiary
Figure 2.9: Commercial letter of credit: Advantages and risks for applicant,
beneficiary, and Citibank
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Import Letter of Credit and Export Letter of Credit
The same letter of credit can be viewed as either an import or

an export letter of credit, depending on the customer’s role in
the trade transaction. For the applicant (importer or buyer), it is
an import letter of credit; for the beneficiary (exporter or seller),
it is an export letter of credit.
Import Letter From the importer’s or applicant’s perspective, the issuing bank
of Credit (local bank) issues an import letter of credit for the account of the
applicant (local importer or buyer), in favor of the beneficiary
(foreign seller), to secure payment for foreign goods purchased.
Export Letter From the exporter’s perspective, it is the same (import) letter of
of Credit credit opened by the issuing bank on behalf of the beneficiary. This
letter of credit is viewed by the advising / confirming / paying /
negotiating bank as an export letter of credit for the account of an
overseas buyer of the exporter’s goods, in favor of the exporter, as
payment for goods purchased.
The differences between the two perspectives are shown in Figure

2.10.
IMPORT EXPORT
Letter of Credit Letter of Credit
Customer’s Role Applicant Beneficiary
(Importer) (Exporter)
L/C Opened by Applicant’s bank
For the Account of Applicant
In Favor of Beneficiary
As Payment for Foreign goods Local goods sold

purchased
Figure 2.10: Import Letter of Credit vs. Export Letter of Credit
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Standby Letters of Credit
The second major category of letter of credit, standby letter of credit,

is an instrument that secures the beneficiary against loss resulting
from the failure of the bank’s customer to perform a contractual
obligation, financial or nonfinancial, that the customer has with the
beneficiary. This means that the bank promises to make a monetary
payment under certain conditions specified in the letter of credit.
While a commercial letter of credit is usually payable against the

presentation of specified documents evidencing the shipment of
goods, documents required in a standby letter of credit may consist
simply of the beneficiary’s statement that the bank’s customer
has defaulted in certain obligations that the customer has with the
beneficiary. The bank does not investigate the underlying facts of
the transaction and it pays against documents only.
Standby letters of credit typically do not require the submission of

shipping documents and are rarely used as a payment mechanism
for the movement of goods.
Other terms In addition to the basic letter of credit components previously
described, the following terms and conditions are also part of a
standby letter of credit:
n Required documentation
n Reimbursement instructions (for bank use only)

Types of standby There are two basic types of standby letters of credit issued either
letters of credit as revocable or irrevocable: guarantee and payment. They are
outlined in Figure 2.11, page 2-50. Later we will describe other
legal forms of guarantee that are commonly used outside the US
in place of a standby letter of credit.
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Standby Letter of Credit: Guarantee Type
Form of The guarantee type standby letter of credit, issued only as

protection irrevocable, may be used as a form of protection to cover
to cover
performance, financial or nonfinancial obligation, under a contract.
performance
under a This instrument protects the beneficiary financially in the event that
contract the bank’s customer fails to perform under the contract mentioned
in the letter of credit. Otherwise, the beneficiary may draw those
funds available under the letter of credit. It is referred to as a
“standby” letter of credit because it provides financial protection to
the beneficiary if the applicant defaults on the terms of the contract
or agreement.
The guarantee type can be used in just about any business

transaction that requires a financial indemnification such as:
n In lieu of bid, performance, and surety bonds
n In lieu of bank guarantees
n To support another bank’s guarantee or undertaking
n To provide security for advance payments
Example of Suppose a government agency advances $1 million to a construction

security for company for materials to build a hospital. The government agency
advance
requires the contractor to have its bank
payments
issue a standby letter of credit to cover the advance in case the
contractor goes out of business or disappears with the money.
If the contractor defaults, the agency can draw the $1 million from
the contractor’s bank under the standby letter of credit. If
the contractor performs as expected, the agency never draws under
the letter of credit.
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Standby Letter of Credit: Payment Type
Functions The payment type standby letter of credit functions as a payment

as a payment mechanism under specified terms and conditions. Payment may be
mechanism
triggered by virtually any mechanism agreed upon by the applicant
for different
conditions and the beneficiary.
A standby letter of credit issued as a payment vehicle can be either

revocable or irrevocable, depending on the applicant’s objective.
n If revocable, the payment under the standby letter of credit

may be issued to cover:
• Salary payments
• Intercompany payments
• Expense payments
n If irrevocable, the payment under the standby letter of credit
may be issued:
• As payment of principal and/or interest on bonds
• In lieu of stock transfer contracts

A stock transfer contract refers to those transactions in
which the securities holder wishes to contract for the
sale of securities, at a selling price established today,
with delivery and payment to be made at a future date.
If the beneficiary (securities holder) presents
conforming documents (e.g., sight draft along with the
endorsed securities), the standby letter of credit assures
that the beneficiary will be paid.
• To pay progress payments
• To pay any type of periodic payment obligation
(e.g. rent, lease, alimony, insurance premiums)
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In Lieu of Bid, Performance

and Surety Bonds
Guarantee Irrevocable In Lieu of

Bank Guarantees
To Support Another Bank’s

Guarantee of Undertaking
To Provide Security for

Advance Payments
Standby Letters
Salary Payments (Abroad)
of Credit
Revocable Intercompany Payments
Expense Payments
Payment Type
Payment of Principal and/or

Interest on Bonds
In Lieu of Stock Transfer

Contracts
Irrevocable
To Pay
Progress Payments
Figure 2.11: Types of Standby Letters of Credit

To Pay Any Type of Periodic
Payment Obligation
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Advantages and Risks of Standby Letters of Credit
Applicant’s Some of the advantages of a standby letter of credit for the applicant
advantages are as follows:
and risks
n The applicant may not have to commit funds to collaterize
the transaction.
n The instrument is widely accepted in the marketplace as

a financial indemnity.
n The instrument is less costly than other indemnification

instruments such as surety bonds.
The applicant will always run the risk that the beneficiary may not
perform honestly, ethically and legally. The applicant has to accept
the risk of the beneficiary’s integrity.
Beneficiary’s The beneficiary enjoys three major advantages with a letter of
advantages credit:
1. The beneficiary may enjoy the advantage of mitigating the

issuing bank’s country risk by requiring that the letter of credit
be confirmed by a bank in its own country. That bank then
takes on the country and commercial risk of the issuing bank.
2. The beneficiary’s foreign exchange risk is eliminated with a letter

of credit issued in the currency of the beneficiary’s country.
3. The beneficiary is assured of payment as long as it complies with

the terms and conditions of the letter of credit. The letter of credit
identifies which documents must be presented and the data
content of those documents. The credit risk is transferred from
the applicant to the issuing bank.
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Citibank’s risks In addition to operational risks, Citibank can incur other risks
depending on the role(s) played by Citibank in a standby letter of
credit transaction. The roles and corresponding risks are as follows:
n Issuing Bank — faces a credit risk, as the bank that

substitutes its creditworthiness for that of its customer.
The issuing bank takes the full risk of the transaction until
its customer, the applicant, is able to repay the full amount
of the payment under the letter of credit.
n Advising Bank — faces operational risks such as delaying

or failing to advise the beneficiary that a letter of credit has
been issued. As a result, the letter of credit may expire or
there may be insufficient time for the beneficiary to present
the documentation under the terms and conditions of the
letter of credit. In addition, the advising bank can be liable
for failure to properly authenticate the letter of credit.
n Paying Bank — faces operational risks such as paying the

beneficiary against nonconforming documents.
n Confirming Bank — faces a credit risk since the confirming

bank takes the full risk of the transaction until its customer,
the issuing bank, reimburses the full amount of the payment
under the letter of credit. It also incurs operational risks and
country risks of the issuing bank’s country.
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The advantages and risks of a standby letter of credit for the applicant,
beneficiary and Citibank are shown in Figure 2.12.
STANDBY LETTER OF CREDIT

The beneficiary’s draft and documents are presented through the
paying / confirming / issuing bank for payment.
Advantages Risks
APPLICANT n May not need to commit n Beneficiary may draw

funds to collaterize the prematurely or present
transaction fraudulent documents
n Instrument widely accepted
in the marketplace
n Instrument less expensive
than other indemnification
instruments
BENEFICIARY n Mitigation of commercial n Non-compliance with L/C

and country risks, if credit is terms and conditions
confirmed
n Elimination of foreign
exchange risk for L/C issued
in currency of beneficiary’s
country
n In case of default, ease of
payment settlement
CITIBANK n Fee-based revenues n Issuing Bank – credit risk

of the applicant;
n Cross-sell opportunities
(Risks may vary operational risks
depending on n Advising Bank –
bank role) operational risks
n Paying Bank – operational
risks
n Confirming Bank – credit
risk of the issuing bank,
operational risks, and
country risk of the issuing
bank’s country
Figure 2.12: Standby letter of credit: Advantages and risks for applicant,
beneficiary and Citibank
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Other Legal Forms of Guarantee
Legal forms of There are different legal forms of guarantee issued by banks located
guarantee: outside the US – bonds and (letters of) guarantee. These instruments
bonds vs. letters
represent the issuing bank’s commitment, made at the request of its
of guarantee
customer, to pay a third party upon the occurrence of an assured
event. They are contingent liabilities of the bank, which become
absolute liabilities when the stated contingency occurs.
In the event an appropriate claim for payment is made, the bank

makes payment and seeks reimbursement from its customer. By
issuing the guarantee, the bank substitutes its creditworthiness for
that of its customer.
Although the terms bond and (letters of) guarantee may be used
interchangeably, there are some distinctions:
n A letter of guarantee or guarantee is a promise made

by one party (the bank) on behalf of some other party (the
bank’s customer and principal) that payment will be made to
a third party (the obligee) at some future date. In the event
that the bank’s customer does not make good its obligation to
pay, the bank undertakes that it will make such payment.
Guarantees are generally issued to assure financial, rather
than nonfinancial contractual, obligations.
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n A bond is a commitment made by one party (the bank) to

another party (the obligee) pledging to cover for financial
loss caused by the act of default of a third party (the obligor –
the bank’s customer). A bond is normally issued to assure
performance of a nonfinancial contractual obligation, e.g. an
obligation to provide goods or services under a contract with
another party. Some of the common types of bonds are:
• Bid bond – an instrument designed to ensure

that the tenderer (e.g., supplier) will honor its
commitment to a buyer when bidding for a
construction or supply contract. The tenderer
submitting a bid requests its bank to issue a bid bond
in favor of the buyer as beneficiary. In the event the
tenderer’s bid is accepted and the tenderer fails to sign
the contract, the bid bond is normally payable against
the buyer’s statement that the bank’s customer, the
tenderer, failed to sign the contract.
• Performance bond – issued when the contract has
been awarded. It is an instrument designed to ensure
that the contractor (e.g. supplier) will perform and
execute the contract in accordance with all its terms
and conditions. A performance bond gives the buyer
an indication of the contractor’s creditworthiness and,
in the case of default, is payable on demand.
• Surety bond – designed to ensure financial
compensation to the buyer if the supplier does not
perform contractually as agreed. It is an instrument
issued by insurance and surety companies for one
of the parties involved in a contract, arbitration, and
judgment who is required to post bond.
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Letters of Whether for an advance payment guarantee or bond (e.g., the

Guarantee vs. contractor requires an advance payment on the contract price to
Standby Letter
finance operations), bid bond, or performance bond, the (letter
of Credit
of) guarantee is the instrument of preference in many countries.
Although banks in the United States are not permitted to provide
bank (letters of ) guarantee, they are allowed by the regulatory
agencies to substitute standby letters of credit in lieu of (letters
of) guarantee, mitigating what would otherwise be a serious
shortcoming for US exporters.
When a guarantee is required, the US bank can ask its foreign

subsidiary, branch, or correspondent bank to open a (letter of)
guarantee on the US bank’s behalf. The US bank then backs up its
request for a (letter of) guarantee from the foreign bank with its own
standby letter of credit.
The terms and conditions stated in a standby letter of credit are

critical to the document. If they are not clearly defined and a dispute
arises between the beneficiary and the bank’s customer, then the
bank may have to play the difficult role of arbitrator. To avoid such a
position, standby letters of credit, unlike a bank (letter of) guarantee,
always include very specific instructions which define all of the
prerequisites for drawing against the standby letter of credit.
We have described certain legal forms of guarantee that are

commonly used outside the US in place of a standby letter of credit.
Note that these other forms of guarantee are not usually issued by
Citibank.
Summary
A letter of credit is an instrument that substitutes a bank’s credit-

worthiness for that of its customer, the applicant. It also provides the
bank’s conditional obligation to pay the party named in the letter of
credit (the beneficiary). The letter of credit offers a certain degree of
protection to both parties, applicant and beneficiary; hence, it is the
preferred payment mechanism in trade.
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A letter of credit may be issued either in revocable or irrevocable

form and will be considered irrevocable if it is not clearly designated
as one or the other. A revocable letter of credit may be altered or
canceled by the issuing bank at any time; an irrevocable letter of
credit cannot be amended or canceled without the express
permission of the parties involved – beneficiary and intermediary
banks.
A letter of credit assures the applicant that the beneficiary will only
be paid if the documents presented by the beneficiary comply with
the terms and conditions of the letter of credit.
If the beneficiary complies exactly with the terms and conditions

of the letter of credit, and if the letter of credit is confirmed, the
beneficiary will be protected against the applicant’s credit risk
and the issuing bank’s country and credit risks. When the letter of
credit is issued in the currency of the beneficiary’s country, the
beneficiary is protected against foreign exchange and cross-border
(transfer and convertibility) risk. (Transfer and convertibility risks
are covered in more detail in Unit 4.)
A bank incurs operational risks and any other risk depending on the
role(s) played in a letter of credit transaction. As the issuing bank, it
faces the applicant’s credit risk; as the advising / negotiating /
paying bank, it faces operational risks; and as the confirming bank, it
faces the issuing bank’s credit and country risks.
The applicant of a letter of credit has the advantage of not always

needing to commit funds to collaterize the transaction and enjoying
the use of an instrument which is widely accepted in the marketplace
and less costly than other indemnification instruments. However, the
applicant runs the risk that the beneficiary may draw prematurely or
present fraudulent documents.
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In terms of the beneficiary’s advantages, when the beneficiary

submits documents in accordance with the terms and conditions
of the letter of credit, the bank becomes obligated to pay. The
beneficiary can mitigate the issuing bank’s country risk by requiring
that the letter of credit be confirmed by a bank in its own country.
If the letter of credit is issued in the currency of the beneficiary’s
country, the beneficiary also eliminates its foreign exchange risk.
In this section we examined the differences between the two major

categories of letters of credit, commercial and standby.
A commercial letter of credit is used to facilitate the payment of

goods in a trade transaction. It is essentially an agreement whereby
a bank assumes a conditional obligation, in behalf of the applicant
(buyer or importer), to make payment to a beneficiary (seller or
exporter) against the presentation of specified documents by the
beneficiary evidencing the shipment of goods.
A standby letter of credit is used as a monetary indemnification

associated with the performance of the bank’s customer in relation
to an underlying contractual obligation with a third party. It protects
a third party, the beneficiary, from loss resulting from the failure of
a bank’s customer, the applicant, in performing some contractual
obligation.
To check your understanding of the fifth trade payment option, letters of credit, please
complete Progress Check 2.2 and check your answers with the Answer Key. If you
answer any questions incorrectly, please reread the corresponding text to clarify your
understanding. Then, proceed to the final section of Unit 2, “Financial and Commercial
Transaction Documents,” where you will learn about different types of trade documents.
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Question 1: Which party typically adds its promise to pay under a confirmed letter
of credit?
_____ a) Buyer
_____ b) Bank in the beneficiary’s country
_____ c) Bank that issued the letter of credit
_____ d) Beneficiary
Question 2: Typically, under what conditions will the paying bank pay the seller under a
commercial letter of credit? (Select all that apply.)
_____ a) Seller presents to the paying bank the documents that meet the L/C
_____ b) Buyer confirms receipt of the goods
_____ c) Buyer presents the title document and guarantees to the issuing bank
_____ d) Buyer places sufficient funds in his or her account with the issuing bank
_____ e) Paying bank receives funds from issuing bank or its agent bank
Question 3: The best protection for the seller is provided by a(n):
_____ a) straight letter of credit.

_____ b) open account.
_____ c) revolving letter of credit.
_____ d) confirmed, irrevocable letter of credit.
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ANSWER KEY
Question 1: Which party typically adds its promise to pay under a confirmed letter
of credit?
b) Bank in the beneficiary’s country
Question 2: Typically, under what conditions will the paying bank pay the seller under a
commercial letter of credit? (Select all that apply.)
a) Seller presents to the paying bank the documents that meet the L/C
e) Paying bank receives funds from issuing bank or its agent bank
Question 3: The best protection for the seller is provided by a(n):
d) confirmed, irrevocable letter of credit.
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(Continued)
Question 4: Identify the type of commercial letter of credit used by an importer with
multiple scheduled payments:
_____ a) Revolving, irrevocable letter of credit

_____ b) Confirmed, irrevocable letter of credit
_____ c) Negotiable, import letter of credit
_____ d) Red clause, straight letter of credit
Question 5: A commercial letter of credit whereby the beneficiary has the right to
request that it be made available to one or more parties and is less risky
to the nominated advisory / confirming bank, is known as a:
_____ a) red clause letter of credit.

_____ b) transferable letter of credit.
_____ c) back-to-back letter of credit.
_____ d) clean letter of credit.
Question 6: In a letter of credit, banks deal:
_____ a) only in goods, not with documents.

_____ b) only with documents, not in goods.
_____ c) with documents and in goods.
_____ d) only with documents, not in goods, as long as it is a standby letter
of credit
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ANSWER KEY
Question 4: Identify the type of commercial letter of credit used by an importer with
multiple scheduled payments:
a) Revolving, irrevocable letter of credit
Question 5: A commercial letter of credit whereby the beneficiary has the right to
request that it be made available to one or more parties and is less risky
to the nominated advisory / confirming bank, is known as a:
b) transferable letter of credit.
Question 6: In a letter of credit, banks deal:
b) only with documents, not in goods.
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(Continued)
Question 7: In a straight letter of credit, the parties involved are always the:
_____ a) applicant, issuing bank, and beneficiary.

_____ b) applicant, issuing bank, paying bank, and beneficiary.
_____ c) applicant, issuing bank, negotiating bank, and beneficiary.
_____ d) applicant, issuing bank, advising bank, and beneficiary.
Question 8: An exporter and importer are about to close a large trade deal but the
issuing bank is unknown to the exporter. What commercial letter of
credit would best meet the needs of the exporter to minimize its risk?
_____ a) Negotiable
_____ b) Confirmed
_____ c) Straight
_____ d) Back-to-Back
Question 9: For each role that a bank plays in a commercial letter of credit, identify
one or more of the most common risks associated with the role.
_____ a) Issuing Bank 1. Credit risk of the applicant

_____ b) Advising Bank 2. Operational risk
_____ c) Paying Bank 3. Credit risk of the issuing bank
_____ d) Negotiating Bank 4. Foreign exchange risk
_____ e) Confirming Bank 5. Interest rate risk
6. Political risk
7. Credit risk of the beneficiary
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ANSWER KEY
Question 7: In a straight letter of credit, the parties involved are always the:
a) applicant, issuing bank, and beneficiary.
Question 8: An exporter and importer are about to close a large trade deal but the
issuing bank is unknown to the exporter. What commercial letter of
credit would best meet the needs of the exporter to minimize its risk?
b) Confirmed
Question 9: For each role that a bank plays in a commercial letter of credit, identify
one or more of the most common risks associated with the role.
1,2_ a) Issuing Bank: Credit risk of the applicant, Operational risk

2 _ b) Advising Bank: Operational risk
2 _ c) Paying Bank: Operational risk
2,7_ d) Negotiating Bank: Operational risk, Credit risk of the beneficiary
2,3,6 e) Confirming Bank: Operational risk, Credit risk of the
issuing bank, Political risk
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(Continued)
Question 10: A seller, who will have a letter of credit opened in his favor, does not
have funds to purchase the goods from his supplier and does not qualify for
a bank loan. What would be the least complicated letter of credit to be
issued that would enable the seller to obtain the goods?
_____ a) Revolving
_____ b) Back-to-Back
_____ c) Transferable
_____ d) Red Clause
Question 11: Match the type of standby letter of credit with the application. Use G for
guarantee and P for payment.
_____ a) In lieu of a bid bond

_____ b) In lieu of bank guarantees
_____ c) Salary disbursements
_____ d) Principal and/or interest on bonds payments
_____ e) Security for advance payments
Question 12: A standby letter of credit is different from a commercial letter of credit
because a:
_____ a) commercial letter of credit requires the beneficiary to present

shipping documentation to draw against the letter of credit.
_____ b) standby letter of credit is always revocable.
_____ c) commercial letter of credit does not have an expiration date.
_____ d) standby letter of credit can be viewed as either an import letter
of credit or an export letter of credit.
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ANSWER KEY
Question 10: A seller, who will have a letter of credit opened in his favor, does not have
funds to purchase the goods from his supplier and does not qualify for a
bank loan. What would be the least complicated letter of credit to be
issued that would enable the seller to obtain the goods?
c) Transferable
Question 11: Match the type of standby letter of credit with the application. Use G for
guarantee and P for payment.
G a) In lieu of a bid bond

G b) In lieu of bank guarantees
P c) Salary disbursements
P d) Principal and/or interest on bonds payments
G e) Security for advance payments
Question 12: A standby letter of credit is different from a commercial letter of credit
because a:
a) commercial letter of credit requires the beneficiary to present

shipping documentation to draw against the letter of credit.
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(Continued)
Question 13: What option is available to a beneficiary who is in need of financing to

pay its supplier, but does not wish to issue another letter of credit or change
a letter of credit already opened in its favor?
_____ a) Revolving
_____ b) Back-to-Back
_____ c) Transferable
_____ d) Assignment of Proceeds
Question 14: Select the one correct tenor for each settlement.
_____ a) Sight Payment 1. Payment is made immediately to the

_____ b) Negotiation beneficiary when complying documents
are presented
_____ c) Deferred Payment
2. Payment is made to the beneficiary at a
_____ d) Acceptance specified future date
3. Payment is made immediately to the
beneficiary, normally at a discount, upon
presentation of the complying documents
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ANSWER KEY
Question 13: What option is available to a beneficiary who is in need of financing to

pay its supplier, but does not wish to issue another letter of credit or change
a letter of credit already opened in its favor?
d) Assignment of Proceeds
Question 14: Select the one correct tenor for each settlement.
_____
1 a) Sight Payment 1. Payment is made immediately to the
_____ beneficiary when complying documents
3 b) Negotiation
are presented
_____
2 c) Deferred Payment
2. Payment is made to the beneficiary at a
_____
2 d) Acceptance specified future date
3. Payment is made immediately to the
beneficiary, normally at a discount, upon
presentation of the complying documents
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(Continued)
Question 15: Match each of the five customer needs to one of the three instruments that
will best meet the need.
_____ a) A seller who is shipping to a buyer on open account may expect the
buyer to provide a bank assurance that payment will be made when due.
_____ b) A company may need to support a foreign subsidiary in its local

borrowing needs. A foreign lending bank has indicated a willingness
to accommodate the subsidiary’s borrowing needs if such borrowings
are backed by a prime international bank.
_____ c) A company may be interested in bidding on a sale of goods to a certain

buyer. The buyer’s invitation to bid includes a stipulation that all
bidders must post a bond or promise to establish financial responsibility
and to assure that, if awarded the bid, the bidder will enter into a firm
contract.
_____ d) A company may enter into a contract to supply services in which the
buyer requires the supplier to post a bond or ensure that, if the supplier
fails to perform and execute the contract in accordance with all its terms
and conditions, a monetary compensation will be made.
_____ e) In the course of a project, a buyer may be required to make progress

payments to the supplier. The buyer may require that the supplier obtain
a bank guarantee that, in the event of nonperformance by the supplier,
the buyer will be reimbursed for all of the progress payments.
_____ f) As part of a divorce settlement, one of the parties requires alimony

payments under a letter of credit by the other party who has moved to
a distant country. The condition is that if the party receiving alimony
marries, the other party is no longer under obligation to continue the
payments. What is the appropriate letter of credit for this situation?
Instruments available:
1. Standby letter of credit, irrevocable, payment type
2. Standby letter of credit, irrevocable, guarantee type
3. Standby letter of credit, revocable, payment type
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ANSWER KEY
Question 15: Match each of the five customer needs to one of the three instruments that
will best meet the need.
_____
1 a) A seller who is shipping to a buyer on open account may expect the
buyer to provide a bank assurance that payment will be made when due.
_____
2 b) A company may need to support a foreign subsidiary in its local
borrowing needs. A foreign lending bank has indicated a willingness
to accommodate the subsidiary’s borrowing needs if such borrowings
are backed by a prime international bank.
_____
2 c) A company may be interested in bidding on a sale of goods to a certain
buyer. The buyer’s invitation to bid includes a stipulation that all
bidders must post a bond or promise to establish financial responsibility
and to assure that, if awarded the bid, the bidder will enter into a firm
contract.
2
_____ d) A company may enter into a contract to supply services in which the
buyer requires the supplier to post a bond or ensure that, if the supplier
fails to perform and execute the contract in accordance with all its terms
and conditions, a monetary compensation will be made.
_____
1 e) In the course of a project, a buyer may be required to make progress
payments to the supplier. The buyer may require that the supplier obtain
a bank guarantee that, in the event of nonperformance by the supplier,
the buyer will be reimbursed for all of the progress payments.
_____
3 f) As part of a divorce settlement, one of the parties requires alimony
payments under a letter of credit by the other party who has moved to
a distant country. The condition is that if the party receiving alimony
marries, the other party is no longer under obligation to continue the
payments. What is the appropriate letter of credit for this situation?
Instruments available:
1. Standby letter of credit, irrevocable, payment type
2. Standby letter of credit, irrevocable, guarantee type
3. Standby letter of credit, revocable, payment type
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(Continued)
Question 16: A letter of credit may be viewed as an import or export letter of credit,
depending on the perspective a given party has of the transaction. Match
the following parties with how they would view the same letter of credit
in a trade transaction.
_____ a) Issuing Bank 1) Import Letter of Credit

_____ b) Beneficiary 2) Export Letter of Credit
_____ c) Advising Bank
_____ d) Buyer
_____ e) Seller
_____ f) Applicant
_____ g) Paying Bank
_____ h) Confirming Bank
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ANSWER KEY
Question 16: A letter of credit may be viewed as an import or export letter of credit,
depending on the perspective a given party has of the transaction. Match
the following parties with how they would view the same letter of credit in
a trade transaction.
_____
1 a) Issuing Bank 1) Import Letter of Credit
_____
2 b) Beneficiary 2) Export Letter of Credit
_____
2 c) Advising Bank
_____
1 d) Buyer
_____
2 e) Seller
_____
1 f) Applicant
_____
2 g) Paying Bank
_____
2 h) Confirming Bank
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FINANCIAL AND COMMERCIAL TRANSACTION DOCUMENTS
Many documents facilitate the exchange of goods and services.

In this section you will learn about the different financial and
commercial documents necessary for different trade transactions.
Financial Documents
A financial document may be a check (cheque), draft (bill of

exchange), or promissory note. We describe them below.
Check
A check must be drawn on a bank and can be payable only at sight.
Draft / Bill of Exchange
Order to pay A draft or bill of exchange (the terms are used interchangeably) is
a written order to pay a sum of money. A draft, the most common
document involved in the payment of trade transactions, represents
a commitment to pay for goods when cash terms are not used.
The seller (drawer), who is the beneficiary of the payment,

generates the draft drawn on the party (drawee) who has agreed to
make the payment. The drawee (buyer) may be a person or business
who owes money to the drawer (seller), or it may be the bank that is
responsible for making payment under a letter of credit.
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Sight and There are two types of drafts: “sight” and “time.”
time drafts
n With a sight draft, the payment is made at “sight” or when
the draft is presented.
n The time draft commits the buyer to release the funds after
a fixed period of time, such as thirty, sixty, or ninety days.
For example, the buyer may want to purchase goods from the
seller, but cannot pay the seller until the goods are resold.
The time draft gives the buyer time to sell the goods and
receive the money needed to pay the seller. A time draft
drawn under a letter of credit is usually drawn on the
negotiating bank by an exporter, which originates a bankers’
acceptance (see Unit 3).
Promissory Note
Promise of A promissory note is the most frequently used borrowing

payment instrument in banking. By signing a note, the borrower
acknowledges receipt of the money and commits to repay it, with
or without interest, in a lump sum or in installments. A promissory
note has most of the same features as a draft or bill of exchange.
The main difference is that it represents a direct promise of
payment by the person who signs the note, rather than an order
to pay. A promissory note is an “I owe you,” whereas a draft is a
“you owe me.”
Negotiable Checks, bills of exchange, and promissory notes are the three
instruments main types of negotiable instruments since they are often used
as payment devices in international trade. Promissory notes and
accepted bills contain an unconditional promise to pay a specified
sum of money. That promise can be bought and sold by endorsing
and handing over the piece of paper on which it is written.
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Commercial Documents
A commercial document may be an invoice, bill of lading,

insurance document / policy, or other shipping document.
Commercial Invoice
Billing A commercial invoice is a billing document issued by the seller and

document addressed to the buyer. It describes the goods or services, their price,
and any other charges or relevant information about the transaction.
The commercial invoice does not give title to the goods. Because it
is a billing document, precise terms must be used and it only can be
amended by a separate debit or credit note.
Bill of Lading
Title document A bill of lading is a transportation or shipping document issued by

the transportation company when moving goods from the seller to
the buyer. The bill of lading provides:
n Receipt for the goods delivered to the carrier for shipment

n Contract of carriage of the goods from the place of receipt
to the place of delivery listed in the bill of lading
n Evidence of title to the goods
The name of the bill of lading indicates the kind of transportation:
n Ocean or marine bill of lading for shipments over water

n Air waybill for air transportation
n Truck bill of lading for transportation by truck
n Rail bill of lading for shipments by rail
n Intermodal bill of lading when more than one type of
transportation is necessary
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Insurance Document / Policy
Coverage The insurance document (policy) provides coverage for any losses
for losses or damages to the merchandise incurred when in transit. Either the
importer or the exporter obtains coverage, depending on who has
title to the goods during shipment.
The policy states all the risks that are covered and the length of
coverage. The time period is usually from the date when the seller
delivers the goods to the shipping agency until the estimated time of
arrival of the goods at the buyer’s warehouse.
Unless otherwise stated in the letter of credit, an insurance policy

should:
n Financially cover the risks mentioned in the letter of credit
n Not be dated after the shipment date, or have an inception

date (beginning of validity period) prior to shipment date
n Be denominated in the same currency as the letter of credit
n Cover at least 110% of the total cost of the goods for

delivery to warehouse
n Be in negotiable form  signed and endorsed
n Be issued by an insurance company, underwriter or their

agents, and not by an insurance broker
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Other Documents
Depending on the needs of the buyer and the characteristics of the

merchandise, one or more other documents may be required.
n A certificate of origin states where the goods were

manufactured or grown. It is usually issued by an
official or an independent party such as a Chamber of
Commerce. The certificate serves as proof for the buyer
to obtain fiscal credit or exchange benefits in the buyer’s
country because of special trade treaties between countries.
n A weight list indicates the gross and net weights per

package or volume and the total gross and net weight of
the overall cargo.
n A packing list, used by customs for inspection purposes,

indicates the contents of each package being shipped and
accompanies the cargo. The packing and weight lists may
be combined to form a single document.
n An inspection certificate is required by importers for

merchandise of great value and quality. For example, a
buyer purchasing steel of a certain grade or quality may
request an inspection certificate indicating the grade of
steel. A designated professional or company inspects the
merchandise upon delivery to the shipping company or
just before shipment and issues the inspection certificate.
n A quality certificate, similar to the inspection certificate, is

issued by an expert who verifies that the merchandise to be
shipped agrees with the description shown on the transport
document and the commercial invoice. The quality certificate
can replace the inspection certificate.
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Sometimes the quality certificate has to be approved by

the embassy of the buyer’s country. Possible scenarios
requiring embassy approval include:
• The importer has had a bad experience with the

supplier or other suppliers from that country
• The importer is new to the business and lacks
experience with offshore purchases
n An analysis certificate, used for mineral or chemical

purchases, verifies the percentage of each component. This
information determines the pricing and possible usage of
the raw materials. Bulk shipments of perishable goods such
as crops and gases also require analysis certificates. The
analysis certificate can replace the inspection certificate.
UNIT SUMMARY
In this section, we examined the two types of documents necessary

to conduct trade transactions: financial and commercial. These
documents include:
n Draft (bill of exchange)  A written order to pay a sum

of money
n Promissory note  Signed commitment to repay a sum

of money
n Commercial invoice  Billing document issued by the seller

to the buyer
n Bill of lading  Shipping document issued by the

transportation company when moving goods. It provides
evidence of title to goods.
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TRADE SERVICES 2-79
n Insurance document  Policy to cover losses or damages to

goods when in transit. It is obtained by the party that has title
to the goods during shipping.
Additional documents may be required depending on the needs

of the buyer and the characteristics of the merchandise.
To check your understanding of trade documents, please complete Progress Check 2.3
and check your answers with the Answer Key. If you answer any questions incorrectly,
please reread the corresponding text to clarify your understanding. When you have
completed the Progress Check, continue with Unit 3: Trade Finance.
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TRADE SERVICES 2-81
Question 1: The document that transfers title is the:
_____ a) commercial invoice.

_____ b) bill of lading.
_____ c) draft.
_____ d) certificate of origin.
Question 2: Which document covers the risks that may affect the merchandise from
the time it is delivered by the seller until it is received by the buyer?
_____ a) Insurance document

_____ b) Analysis certificate
_____ c) Commercial invoice
_____ d) Quality certificate
Question 3: Which document is provided by the seller to the buyer and gives
a description and cost of goods and/or services?
_____ a) Analysis certificate

_____ b) Inspection certificate
_____ c) Weight list
_____ d) Commercial invoice
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ANSWER KEY
Question 1: The document that transfers title is the:
b) bill of lading.
Question 2: Which document covers the risks that may affect the merchandise from
the time it is delivered by the seller until it is received by the buyer?
a) Insurance document
Question 3: Which document is provided by the seller to the buyer and gives a
description and cost of goods and/or services?
d) Commercial invoice
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(Continued)
Question 4: A document that demands payment when it is presented is a:

_____ b) sight draft.
_____ c) time draft.
_____ d) promissory note.
Question 5: Merchandise imports that are priced according to a quality criteria may
require a(n):
_____ a) certificate of origin.

_____ b) shipping guaranty.
_____ c) letter of indemnity.
_____ d) inspection certificate.
Question 6: Which of the following documents are negotiable instruments?
_____ a) Promissory Note

_____ b) Commercial Invoice
_____ c) Bill of Lading
_____ d) Bill of Exchange
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ANSWER KEY
Question 4: A document that demands payment when it is presented is a:
b) sight draft.
Question 5: Merchandise imports that are priced according to a quality criteria may
require a(n):
d) inspection certificate.
Question 6: Which of the following documents are negotiable instruments?
a) Promissory Note
c) `Bill of Lading
d) Bill of Exchange
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(Continued)
Question 7: Place an F in front of the names of financial documents and a C in front

of the names of commercial documents.
_____ Bill of Exchange

_____ Bill of Lading
_____ Promissory Note
_____ Commercial Invoice
_____ Certificate of Origin
_____ Weight List
Question 8: A document that represents the buyer’s commitment to pay is a:

_____ b) sight draft.
_____ c) time draft.
_____ d) promissory note.
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ANSWER KEY
Question 7: Place an F in front of the names of financial documents and a C in front

of the names of commercial documents.
F Bill of Exchange
C Bill of Lading
F Promissory Note
C Commercial Invoice
C Certificate of Origin
C Weight List
Question 8: A document that represents the buyer’s commitment to pay is a:
d) promissory note.
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Unit 3
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UNIT 3: TRADE FINANCE
INTRODUCTION
All trade transactions require some form of financing. If the seller allows the buyer time to
pay for purchased goods, the seller must borrow money or finance that period through
available cash. Conversely, if the seller requires cash on delivery, the buyer must cover the
period between payment for the goods and the conversion of the goods into cash through a
subsequent sale. In this unit, we examine the many factors that banks must consider in
extending credit to customers (buyers and sellers). We then define the types
of transactions which may require trade financing as well as the credit instruments that
have been developed to meet these needs. From the perspective of a customer requiring
pre- or export financing, we examine the structure and parties involved in export
financing. You will see how trade financing is provided by banks acting independently,
with government support, or in cooperation with other banks.
UNIT OBJECTIVES
n Understand the process of extending credit to customers

n Identify trade financing options for trade transactions
n Understand two trade financing products: bankers’ acceptance
and forfaiting
n Recognize funding structures and mechanisms used by export
credit agencies
n Understand how correspondent banks facilitate international trade
n Recognize three trade products that are common in international
correspondent banking relationships
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3-2 TRADE FINANCE
EXTENSION OF CREDIT
The decision to extend credit to a customer is based on past experience

and present conditions. While it is not a precise science, the credit
decision does require consideration of specific issues. The goals of
extending credit are to service the needs of the customer and to earn
a profit for the lending bank. In this section, we examine the process
of extending credit while achieving both goals.
Establishing Creditworthiness
Risk that Whenever a bank extends credit, there is always a risk that the
borrower may borrower may not repay the loan. For each credit request, the bank
not repay
must gather all of the facts, analyze them, and make a decision about
the creditworthiness of the customer.
The process of extending credit begins with the bank asking some
basic questions:
1. How much money does the customer want?
2. For what purpose is the money going to be used?
3. For how long does the customer need to borrow

the money?
4. How does the customer plan to repay the money?
5. Does the customer’s business generate sufficient

cash for repayment?
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In addition, the customer must provide specific information

about its financial strength and reputation. The bank analyzes the
customer’s financial statements in order to assess capacity and
capital. The financial statements include the income statement,
balance sheet, and cash flow report. These statements summarize
the financial strength of an individual or company on any date and
for any period of time. They should be prepared and signed by
independent auditors.
For more information on statement analysis, you can order the

self-instruction workbook, Financial Statement Analysis, through the
Training Coordinator in your country or the training area responsible
for your region.
Identifying Risks
Besides evaluating the customer’s creditworthiness, the bank also

must consider the risks of lending in other countries. Country risk
includes political (sovereign) and cross-border (transfer and
convertibility) risk.
Political The political and economic environment of the borrower’s
(sovereign) risk country must be determined before credit is extended. For
example, a country may experience civil wars, riots, or
revolutions that can affect world trade and the borrower’s
ability to repay his/her obligations.
Convertibility In international lending, one of the parties has a currency
risk conversion exposure. US commercial banks usually extend loans
in US dollars to foreign customers and want to be repaid in US
dollars. When a borrower sells goods in a foreign country,
payment will be in the currency of that country. Convertibility
risk may occur if the central bank of, or the foreign exchange
market in, the borrower’s country does not have the US dollars
available to sell to the borrower to allow repayment of the loan.
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Transfer risk Governments may change laws, regulations, or procedures which

also may affect a borrower’s ability to repay loans. The borrower
in the country may not be allowed to transfer funds in the foreign
currency of payment to the place of payment. As a result, the bank
must be knowledgeable about the situation in the borrower’s
country before approving an extension of credit.
We discuss risk in greater detail in Unit 4.
Setting Interest Rates
Interest rate As compensation for assuming risk, the bank charges a certain
reflects degree interest rate for the use of its funds. The interest rate represents
of risk
a percentage that the bank charges the customer for using the
borrowed funds for a predetermined time. The amount of interest
reflects and compensates for the degree of risk assumed by the bank.
If the risk is higher, or the term of the loan longer, then the interest
rate is higher.
Fixed / floating A fixed interest rate does not change during the life of the loan. A
interest rate floating interest rate is reset periodically, depending on the existing
market rate on the reset date. Loans may be funded with domestic
dollars or Eurodollars. Eurodollars are US dollars deposited in a
bank outside the US such as a foreign bank, an overseas bank of a
US bank, or an International Banking Facility (IBF) (covered
under “Use of Offshore Vehicles” later in this unit).
Prime rate Each bank sets its own prime rate for domestically-funded loans.
The prime rate is a floating rate that is the most favorable interest
rate charged by a commercial bank on short-term loans to its most
creditworthy customers. If a borrower is not a most creditworthy
customer, the bank will quote an interest rate of prime plus a spread.
Each bank’s prime rate is set at a level that covers the bank’s cost
of funds, its operating expense, and includes a margin of profit.
Citibank calls the prime rate its “base rate.”
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LIBOR When loans are funded with Eurodollars, the bank borrows the
Eurodollars, pays the London Interbank Offered Rate (LIBOR), and
lends these dollars to its customer. LIBOR is also a floating rate and
represents the interest cost to the bank to obtain funds in this market.
These loans are quoted as “LIBOR + x percent p.a.” The “x percent
p.a.,” called the “spread,” represents the bank’s earnings.
The Eurodollars are time deposits and, therefore, LIBOR is quoted

as a fixed rate based on tenor (30, 60, 90, 180, and 360 days, and
beyond one year). For a loan with a maturity of over a year, the bank
may take a Eurodollar deposit for six months at LIBOR and reprice the
loan for successive six month increments. The borrower’s interest rate
is fixed for each six month period and may change each time the
deposit is renewed.
Notice the difference in earnings between these two kinds of funding.

The prime rate includes the cost of funds to the bank, plus an amount
to cover the bank’s overhead, plus an amount to provide the bank with
a profit. Since LIBOR only accounts for the cost of funds, the bank
must cover its overhead, be compensated for the credit risk, and earn a
profit from the increment charged over LIBOR (i.e. spread).
Establishing Credit Terms
In addition to setting the interest rate, the decision to extend credit

also involves establishing the terms of the credit. Different types of
loans have been developed for customers that cannot qualify for
credit based on their financial strength. Each customer’s financial
situation is unique, and the bank tries to find the best solution to meet
the customer’s needs.
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Secured loans When the bank makes a secured loan, it requires possession of,
or title to, some outside value in addition to the signing of a debt
instrument. This collateral provides additional protection for the
bank. Sometimes the provision of collateral results in the bank’s
willingness to charge a lower interest rate. Other times, the bank
will lend only if collateral is pledged. (Note that an unsecured loan
is granted on the financial strength and reputation of the borrower.
The debt obligations are not backed by pledged collateral or a
security agreement. A security agreement is a document which
links the collateral to a loan or credit facility.)
Guaranteed Sometimes, a borrower may not qualify for a loan based on its
loans own financial strength or have collateral available to secure the loan.
In this situation, another individual, bank, or company can guarantee
repayment of the loan to the bank. This is called a guaranteed loan.
The guarantor is the third party that assumes responsibility if the

original borrower fails to repay the loan. The bank makes the credit
decision based on the guarantor’s creditworthiness. In international
trade, the country risk of the guarantor also must be considered.
When the guarantor is from the same country as the borrower, the
same risks apply. If the guarantor is from a different country than the
borrower, the bank makes its decision based on the country risk of the
guarantor.
Determining the Type of Financing
The nature of the transaction determines which type of financing

should be used. The various types of financing available for different
credit needs include short and medium term loans, lines of credit, and
syndications.
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Short Term Loan
Loan up to A short term loan is a loan with a maturity of up to one year. The
one year principal and interest are paid at maturity date and this is evidenced
by a promissory note. As mentioned in Unit 2, a promissory note is
a legal contract that formally recognizes the borrower’s obligation to
repay the lender the loan amount, with interest, over a certain period
of time or by a stated date.
When the borrower is from a foreign country, the promissory note

must be enforceable in the United States courts and also, if possible,
in the court of the borrower’s country.
Medium Term Loan
Maturity greater A medium term loan is a loan with a maturity greater than one
than one year year and less than five years. It is payable in installments and is
evidenced by a credit agreement and a promissory note. If the
bank implements a schedule of single or multiple disbursements
(drawdowns) to the borrower, it should include the schedule of
repayments (installments) by the borrower.
Line of Credit
Short-term A line of credit is an agreement with a bank for short-term

borrowings borrowings on demand. It is the maximum amount a bank is willing
on demand
to lend to a particular customer over a future period. Customers use
a line of credit when they have a series of transactions to be financed
over a period of time. In some cases, establishing a line of credit is
more appropriate than approving a series of one-time loans.
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Syndication
Loan made by If a single bank is unwilling or unable to fund a single loan, it may
several lenders invite several other banks to extend the loan jointly in order to spread
the risks among the banks. A syndication is a loan made by several
banks or lenders that form an association to assume the responsibility
and share the risks of the loan.
In a syndication, a lead bank manages the transaction, and all other

banks in the consortium are disclosed to each other and to the
customer (borrower). The customer must assess the counterparty
risk of each member of the consortium. If one bank fails to provide
its portion of the loan, the customer (borrower), not the lead bank,
bears the risk.
A smaller bank often joins a syndication to diversify its loan portfolio

and to gain recognition as an international bank — a status which
may generate new business opportunities, but which may also create
risks that it may not be prepared to manage.
Booking Transactions
Offshore An offshore vehicle, such as Citibank NY International Banking

vehicle: Facility (IBF), is used for booking international trade transactions.
International
It is not a separate banking entity, but a separate group of accounts
Banking Facility
(IBF) or bookkeeping systems set up by a US bank or a US branch of a
foreign bank to record international banking transactions. Although
IBFs are physically located in the US, they are not subject to either
reserve requirements or assessments for deposit insurance. Unlike
other US banking facilities, they may offer deposits denominated
in currencies other than the US dollar. They also can receive
deposits from, and make loans to, nonresidents of the US or other
IBFs. The IBF is the offshore vehicle most frequently used for
booking trade loans.
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Managing the Credit
Monitoring The bank must remain in contact with the customer (borrower)
the customer during the disbursement of a credit to ensure that the customer
receives the funds as directed on the loan agreement and that the
funds are being used for the purpose stated in the loan agreement.
The bank should closely watch the customer’s financial health.

Delayed payments, information from trade sources of other late
payments, or requests for additional short-term financing may
indicate that the borrower is having difficulties. It is important to
recognize problems and address them as soon as possible.
Now that you have a feel for the bank’s credit process, we will
look at the types of trade transactions that may require an extension
of credit.
PURPOSES FOR TRADE FINANCING
Trade financing is the process of making available extensions of

credit or other financing to meet the needs of both the importer
(buyer) and the exporter (seller).
Parties to an international transaction usually buy and sell on either

a cash or credit (deferred payment) basis. Even cash transactions,
when payment is made on receipt of the goods, may require:
1) A term of credit from the completion of manufacturing /

production to the receipt of payment
– or –
2) Financing to provide the necessary capital to manufacture

and/or assemble the goods to be exported
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3-10 TRADE FINANCE
Product / If the exporter has a product / service in high demand due to a

Service— limited number of suppliers, it is most likely that the exporter will
limited suppliers
want to be paid in cash at the time of sale. In this case, either the
importer has sufficient funds to pay the exporter based on the terms
and conditions of the sale or the importer cannot pay within the
timeframe designated by the exporter. If the importer cannot pay
according to the terms and conditions of the sale, the exporter has
the following options:
n Consider other importers able to meet the exporter’s

payment terms
n Insist that the importer obtain financing from a local or

international bank to make the payment
n Obtain financing for the buyer either through the exporter’s

own bank or through government programs such as the
export credit agency of the exporter’s country. (This is
called buyer credit and is covered in more detail in the
third section of this unit.)
n Wait until the importer is able to sell the imported goods
in order to generate the cash for payment
n Provide credit to the importer by offering deferred payment
terms (This is called supplier credit and is covered in more
detail in the third section of this unit.)
Depending on the option, the exporter may want to obtain the

necessary insurance coverage for those risks which prevent the
importer from:
n Generating the funds
n Converting its local currency to the exporter’s country

currency
n Transferring the currency to the exporter’s country
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If the exporter needs financing to produce the products, the exporter

may obtain it from a local or international bank or through
government programs offered by its own country.
Product / If the exporter (seller) has a commodity product / service that is
Service — offered by many suppliers, the exporter should be more willing to
many suppliers
provide credit terms to the importer (buyer). If the importer can
only pay at a future date, because the goods must be sold in order to
generate the cash payment, the exporter can provide supplier credit
financing. In this case, the exporter has the following two options:
n Receive payment by selling its receivable due from the

importer (goods or services capable of being converted
into cash, now or at a future date) to a bank
n Hold it as a receivable until payment date
Trade finance serves a variety of purposes such as pre-export

financing, export financing, import financing, and inventory
financing. Next, we define each of these transactions.
Pre-Export Financing
Acquisition and In pre-export financing, the exporter (seller) has a firm contract of
preparation of sale but needs financing to acquire and prepare the goods for
goods for export
shipment. Manufactured or processed goods, as well as readily
marketable staples (e.g. wheat, sugar, corn, coffee, copper, silver),
may be financed.
Lack of working capital financing is one of the greatest obstacles

an exporter may face and often can prevent companies from filling
export orders. For instance, a manufacturer lacks the resources to
obtain financing domestically for an overseas sale. The company
has already reached the borrowing limit on its domestic line of credit,
and its domestic bank is unwilling to lend against a foreign contract
and the foreign receivable it will generate. If unable to obtain the
necessary pre-export working capital, the exporter will risk losing the
sale to its overseas competitors.
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3-12 TRADE FINANCE
Citibank in Latin America offers a flexible financing approach

called pre-payment of exports, a unique product of Brazil.
Pre-payment Pre-payment of exports allows an exporter to obtain financing
of exports from foreign banks or directly from the importer. Depending on
the exporter’s track record or current export sales contract, the
exporter may obtain pre-payment of exports from Citibank.
Once Citibank agrees with the exporter on the financing terms

(e.g., tenor, amount, pricing, importer(s), documentation), Citibank
advances the funds by remitting a US dollar payment order from any
offshore vehicle (Citibank NY IBF, Citibank Nassau) to the exporter.
The exporter closes a spot export foreign exchange contract with

Citibank (or some other local bank as agreed in the initial
negotiations). As a result, the exporter receives the local currency
equivalent to be used for the purchase, manufacturing, and shipping
of the goods.
Once the exporter ships the goods in accordance with the schedule
previously negotiated with Citibank, the exporter presents the
shipping documentation to the bank for review and collection.
Upon acceptance, the bank delivers the documentation to the importer

and, in return, the importer pays Citibank NY. On the other hand, the
exporter pays interest to Citibank NY (or any other vehicle as
appropriate) on the advance it received based on the negotiated
pricing and conditions (end-of-period, quarterly, semi-annually, upon
each shipment, or as otherwise negotiated).
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Export Financing
Interval between In export financing, the exporter (seller) needs financing for the
shipment and period between shipment of the goods and receipt of payment from
receipt of
the importer (buyer). The exporter can ship under an open account,
payment
documents against acceptance or documents against payment basis,
or letter of credit. In this instance, the exporter (seller) is providing
supplier credit to the importer (buyer).
Import Financing
Financing In import financing, the importer (buyer) who is purchasing goods
to pay for under a sight letter of credit or under other payment terms (open
purchased
account, term letter of credit) may need financing to meet the
goods
required payment.
Inventory (Warehouse) Financing
Inventory and In inventory or warehouse financing, an exporter (seller) needs

sale of readily financing to hold readily marketable staples in storage and complete
marketable
the sale of these staples to a buyer within the seller’s country or
staples
overseas. In reality, inventory or warehouse financing is a type of
secured lending because the goods serve as collateral for the loan.
The exporter (seller) must pledge to the bank a warehouse receipt

covering the goods, issued by an independent third party. The
warehouse receipt is a title document which states that a warehouse
company is holding a certain quantity of a specific commodity
and that the company will continue to hold these goods until the
warehouse receipt is presented. At such time, the merchandise is
returned in exchange for the warehouse receipt.
Only readily marketable staples or commodities (such as oil) qualify

for storage financing on an eligible banker’s acceptance basis
(discussed under “Commercial Financing” in the next section).
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3-14 TRADE FINANCE
Summary
A decision to extend credit requires the bank to establish the

creditworthiness of the customer, identify the risks, set the interest
rate, establish credit terms, select the type of financing, book the
transaction, and manage the credit.
Trade financing may be required by an importer when the exporter

has a product or service that is in high demand. In this case, the
importer may have to pay cash at the time of the sale. On the other
hand, if there are many suppliers of a product or service, the exporter
may have to extend credit to the importer in order to attract the
customer’s business. In this case, the exporter may need financing
until the receivable is paid.
Actually, there are four potential elements of a trade transaction

that may require trade financing — pre-export, export, import,
and inventory.
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TRADE FINANCE 3-15
Question 1: When a bank extends credit to finance a trade transaction, the spread
charged by the bank reflects (select two):
_____ a) LIBOR.
_____ b) the creditworthiness of the borrower.
_____ c) the degree of risk assumed by the bank.
_____ d) the borrower’s line of credit.
Question 2: The prime rate is:

_____ a) a fixed interest rate charged by a bank to its “prime” customers.
_____ b) a floating interest rate that a bank pays to borrow Eurodollars.
_____ c) an interest rate that only accounts for the bank’s cost of funds.
_____ d) the best rate charged by a bank on short-term loans to customers
with the highest credit ratings.
Question 3: Select two types of loans that may be given to customers that cannot
qualify for credit based on creditworthiness.
_____ a) Loans that require possession of, or a title to, something of value
_____ b) Obligations that rely on the sound financial health and reputation
of the borrower
_____ c) Loans backed by another bank
_____ d) Loans with tenors of less than one year
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3-16 TRADE FINANCE
ANSWER KEY
Question 1: When the bank extends credit to finance a trade transaction, the spread
charged by the bank reflects (select two):
b) the creditworthiness of the borrower.
c) the degree of risk assumed by the bank.
Question 2: The prime rate is:

d) the best rate charged by a bank on short-term loans to customers
with the highest credit ratings.
Question 3: Select two types of loans that may be given to customers that cannot
qualify for credit based on creditworthiness.
a) Loans that require possession of, or a title to, something of value
c) Loans backed by another bank
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TRADE FINANCE 3-17

(Continued)
Question 4: LIBOR is a rate which banks may use to:

_____ a) establish the acceptance discount rate.
_____ b) quote a floating-rate loan to a customer.
_____ c) set their fixed lending rates.
_____ d) determine interest charges for unsecured loans.
Question 5: “Import financing” means that the:

_____ a) seller needs financing to acquire and prepare goods for shipment.
_____ b) seller needs financing for the period between shipment of the
goods and receipt of payment from the buyer.
_____ c) buyer needs financing to meet the required payment for the
purchase of the imported goods.
_____ d) buyer needs financing to store purchased goods prior to their sale.
Question 6: When a buyer requires financing to meet the required payment under
a sight letter of credit, the transaction may be described as:
_____ a) pre-export financing.

_____ b) warehouse financing.
_____ c) export financing.
_____ d) import financing.
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3-18 TRADE FINANCE
ANSWER KEY
Question 4: LIBOR is a rate which banks may use to:

b) quote a floating-rate loan to a customer.
Question 5: “Import financing” means that the:

c) buyer needs financing to meet the required payment for the purchase
of the imported goods.
Question 6: When a buyer requires financing to meet the required payment under
a sight letter of credit, the transaction may be described as:
d) import financing.
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TRADE FINANCE 3-19

(Continued)
Question 7: Exporters with firm sales contracts may need pre-export financing
to provide:
_____ a) adequate working capital to prepare goods for shipment.

_____ b) a hedge against foreign exchange risk.
_____ c) warehouse facilities prior to delivering the goods.
_____ d) an extension of credit to the importer.
Question 8: Export financing:
_____ a) is supplier credit extended by the importer to the exporter.

_____ b) improves the exporter’s cash flow until payment is received from
the importer for goods that have been shipped.
_____ c) is obtained from the bank by the importer to fulfill the terms of a
documentary collection.
_____ d) can only be obtained by the exporter to finance an open account
transaction.
Question 9: Inventory financing may be needed by the:
_____ a) importer to increase its inventory.

_____ b) exporter to purchase inventory for the production of goods.
_____ c) importer who uses the goods to secure the loan.
_____ d) exporter to store goods until completion of the sale.
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3-20 TRADE FINANCE
ANSWER KEY
Question 7: Exporters with firm sales contracts may need pre-export financing
to provide:
a) adequate working capital to prepare goods for shipment.
Question 8: Export financing:
b) improves the exporter’s cash flow until payment is received

from the importer for goods that have been shipped.
Question 9: Inventory financing may be needed by the:
d) exporter to store goods until completion of the sale.
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TRADE FINANCE 3-21

(Continued)
Question 10: Transatlantic Imports is a Citibank customer and wants to pay for imported
goods 120 days from the shipment date. However, the exporter demands
payment at sight. What type of financing should Citibank provide?
_____ a) Import financing to the importer

_____ b) Pre-export financing to the importer
_____ c) Import financing to the exporter
_____ d) Pre-export financing to the exporter
Question 11: ABC Company, located in Korea, is a reliable producer and exporter of
silicon chips. Due to company finances, they are having difficulty in meeting
their commitment to provide Hi-Tec, Inc., a US importer, with 600,000 chips
within the next two months. What type of financing would
be the best solution for this situation?
_____ a) Pre-export Financing

_____ b) Import Financing
_____ c) Export Financing
_____ d) Inventory Financing
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3-22 TRADE FINANCE
ANSWER KEY
Question 10: Transatlantic Imports is a Citibank customer and wants to pay for imported
goods 120 days from the shipment date. However, the exporter demands
payment at sight. What type of financing should Citibank provide?
a) Import financing to the importer
Question 11: ABC Company, located in Korea, is a reliable producer and exporter of
silicon chips. Due to company finances, they are having difficulty in meeting
their commitment to provide Hi-Tec, Inc., a US importer, with 600,000 chips
within the next two months. What type of financing would
be the best solution for this situation?
a) Pre-export Financing
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TRADE FINANCE 3-23
TYPES OF EXPORT FINANCING
We have seen that trade financing may serve a variety of purposes. In

this section, we focus on export financing and examine several ways
such financing may be structured. Remember, export financing from
the exporter’s perspective is when the exporter (seller) needs
financing between shipment of goods and receipt of payment; from
the importer’s perspective, the importer (buyer) needs deferred
payment terms for the goods or services that an exporter (seller)
is providing. Export financing alternatives include:
n Commercial financing
n Export Credit Agency (ECA)-supported financing
n Private insurance-supported financing
Commercial Financing
Small-scale Commercial financing in export financing usually involves letters of

export contracts credit, bankers’ acceptances, and forfaiting. It is most appropriate
for financing small-scale export contracts with maturities usually
under one year. We have already covered letters of credit, so we
will now describe the use of bankers’acceptances and forfaiting
for export financing.
Recall, from Unit 2, that drafts may be drawn payable at “sight”

or at a predetermined future point in time (normally anywhere from
30 to 180 days after “sight”).
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3-24 TRADE FINANCE
Time Draft Suppose that an importer (buyer) requires a period of credit which
the exporter (seller) is prepared to grant. This gives the importer
time to sell some or all of the goods before having to pay. The
exporter draws a time draft or bill of exchange on the importer
with a usance period (a length of time allowed for payment). The
importer then “accepts” the bill of exchange and returns it to the
exporter.
Acceptance An acceptance, therefore, is a time draft (bill of exchange) that
represents a promise made by the buyer (drawee) to honor the
instrument at maturity date. The buyer writes “accepted” over
his/her signature. The act of acceptance is without recourse as it is
a commitment to pay at maturity. The party is accepting or agreeing
unconditionally to pay the time draft at a particular time and place.
Trade In a trade acceptance, the exporter (seller) of the goods draws a
acceptance time draft on the importer (buyer). It is accepted by the importer for
payment at a specified future date. The payment of the time draft is
not assured by the bank.
The seller may require a guarantee or an “aval” if a bank is to

cover the commercial risk. (This concept is discussed further in
the “Forfaiting” section — see page 3-29).
For instance, in the case of documentary collections, where the

exporter (seller) provides 180-day terms, the exporter draws a
180-day draft on the importer (buyer), payable to either the seller or
the collecting bank that represents the seller. A trade acceptance is
created when the importer (buyer) accepts the 180-day draft which
gives the buyer possession of the documents. The acceptor is the
buyer who has the obligation to pay.
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TRADE FINANCE 3-25
Banker’s Acceptance
Bank’s A banker’s acceptance is a short-term credit instrument that is

obligation often used in international trade. It is a time draft drawn by the
to pay
customer / obligor (e.g. an applicant of a letter of credit) on a bank
“and accepted by the bank” and is called the accepted draft. This
represents the bank’s obligation to pay another party (e.g. the
beneficiary of a letter of credit) a stated amount on a predetermined
future date. The creation of a banker’s acceptance is an extension of
credit by the bank to its obligor. The bank is responsible for paying
the face value of the acceptance at maturity even if the customer
goes out of business.
A banker’s acceptance is most commonly used in conjunction with

letters of credit and is a mechanism for financing short-term trade.
As with any extension of credit, the bank makes its decision based
on the customer’s credit history, current financial condition, and
risks involved. Since there is an active secondary market for bankers’
acceptances, the bank may subsequently sell the acceptances to an
investor in the secondary market.
Application of Bankers’Acceptances
The following example illustrates the use of a bankers’ acceptance for

export financing.
Example n A US exporter (seller) agrees to the terms of a sale of

goods to a foreign buyer which require that the importer
(buyer) open a letter of credit. The letter of credit is opened
by the foreign bank and is advised through a US bank.
n The US exporter (seller), the beneficiary of the letter of credit,

has offered 90-day financing to the importer (buyer). The
seller presents documents to the paying bank and draws a
draft that matures in 90 days. The value of the draft equals the
cost of the goods which includes the exporter’s estimate of an
interest rate for the 90-day period.
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n The paying bank accepts the draft and the draft becomes
a banker’s acceptance. The exporter (seller) owns the
banker’s acceptance.
n The exporter (seller) may hold the banker’s acceptance

and present it to the bank at maturity for payment, but, more
likely, it will discount it with the bank.
Acceptances are popular as short-term investments, and banks

normally keep them on their balance sheets (an active secondary
market exists, composed of investors and banks).
Use of the banker’s acceptance enables the exporter in the US to

take advantage of the generally lower cost of US financing; the cost
savings may be reflected in a lower purchase price for the buyer.
Pricing
Price Acceptance financing contains two cost elements:

components
1. Acceptance Commission Rate (spread)
When accepting a draft, a bank charges an acceptance

commission to compensate for its assumption of the credit risk
and to cover the administrative costs of the transaction. The
amount charged depends on the bank’s assessment of
the credit risk involved.
2. Acceptance Discount Rate (cost of funds)
When the bank discounts an acceptance, remitting funds to the

seller (drawer of the draft), it charges interest in the form of a
discount from the face value. This rate is the bank’s charge for
the cost of funds. The specific rate is determined by conditions
present in the money markets at the time of discount.
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All-in rates Acceptances are quoted on a discount basis, frequently as “all-in

rates” that mask the actual acceptance commission rate. (The all-in
rate is the acceptance commission rate plus the discount rate.)
Eligible and Ineligible Banker’s Acceptance
A banker’s acceptance, accepted by a bank in the US, may be either

eligible or ineligible for discount or purchase by a Federal Reserve
Bank. Although the Fed actually stopped discounting acceptances
in the late 1970s, the eligibility requirements remain important. The
accepting bank does not have to maintain reserves against eligible
bankers’ acceptances, even though they are kept on the bank’s
balance sheet, and there is an active secondary market.
Eligible To be “eligible,” the tenor of a banker’s acceptance cannot exceed
banker’s six months (180 days). The acceptance must be self-liquidating
acceptance
and there can be no other financing for the same transaction. The
merchandise must be in the “channels of trade,” which means that
the goods are being manufactured, packaged, shipped, received,
stored, or resold. An eligible banker’s acceptance must come from
one of three transactions:
n Import or export of goods between the US and

foreign countries and between foreign countries
n Domestic shipment of goods within the US
n Storage of marketable commodities in the US and/

or in foreign countries
Ineligible If a banker’s acceptance has not been created from one of the
banker’s eligible transactions, or if it involves a draft with a tenor of
acceptance
more than six months, it is considered an ineligible banker’s
acceptance. By accepting an ineligible draft, the bank is simply
extending a loan to its customer and must post reserves against it
since the acceptance is not backed by the Federal bank. When the
bank’s prime rate is high, the bank may use an ineligible banker’s
acceptance as a way to make a loan at a lower rate than the
bank’s prime rate.
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Both types of bankers’ acceptances are permissible and both are

freely negotiable. Because the accepting bank is not required to
post reserves against the eligible banker’s acceptance, it is more
appealing to banks (they can be more freely discounted in the
marketplace) and less expensive to the borrower (e.g. beneficiary).
When pre-export expenses related to manufacturing are financed,

bankers’ acceptances cannot be used to acquire raw materials and
cover manufacturing costs.
Risks
For the creation of the eligible banker’s acceptance transaction, there

are three major sources of risk for the bank:
n Legal and Regulatory Risks
n When the banker’s acceptance is initiated, the bank

must comply with US regulations; otherwise, the bank
may be exposed to fines, civil and criminal penalties,
and negative publicity.
n Credit Risk
n Operational Risks
When payment is made, the documents must be complete and

properly authenticated. When documents do not conform, the
bank is exposed to litigation and financial loss.
When the bank discounts the acceptance, the bank may be

exposed to financial loss if it uses the wrong rate or wrong
time period.
In addition to letters of credit and bankers’ acceptances, there is

a third option for the pure commercial financing of international
trade. Let’s now examine forfaiting.
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Forfaiting
Rights “Forfaiting” is a term that comes from the French word à forfait,
exchanged meaning to surrender or relinquish the rights to something. The
for discounted
exporter (seller) surrenders the right to any claim for payment on
cash payment
the goods delivered to an importer in return for a discounted cash
payment for these same goods from a forfaiting institution.
Primary market Forfaiting, therefore, is the purchase of debt instruments due to
mature in the future that originated from the provision of goods and
services, primarily export transactions. Their purchase is without
recourse to any previous holder of the instruments.
Forfaiting allows an exporter to offer extended terms to an importer

(buyer). The exporter receives a bill of exchange or promissory note
for the goods from the importer and then sells the note to a financial
agent (forfaiter or forfaiting company).
A bank, such as Citibank, may be the financial agent which

purchases from the exporter (seller) and may decide to:
n Hold the bill of exchange or promissory note, taking

the importer’s credit risk (may eliminate the need for
bank guarantee) and the importer’s country risk
n Resell through the forfait market
Secondary As soon as a forfaiter has purchased forfaited assets, it has made

Market an investment. The forfaiter may not wish to hold this asset until
its maturity and may, therefore, resell the note to an investor who
then becomes the forfaiter. Investors who buy / sell forfaited assets
in this way operate in the “secondary market.”
Guarantor Because the forfaiter is purchasing a debt instrument without
recourse to the seller, the forfaiter is bearing all the risks of non-
payment by the importer. If the importer’s financial strength is
inadequate and the importer does not have sufficient collateral to
pledge, the forfaiter will require that another corporation or bank
(guarantor) be chosen to guarantee payment to the forfaiter in the
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event of the importer’s nonpayment.
Before its sale in the primary and/or secondary markets, the

promissory note must be issued in an unconditional and negotiable
form that completely separates debt repayment from any contract
disputes between the buyer and the seller regarding performance
or quality of the goods sold.
Forfaiting Forfaiting can be used for short-term or medium-term credit.
applications The maturities range from six months to ten years, with periodic
installment payments for the goods and services sold usually
required by the forfaiters. While it can be arranged for smaller
transactions, forfaiting is usually done for transactions of more
than one million dollars.
In theory, the paper may be denominated in any currency. However,

currencies which are not freely convertible, and are restricted by
control regulations, are not attractive to investors.
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A step-by-step example of a forfait transaction is illustrated in

Figure 3.1, below.
Figure 3.1: Forfaiting flow
Transaction The steps are as follows:

steps
1. The exporter and importer agree on the deferred payment
terms and the interest rate to apply on the settlement of a
commercial contract.
2. The importer obtains a commitment from a bank to give

its “aval” (unconditional and irrevocable guarantee) on the
negotiable document (accepted draft / bill of exchange /
promissory note) which represents the obligation of the
importer.
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3. The importer informs the exporter of the name of the bank

which agreed to give its aval to the importer’s indebtedness.
4. The exporter proposes business to a forfaiter, and obtains

an offer from the forfaiter to buy the draft(s) or promissory
note(s) at the quoted discount rate based on yield to maturity
(YTM). Offers are generally firm and incorporate an option
period (for example, 30 days) to allow the exporter to fully
receive the documents to be discounted. Thus, the offer
contains:
n A discount rate based on the YTM
n The option fee (for example, 0.125% flat)
n The commitment fee (for example, 0.10% per

month) for the time from expiration of the
option period until delivery of the documents
5. The exporter confirms with the forfaiter his/her acceptance

of the offer and pays the option fee.
6. The exporter ships the goods.
7. The exporter draws a draft(s) on the importer and requests

its acceptance, together with the bank aval. Alternatively,
the exporter requests from the importer the promissory notes
in favor of the exporter, with the same bank’s aval.
8. As the exporter awaits the guaranteeing bank’s avalization,

as of the expiration of the option period, the exporter starts
paying the commitment fee to the forfaiter until delivery of the
documents.
9. The exporter delivers to the forfaiter the avalized bills

of exchange (accepted drafts) or promissory notes.
10. The forfaiter discounts them and pays the exporter.
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11. The bills of exchange or promissory notes are further

discounted and traded (partially or fully) in the secondary
market without recourse.
12. At maturity, the final holder(s) of the document(s) present

them to the importer and, if unpaid, to the guaranteeing bank
for payment of the full face value of the document(s) , plus
the interest mentioned thereon.
NOTE: An aval is an unconditional guarantee placed on each of the

indebtedness instruments, e.g. promissory note or bill of exchange.
By placing an “aval” on the instrument, the bank commits itself
unconditionally to pay should the maker or drawee default. In those
countries where an aval is not recognized by local law, the bank may
give a guarantee instead – usually on a separate document called a
“letter of guarantee.”
Example As an example of forfaiting, assume an emerging markets customer
(importer) wants six-year credit terms for a purchase totaling
US$6MM, to be delivered in four semiannual shipments. The
importer is sufficiently creditworthy to get a local bank to grant
one of the following:
n An unconditional bank guarantee to pay the

holder of the debt obligation (forfaiter)
n An aval on the exporter’s bill of exchange that

guarantees payment
The forfaiter and the emerging markets customer together

negotiate directly with the customer’s bank to determine which
debt instrument will be used. Next, the forfaiter discounts the debt
instrument and, since the amount of the discount will be known
in advance, it can be included in the selling price of the order.
When the exporter presents a complete set of documentation proving

that the shipment has left, the forfaiter pays the exporter 100 percent
of the selling price – less the discount if it was included in the selling
price. Such payment is made within two days of the presentation of
shipping documents.
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The forfaiter then collects against the letter of credit directly from the
emerging markets customer or from the customer’s bank.
When compared to bankers’ acceptance financing, forfaiting presents

several distinct advantages and disadvantages to the trading parties.
Advantages of Forfaiting
To the exporter The basic advantages of forfaiting to the exporter are the speed and
simplicity of the transaction. Additional advantages for the exporter
(seller) include:
n Exporter receives immediate cash
n Avoidance of credit and country risks
n Improved business liquidity, reduced bank borrowing,

and freedom to reinvest or use financial resources for
other purposes
n Relief from administration and collection problems
n Simplicity and ease of arranging documentation
To the importer The basic advantage of forfaiting to the importer (buyer) is also
the speed and simplicity of the transaction. In addition, forfaiting
provides the importer with a(n):
n Alternative form of financing
n Fixed interest-rate credit
n Increased and diversified borrowing capacity
n Rapid conclusion for a commercial contract
n Elimination of the administrative and legal costs

associated with credit loan agreements
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To the forfaiter The basic advantage to the forfaiter is that the transaction provides
a crisp, marketable instrument with a bank obligation.
Disadvantages of Forfaiting
To the exporter The disadvantages to the exporter are:
n Need to ensure that the importer obtains a guarantor

that is satisfactory to the forfaiter
n May have to absorb part of the discount from

commercial profit
To the importer The disadvantages to the importer are:
n Payment of a guarantee fee (higher costs) charged by the

guarantor (e.g. bank)
To the forfaiter The forfaiter also is disadvantaged in several ways. These include:
n Risk of adverse interest rate changes (interest rate risk)
n Credit risk on the actual obligor / guarantor and/or related

country risk
Required Documentation
As mentioned earlier, the documentation for a forfait is relatively

simple and quickly arranged. It consists of:
n A note or bill purchase agreement between the forfaiter

and the exporter covering the terms and conditions of
the purchase
n Bills of exchange (drafts) or promissory notes
n Letters of guarantee or aval
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n Signature confirmations
n Copies of exchange control approvals, if applicable
Summary
In this section, we examined the first of three export financing

alternatives: commercial financing, which usually involves letters of
credit, bankers’ acceptances, and forfaiting. We focused on bankers’
acceptances and forfaiting.
A trade acceptance is a time draft that has been accepted by the buyer
for payment to the beneficiary at maturity. The payment of
the time draft is not assured by a bank. A banker’s acceptance is
a time draft that has been accepted by the bank for payment to
the beneficiary at maturity. It is a short-term credit instrument
commonly used in international trade.
Forfaiting is a longer-term financing technique whereby the seller

receives a discounted payment for its goods in exchange for the
buyer’s promissory note. It allows the seller to offer extended
terms to the buyer without having to wait for payment.
Before continuing to the remaining two export financing alternatives

(ECA and private insurance-supported financing) in our discussion of
“Types of Export Financing,” please complete Progress Check 3.2 to
confirm your understanding.
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Question 1: Which trade financing product involves the purchase of a debt instrument
without recourse to the party from whom it was purchased?
_____ a) Forfaiting
_____ b) Extension of credit
_____ c) Bankers’ Acceptance
Question 2: Bankers’ Acceptances are:

_____ a) generally used as medium-term credit for capital goods with
maturities ranging from six months to ten years.
_____ b) usually used by borrowers from foreign countries because they
provide financing that is enforceable in the courts of the US and
their home countries.
_____ c) popular as short-term investments and, therefore, among the least
expensive short-term financing alternatives.
_____ d) short-term borrowings on demand that are used by customers when
they have a series of transactions to be financed over a period of time.
Question 3: When the bank accepts a time draft, it:

_____ a) may sell the acceptance to a third party investor.
_____ b) eliminates credit risk.
_____ c) is eligible to discount the acceptance with the Federal Bank.
_____ d) extends credit to its customer for six months or more.
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ANSWER KEY
Question 1: Which trade financing product involves the purchase of a debt instrument
without recourse to the party from whom it was purchased?
a) Forfaiting
Question 2: Bankers’ Acceptances are:
c) popular as short-term investments and, therefore, among the

least expensive short-term financing alternatives.
Question 3: When the bank accepts a time draft, it:
a) may sell the acceptance to a third party investor.
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TRADE FINANCE 3-39

(Continued)
Question 4: Select two criteria of an “eligible” banker’s acceptance.

_____ a) Tenor of at least six months
_____ b) Self-liquidating
_____ c) Minimum annualized return of 10%
_____ d) Transactions limited to five types
_____ e) Merchandise in the “channels of trade”
Question 5: Which trade product is usually quoted with an “all-in” rate?

_____ a) Extension of credit
_____ b) Trade acceptance
_____ c) Banker’s acceptance
_____ d) Forfaiting
Question 6: Forfaiting improves business liquidity by allowing the exporter to:
_____ a) offer extended payment terms to the buyer while receiving cash
immediately.
_____ b) take advantage of floating interest rate financing.
_____ c) avoid paying the acceptance commission and passing its costs on
to the buyer.
_____ d) receive an aval on the negotiable document.
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ANSWER KEY
Question 4: Select two criteria of an “eligible” banker’s acceptance.
b) Self-liquidating
e) Merchandise in the “channels of trade”
Question 5: Which trade product is usually quoted with an “all-in” rate?

c) Banker’s acceptance
Question 6: Forfaiting improves business liquidity by allowing the exporter to:
a) offer extended payment terms to the buyer while receiving cash

immediately.
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TYPES OF EXPORT FINANCING (Continued)
Export Credit Agency-Supported Financing
We have seen that the commercial financing of international

trade usually involves letters of credit, bankers’ acceptances,
and forfaiting. We now look at a second type of export financing
where governments, acting through their Export Credit Agencies
(ECAs) and through Multilateral Agencies (MLAs), also facilitate
international trade. They provide export financing both directly to
borrowers and indirectly through cooperation with commercial
banks.
The involvement of ECAs and, to a large extent MLAs, depends

on the:
n Types of risk of the importer’s country
n Nature and origin of the underlying exports and services
n Maturity of the financing required
n Acceptability of the borrower’s underlying credit structure
While ECA-supported financing is driven by the exporter’s country,

MLA-supported financing is handled at the importer’s country.
The MLA is a worldwide institution not associated with a local
government as in the case of ECAs. MLAs more often are involved
with project financing rather than export financing. We discuss MLAs
in greater detail later in this section.
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In Unit 1, we told you that ECA programs include guarantees,

insurance for country and/or credit risk, guaranteed payment to
commercial banks, and preferential fixed interest rate. We now
look at these characteristics in more detail.
ECA Guarantee and Insurance
Protection The ECAs offer protection to the lender (or exporter) against non-
against non- payment by the buyer in one of two forms of coverage – guarantees
repayment
and insurance. A guarantee typically implies 100 percent protection
by buyer
for the covered risks in an event of default.
Insurance implies that the probability of coverage is less than 100

percent, with the lender (insured party) remaining at risk for the
percentage not covered. Insurance is a contract between an insurer
and an insured under which each has obligations to the other. Upon
satisfaction by the insured of its obligations, including documenting
that a claimable event has occurred, the insurer will pay the claim.
Under either form of protection, the lender can choose to protect
itself against country risk only or against both country risk and buyer
non-payment (comprehensive cover).
Cash Payment Requirement
Minimum of ECAs require from prospective buyers a cash payment equivalent to

15% a minimum of 15% of the price of an export contract. This limits the
ECAs’ coverage to 85% of the export contract value.
Sourcing from Multiple Countries
National content For those export contracts involving the sourcing from multiple
requirements countries, the export contract value includes all imported goods
and services contracted by the buyer, regardless of the supplier’s
sourcing. In most cases, a country’s ECA supports only export
contract values of its own country’s goods and services.
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TRADE FINANCE 3-43
Local Costs Financing
Limited to Many overseas projects involve substantial in-country installation

15% of export or construction expenditures which must be provided by the exporter
contract value
as part of his/her contract. Sometimes, such expenditures involve
sourcing of construction services from the buyer’s country. These
expenditures may constitute a portion of the imported goods and
services eligible for export credit support. ECAs permit financing
of identified local costs in amounts not exceeding 15% of export
contract value. Only in such cases is ECA financing permitted to
cover the equivalent of 100% of the country’s export contract value.
Example For instance, suppose a US exporter is awarded a contract totaling
$120MM for supplying a turnkey power plant to China. The US
export contract value is $100MM and the $20MM balance of the
total contract value is for building part of the plant’s infrastructure.
We know that EXIMBANK covers up to 85% of the US export

contract value ($100MM) which, for this example, amounts to
$85MM. The $15MM balance of the export contract value not
covered by EXIMBANK has to be covered by the local bank(s)
in China. On the other hand, ECA covers part of the identified
local costs not exceeding 15% of the export contract value. In our
example, the ECA will cover $15MM out of the $20MM for the
local expenditures and the risks of the remaining $5MM have to be
assumed by commercial banks (local or international).
Funding Mechanisms
There are three major types of funding mechanisms for ECA-supported

export financing dealing with short-, medium-, or long-
term contracts. These are direct lending (co-financing), deposit /
relending, and interest make-up. We examine the role of commercial
banks in each funding mechanism.
Direct Lending – The ECA lends directly to the buyer (importer)

and, as a result, there are no financing earnings
(spread) opportunity for banks.
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Deposit / Relending – The ECA lends to the bank which, in turn,

re-lends to a borrower–buyer (importer).
This funding approach offers banks attractive
fixed interest-rate funds, but the ECA usually
limits the spread that the bank can add.
Interest Make-Up – The ECA provides compensation to lending

banks for the difference between market
rates of funding and the ECA’s concessional
terms for a specified export contract. The
lending bank and the borrower enter into an
agreement to finance the export contract at
a fixed interest rate over a time period. The
bank then enters into a separate agreement
with the ECA. The ECA compensates the bank
for the difference between its cost of funding
plus spread and the fixed interest
rate on the loan to the borrower.
For instance, if the fixed interest rate on

the loan to the borrower is 7.0 % and if the
bank’s price is 7.5% (LIBOR at 6.50% plus
a 1.0% spread), then the interest make-up
would be 0.5% (7.5% - 7.0%).
Interest Rates: Floating and Fixed
Interest rates Lenders, whether they are financial institutions or exporters

providing deferred payment terms of sale, charge the buyer interest
on the loan or deferred payment terms. For those financings covered
by an ECA guarantee or insurance, there is no restriction (floor or
ceiling) placed by the ECAs on the interest rate charged. The interest
rate will be a reflection of the risks (country only or comprehensive)
being covered by the ECA, the risks being assumed by the lender,
and the pricing quoted by the competition.
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Lender / borrower ECA-supported export credits can involve either a floating or a

agree on basis for fixed rate of interest. Whether the rate will be fixed or floating,
calculating rate
the basis for calculating the rate is agreed upon between the lender
and borrower as part of the negotiations between these two parties
before the financing mandate is awarded to the lender.
Floating Floating rates are adjusted periodically, usually semi-annually, on
interest rates the dates when repayment installments of the loan principal are due.
Most medium term floating rate loans use LIBOR as the base for
calculation of the rate, and the lender then adds a pre-agreed margin
(the spread) to the LIBOR rate to arrive at the “all-in” interest rate
paid by the borrower.
Fixed Fixed rates remain constant for the life of the financing. Financial
interest rates intermediaries usually make fixed rate financing available for very
large (greater than $50MM) financings. The rate, or the basis for
calculating the rate, is established between the lender and borrower
prior to any disbursements, usually prior to the loan documentation
process.
Commercial Most ECAs provide official fixed rate financing support. The ECAs
Interest have established guidelines among themselves on how this fixed
Reference
rate (called the Commercial Interest Reference Rate or CIRR
Rate (CIRR)
rate) will be calculated so that the ECAs do not get into pricing wars.
The CIRR rate used is typically the rate in effect at the time the
ECA approves the export transaction as eligible for its support. This
support may take the form of a direct fixed rate loan or an interest
make-up to financial intermediaries.
A direct fixed rate loan is one which the ECA makes directly to the
borrower without using a financial intermediary. For an interest
make-up, the ECA provides the financial intermediary with a
compensation for the difference between the CIRR rate (the rate
charged to the borrower by the lender) and the lender’s cost of funds
plus a small pre-agreed (with the ECA) spread. Under both the direct
loan and the interest make-up, the borrower is paying the CIRR rate.
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3-46 TRADE FINANCE
Risk-related All ECAs charge insurance premiums or guarantee fees to help

exposure fees offset future losses due to credit risk exposure. These fees may vary
with country, credit risk, and with the duration of the transaction.
Insurance Coverage
If the exporter or lender is not prepared to take the country risk and/or
credit risk, the exporter should apply for insurance coverage.
Insurance coverage, in turn, often determines the availability of
financing for the exporter.
For example, an ECA’s short-term program may provide insurance

which can be used to obtain financing for the export of consumer
goods, small manufactured items, spare parts, and raw materials.
The medium-term insurance program may facilitate the financing
of such capital goods and services as mining and refining equipment,
construction equipment, agricultural equipment, telecommunications,
computer equipment, and manufacturing equipment.
Types of ECAs offer coverage directly to a lender or to the exporter for certain
coverage commercial and credit risks.
Commercial / credit risk refers to a borrower’s ability to generate

sufficient local currency to purchase the necessary amounts of foreign
currency to repay the financing.
Extent of In most cases, the insurance applies to a maximum of 85% of the
coverage commercial contract. In certain cases, the percentage may be higher,
but it applies to the contract value less any required cash payment.
For instance, the US ECA medium and long-term programs require

the buyer to make a 15% cash payment. These programs cover up to
85% of the contract value for items that are 100% US content but no
less than 50%. The US ECA guarantees such items as US equipment,
financing and legal fees (US-sourced and included in the contract),
freight, insurance, and local costs (under certain conditions).
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Transaction Structures:
Buyer Credit and Supplier Credit
In a typical transaction structure, an ECA financing extends credit

to the importer either directly, through a Buyer Credit, or indirectly,
through a Supplier Credit.
Buyer’s Credit Financing
Exporter’s bank In buyer’s credit financing, the exporter’s bank (e.g. Citibank)
lends directly extends credit directly to a buyer (importer) of goods and services.
to importer
The credit may also be fully or partially guaranteed or insured by
an ECA. The cash payment (15%), if any, may be financed by the
exporter or a bank, or paid in cash by the importer.
The supplier (exporter) and the buyer (importer) agree on the

commercial terms. The bank and the buyer agree on the financing
terms. When the buyer receives the loan from the bank, the buyer
pays the supplier. This process is shown in Figure 3.2.
SELLING COUNTRY BUYING COUNTRY

Establish
commercial
Supplier terms of trade
1 Buyer
(Exporter)
5 (Importer)
Payment
Loan
4
agreement /
Establish financing
Applies for / receives financing 2
insurance policy terms
and / or preferential
Export Credit interest rate
3 Citibank
Agency
(EXIMBANK)
Figure 3.2: Buyer’s credit financing
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3-48 TRADE FINANCE
Supplier’s Credit Financing
Importer’s debt In supplier’s credit financing, the supplier (exporter) offers financing
instrument to the buyer (importer) by giving credit terms to the buyer. The
insured by ECA
supplier usually sells a receivable (e.g. promissory note or bill of
exchange) from an importer (buyer) to a bank for cash. An ECA
guarantees or insures a portion of the receivable. The cash payment
(15%), if any, may be financed by the exporter or a bank, or paid in
cash by the importer.
The step-by-step illustration of the process is presented in Figure 3.3.
SELLING COUNTRY BUYING COUNTRY
1
Supplier Promissory Buyer
(Exporter) note / bill of (Importer)
Sells note / bill and exchange
3 assigns insurance
Applies for / rights
2 receives
insurance Principal and
4 Payment 5 interest repaid
coverage
for note / bill at maturity
Export Credit Citibank

Agency
Figure 3.3: Supplier’s credit financing
1. Once the buyer and the supplier agree on the commercial terms,
the buyer issues promissory notes or bills of exchange in favor
of the supplier.
2. The supplier accepts these notes and seeks insurance coverage

from an ECA. The supplier is the original beneficiary of the
insurance policy or guarantee from the ECA.
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TRADE FINANCE 3-49
3. The supplier sells the notes to a local bank and assigns

the rights of the ECA coverage to the bank.
4. The supplier receives a discounted payment, and the

bank becomes the holder of the buyer’s obligation to pay.
5. The buyer repays principal and interest to the bank.
Exact terms and conditions offered by the ECAs frequently change.

Trade officers need to be updated continually on current programs,
policies, and rates offered by these agencies.
Organization In Figure 3.4, below, we summarize the characteristics of some of
for Economic the major export credit agencies. In this figure, we make reference
Cooperation
to the Organization for Economic Cooperation and Development
and
Development (OECD) which is the international organization of the industrialized,
(OECD) market-economy countries. At OECD, representatives from Member
countries meet to exchange information and harmonize policy with
a view to maximizing economic growth within Member countries
and assisting non-Member countries to develop more rapidly. As
of 1997, there were 29 Member countries.
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3-50 TRADE FINANCE
Country Export Credit Agency Type of Program Currency

Description Cover of Cover
Canada EDC – Export Development Insurance Buyer & Canadian Dollars &
Corporation Supplier Credit US Dollars
France COFACE – Compagnie Française Insurance Buyer & French Franc or main
d’Assurance pour de Commerce Supplier Credit OECD currencies
Exterieur
Germany HERMES – Hermes Insurance Buyer & DM Contracts
Ausfuhrgarantien undbuergschaften Supplier Credit denominated in US
dollars are also
insured
Italy SACE (Export Credit Agency) – Insurance Buyer & Italian Lira and main
Sezione Assicurazione Crediti alla Supplier Credit OECD currencies
Exportanzione
Interest
MEDIOCREDITO CENTRALE make-up
(Export Credit Funding Agency)
Japan J-EXIM – Export-Import Bank of Guarantee Buyer & Japanese Yen and
Japan Lending Supplier Credit main OECD
MITI – Ministry of International Trade currencies
Insurance
and Industry
Spain CESCE – Compania Española de Insurance Buyer & Pesetas and main
Seguros de Credito a la Exportacion Supplier Credit OECD currencies
Sweden EKN (Export Credit Guarantee Insurance Buyer & Swedish Kronor and
Agency) – Exportkreditnämnden Supplier Credit main OECD
EKX (Export Credit Funding currencies
Lending
Agency) – Swedish Exportkredit
United ECGD – Export Credits Guarantee Guarantee Buyer & British Pound and
Kingdom Department Supplier Credit main OECD
currencies
United EXIMBANK – Export-Import Bank Direct Loan Buyer & US Dollar and main
States Guarantee Supplier Credit OECD currencies
Insurance
Figure 3.4: Export Credit Agencies by country: Type of Cover,

Program, and Currency of Cover
Multilateral Agency (MLA)-Supported Financing
As you learned in Unit 1, indirect government aid is often associated

with MLA-supported financing. MLAs are more involved in project
financing than financing for the export of goods and services.
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TRADE FINANCE 3-51
Project financing Project financing implies that the providers of finance look initially
at the economics of a project such as projected cash flows, rather
than the traditional financial strengths of the borrowers. Such
projects are expected to generate sufficient cashflow to pay the
interest and repay the principal which originally supported the
project. Examples of suitable projects include power plants, mining,
and telecommunications installations.
Depending on the complexity and size of the project to be financed,

various sources of funding can be applied. Normally, several different
funding sources are required to complete the financial package. Many
MLAs operate on a complementary basis with export credit agencies
and commercial sources. The involvement of MLAs adds credibility
to a project, thereby facilitating the process of raising financing.
MLAs recognize the need to select projects that bring economic value
to the importer’s country. Improved project selection by MLAs is
regarded as an important policy step together with the introduction
of new measures in macroeconomics management in the countries
concerned.
Financing MLAs lend for periods of up to 20 years with grace periods of five
structure years and charge interest at a margin above their cost of funds.
MLAs rarely finance 100% of a project: approximately 50% is
a rough guideline for loans, equity, or guarantees.
Private Insurance-Supported Financing
Although ECAs insure many export transactions, the private sector

also plays a role in providing coverage for country and limited
commercial risks. We now look at this third type of export financing.
Private insurers primarily focus on short-term trade transactions

and are generally limited to terms of three years for medium-term
transactions. Some well-known insurers, which we describe in Unit 4,
include Lloyds of London and Citicorp International Trade
Indemnity (CITI).
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3-52 TRADE FINANCE
Private insurance coverage places no limitation on the national

content of products. Military or paramilitary goods are acceptable if
the trade transaction meets a bank’s credit policy approval. Insurance
policy exclusions exist to limit coverage.
Contract The predominant policy type is Contract Frustration which covers
Frustration for non-payment resulting from specific country risks. Coverage under
Export
the Contract Frustration entitles the exporter to receive payment in
Financing
the following instances:
n Coverage usually requires the bank to take some

percentage of the risk
n Can be used to cover pre- or export financing or

import financing
n Can cover loans or drafts purchased as well as letters

of credit
EXPORT FINANCE: STRUCTURING THE DEAL
The structure of export financing (commercial, ECA-supported,

or privately insured) ultimately will reflect the results of the credit
and country risk analysis processes. We now present an example
that illustrates how Citibank structures a deal that mitigates the risks
associated with the transaction while satisfying the financing needs
of the customer. (This example also introduces the concept of risk
transfer which we discuss in the next unit.)
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TRADE FINANCE 3-53
Example: Suppose a US exporter bids for the sale of $10 million of capital
Situation equipment to a buyer in a developing country. The exporter
recognizes that, as in many international bidding situations, the
terms of the accompanying financing proposal are a key factor in
the final bid selection. Since the exporter is unwilling to finance the
purchase for reasons of both liquidity and credit exposure, it turns
to Citibank to provide a complete financing package.
Risk analysis In this case, financing of the overseas buyer represents medium-
or long-term commercial and country risk. In an attempt to reduce
or eliminate these risks, Citibank may:
n Provide a buyer’s credit and cover portions of the risk

through insurance or ECA guarantees which then
make the asset more attractive for Citibank to retain
n Purchase the draft or promissory note from the exporter

and sell it through the forfaiting market at a discount
that reflects the current market assessment of the
underlying risk
n Provide some combination of the above two options
Risk coverage options, however, often leave residual risks which may
include:
n Shortfalls of principal and/or interest coverage in

various insurance and guarantee programs
n Non-coverage of principal and interest for the 15%

of the contract value which is usually required as a
downpayment
n Possible exporter retention / recourse
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3-54 TRADE FINANCE
Option One — Buyer’s Credit Combined with

Insurance
or ECA Guarantee
Assumption Citibank’s in-country branch will take the commercial risk of the
buyer and/or allocate cross-border facilities for a portion of the
contract value / purchase price. The branch, however, wants to
leverage its limited cross-border availability.
Solution Citibank obtains a guarantee from the Export-Import Bank of the
United States (EXIMBANK) covering 100% of the country and
commercial risk of non-payment on 85% of the contract value of
the equipment. The buyer, however, requires financing for the full
purchase price. Citibank’s ability to allocate cross-border exposure,
as well as commercial risk to cover the 15% down payment, gives
the US exporter a competitive advantage in its bid to supply
equipment to the buyer. If the branch is unable to allocate 100%
of the cross-border exposure, but can approve the commercial risk,
Citibank may cover the 15% down payment portion with CITI
insurance.
Option Two — Forfait Market
Assumption Citibank’s in-country branch is unable to assume the commercial

risk and is unwilling to make a cross-border allocation available.
Solution After combining: (a) an EXIMBANK guarantee for the commercial
and country risk that covers 85% of the contract value, with (b) local
bank guarantee covering the 15% downpayment, Citibank works
with a forfaiter to sell the combined EXIMBANK and “clean-risk”
asset through established distribution channels. Funds paid to the
exporter may be discounted based on investor-required returns and
the nominal interest rate on the notes.
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TRADE FINANCE 3-55
Frequently, exporters will increase the contract price to the buyer to

compensate for receiving any discounted proceeds. If, however, the
returns required by investors make the all-in cost of purchasing the
equipment too expensive for the buyer, the exporter may be willing to
subsidize this return or retain a nominal risk exposure in order to
secure the commercial contract.
Summary
In Unit 2, we discussed payment options and the documents needed

for international trade transactions. In the “Commercial Financing”
section of this unit, we examined two trade financing products —
banker’s acceptance and forfaiting. Then, in this section, we looked at
the specific structures available for export financing through ECAs,
MLAs, and private insurers. All of these banking activities often
require the cooperation of more than one bank.
In the next section, we further describe how banks cooperate to

provide trade financing to their customers. We examine the unique
working relationship among banks as well as three trade products that
require a correspondent banking relationship.
CORRESPONDENT BANKING
Service the While banking is a highly competitive industry, members of the

needs of global banking community are active customers of one another and often
customers
assist each other with different aspects of their business. If a bank
does not have branches in countries where its customers conduct
business, it arranges with banks in those countries to service the
foreign needs of its customers.
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3-56 TRADE FINANCE
Relationship Among Banks
A bank that performs banking services for another bank is known as

a correspondent bank. Services performed by correspondent banks
(including the transfer of funds, trade transactions, financing, and
perhaps an account relationship) provide the foundation for
international banking.
Banks initiating a correspondent relationship must agree to the

terms and conditions that will apply to transactions conducted
between them. The banks must exchange their signature books and
test keys in order to validate the contents of future communications.
(Signature books are used to verify customers’ signatures. Test keys
are used to establish the authenticity of instructions from bank to
bank. They generally consist of tables of numbers that are used to
indicate date, currency, amount, and other information.)
There are different ways a bank can provide worldwide services

for its customers. Sometimes international banks seek local banks to
meet their local business needs. Local banks look to the
international banks to provide coverage for their offshore needs.
Let’s look at some of the products that require a correspondent

banking relationship.
Products
Citibank has developed three products to use with correspondent

banks who have the capacity to approve country risk, and to some
extent, commercial risk, but lack an origination capability. Each
product requires working out an agreement between Citibank and the
correspondent bank.
The three products are:
n Letter of credit confirmation
n Nonsovereign funding
n Participations
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TRADE FINANCE 3-57
Let’s examine Citibank’s role in each of these products.
Letter of Credit Confirmation
Standard clause Citibank has a standard clause which is a pre-agreement between

Citibank and the confirming bank abroad. It addresses the issues of
country and commercial obligation in letters of credit opened by any
of its branches worldwide. The clause states that the obligations of
the Citibank branch will be performed under the regulations of the
country in which it is located, and the correspondent bank cannot
go against Citibank NY for the fulfillment of such obligations. The
clause allows the Citibank branch to operate as a typical local
private bank in the country. The wording of the clause cannot be
amended without prior legal counsel and country risk approvals that
come from the Head Office. The clause does not apply when the
correspondent bank is another Citibank branch.
Nonsovereign Funding
While correspondent banks may be prepared to take the country

risk, they may be unable to cover the specific commercial risk of the
borrowers. Citibank has developed a product to address this concern.
There are two methods for nonsovereign funding.
1. In Figure 3.5, the Citibank branch borrows from an

(offshore) correspondent bank and lends to a local importer
or exporter (borrower). The branch issues a financing
agreement with a disbursement request. The borrower signs a
promissory note in favor of the local branch. Assets and
liabilities are registered on the local books.
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3-58 TRADE FINANCE
(Offshore) Correspondent
Bank
Country A
Country B Borrows
Citibank Lends Importer /

Branch Exporter
(Borrower)
Signs promissory note
Figure 3.5: Transaction recorded on the local books
2. In Figure 3.6, the Citibank branch uses an offshore booking

center, such as the IBF, to book its import /
export financings. The correspondent bank deposits
the funds in the offshore booking center account and
acknowledges that the funds will be lent directly to the
importer / exporter. There is a disbursement request and
a promissory note signed by the obligor (borrower) to the
offshore booking center that is acting as the lender. With
this method, all entries are done at the offshore unit level.
Because the local Citibank branch is not legally involved in
the transaction, the transaction is not recorded on the
local books.
Correspondent Deposits
Bank
OFFSHORE
Booking Center
Signs
Country A Lends promissory
note
Country B
Importer /
Citibank
Exporter
Branch
(Borrower)
Figure 3.6: Transaction not recorded on the local books
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TRADE FINANCE 3-59
Nonsovereign For both methods, the correspondent bank assumes: (1) the country
funding risks risk of the country of the Citibank branch or the borrower and (2)
the Citibank N.A. commercial risk.
A copy of the standard financing agreements, and further details on

these procedures, may be obtained from the product specialists or
the managers involved with country risk.
Participations
Silent / Correspondent banks may be prepared to take a certain percentage

nonsilent of Citibank’s exposure to the country and commercial risk of the
borrower. The participation may be silent if the borrower has not
been informed of the action. If the lender informs the borrower that
the correspondent bank is taking a percentage of the exposure, then
the participation is nonsilent or open.
The difference between a participation and a discount, sale, or forfait

finance of the note is that, with participation, the branch remains the
original lender; however, the amount of exposure is reduced. Even if
the correspondent bank’s participation is 100%, the lender remains
the same and all communications and negotiations are done with the
original lender (branch).
The participation may include a:
n Percentage of country risk (political, convertibility,

and transfer)
n Percentage of commercial risk
n Combination of both risks
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3-60 TRADE FINANCE
There is an alternative that applies only to country exposure. The

correspondent bank agrees to pay the full amount of the obligation
at its maturity only if the lender (Citibank) cannot collect because
of a country risk event. In this situation, the document signed is an
“unfunded participation agreement” that operates like an insurance
policy. The “insured party” pays a fee to the correspondent for such
coverage and funds the lending alone. It is very important to analyze
the risk of the correspondent bank. Citibank has defined that only
“AA” correspondents may be used for this alternative and a credit
approval must be received from the correspondent bank’s Citibank
credit control unit.
UNIT SUMMARY
In the beginning of this unit, you learned important factors on which

the Bank bases decisions to extend credit to customers, as well as the
types of rates, terms, and conditions that may be applied to a credit
extension. We then examined four purposes for trade financing.
Next, you were introduced to two trade financing products —

banker’s acceptance and forfaiting. We also discussed the
relationships that banks maintain with other banks, with ECAs, MLAs,
and with private insurance providers to facilitate export financing and
other international trade transactions.
Depending on the risks involved and the nature of the transaction,

banks may require the support of ECAs in the form of insurance,
subsidies, and/or guarantees for buyers’ or suppliers’ credit financing.
ECAs provide deposit / relending, discounting, and interest rate make-
up programs to commercial banks, as well as
lend directly to importers and exporters.
MLA financing is often associated with long-term financing for

projects that bring economic value to the importer’s country.
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TRADE FINANCE 3-61
Private insurance often covers the commercial and country risks for
export financing transactions which are not insured by ECAs, MLAs,
or other government entities.
Correspondent banking is a relationship among banks that is often

required for international trade transactions. Three trade products that
involve correspondent banking were identified: 1) letter of credit
confirmation, 2) nonsovereign funding, and 3) participations.
You have completed Unit 3: Trade Finance. Please complete Progress Check 3.3 to test
your understanding of the concepts and check your answers with the Answer Key. If you
answer any questions incorrectly, please reread the corresponding text to clarify your
understanding and then continue to Unit 4: Risk and Compliance.
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TRADE FINANCE 3-63
Question 1: Place a T in front of the statements which are true and an F in front of the
statements which are false.
_____ Direct extensions of credit to exporters are granted only by importers.
_____ A small exporter’s best option for securing short-term pre-export financing
is a commercial lender.
_____ Bankers’ acceptances are the instruments used by suppliers to offer
ECA-supported financing to buyers.
_____ In a buyer’s credit financing, Citibank lends directly to the buyer.
_____ Commercial banks may receive interest-rate subsidies from export credit
agencies for specific export contracts.
_____ In a buyer’s credit financing, the buyer is assigned the rights to the ECA’s
insurance policy.
_____ Export credit agencies compensate commercial banks for preferential
fixed rate financings for certain export contracts.
_____ A country’s export credit agency may focus on short-, medium-, or long-
term contracts to promote the exporting sector of its country.
_____ Multilateral agencies focus on short-term contracts that promote the
exporting sector of developed economies.
Question 2: A US exporter provides financing, insured by EXIMBANK, to an importer in

a Latin American country. The exporter sells the buyer’s promissory
note and assigns the insurance policy rights to Citibank in exchange for
immediate payment. The buyer repays the principal and interest to:
_____ a) the supplier.
_____ b) EXIMBANK.
_____ c) Citibank.
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3-64 TRADE FINANCE
ANSWER KEY
Question 1: Place a T in front of the statements which are true and an F in front of the
statements which are false.
F Direct extensions of credit to exporters are granted only by importers.

T A small exporter’s best option for securing short-term pre-export financing
is a commercial lender.
F Banker’s acceptances are the instruments used by suppliers to offer ECA-
supported financing to buyers.
T In a buyer’s credit financing, Citibank lends directly to the buyer.
T Commercial banks may receive interest-rate subsidies from export credit
agencies for specific export contracts.
F In a buyer’s credit financing, the buyer is assigned the rights to the ECA’s
insurance policy.
T Export credit agencies compensate commercial banks for preferential
fixed rate financings for certain export contracts.
T A country’s export credit agency may focus on short-, medium-, or long-
term contracts to promote the exporting sector of its country.
F Multilateral agencies focus on short-term contracts that promote the
exporting sector of developed economies.
Question 2: A US exporter provides financing, insured by EXIMBANK, to an importer in

a Latin American country. The exporter sells the buyer’s promissory
note and assigns the insurance policy rights to Citibank in exchange for
immediate payment. The buyer repays the principal and interest to:
c) Citibank.
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TRADE FINANCE 3-65

(Continued)
Question 3: In a buyer’s credit financing, the financing terms are negotiated by the:
_____ a) buyer and seller.

_____ b) buyer, buyer’s bank, and MLA.
_____ c) buyer and buyer’s bank.
_____ d) buyer and ECA.
Question 4: Export Financing for a USD 250,000 sale of US computer parts to an

importer in a developing country is most likely to involve a(n): (Select
all that apply).
_____ a) buyer’s credit financing.

_____ b) EXIMBANK insurance.
_____ c) line of credit from Lloyds of London.
_____ d) discounted purchase by a forfaiter of a bill of exchange drawn on
the exporter, due to mature in 30 days.
_____ e) banker’s acceptance.
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3-66 TRADE FINANCE
ANSWER KEY
Question 3: In a buyer’s credit financing, the financing terms are negotiated by the:
c) buyer and buyer’s bank.
Question 4: Export Financing for a USD 250,000 sale of US computer parts to an

importer in a developing country is most likely to involve a(n): (Select
all that apply.)
a) buyer’s credit financing.
b) EXIMBANK insurance.
e) banker’s acceptance
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TRADE FINANCE 3-67

(Continued)
Question 5: In a trade transaction that involves payment by confirmed letter of credit,

the issuing bank, confirming bank, and paying bank are most likely to be:
_____ a) insured by an export credit agency.

_____ b) correspondent banks.
_____ c) discounting trade receivables with EXIMBANK.
_____ d) sharing a percentage of the acceptance commission rate.
Question 6: ECAs offer interest rate make-ups to facilitate import financing by:
_____ a) compensating lending banks for the difference between market

floating interest rates and preferential fixed interest rates.
_____ b) allowing banks to sell promissory notes to an ECA at an appropriate
discount rate.
_____ c) providing a pool of attractive fixed-rate funds.
_____ d) guaranteeing the debt instrument(s) of the borrower.
Question 7: Match the name of the export credit agency with the country it represents.
(A country may be represented by one or more agencies.)
_____J-EXIM a) Italy
_____ECGD b) United States
_____COFACE c) Germany
_____SACE d) Japan
_____EXIMBANK e) United Kingdom
_____HERMES f) France
_____MITI
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3-68 TRADE FINANCE
ANSWER KEY
Question 5: In a trade transaction that involves payment by confirmed letter of credit,

the issuing bank, confirming bank, and paying bank are most likely to be:
b) correspondent banks.
Question 6: ECAs offer interest rate make-ups to facilitate import financing by:
a) compensating lending banks for the difference between market

floating interest rates and preferential fixed interest rates.
Question 7: Match the name of the export credit agency with the country it represents.
(A country may be represented by one or more agencies.)
d J-EXIM a) Italy
e ECGD b) United States
f COFACE c) Germany
a SACE d) Japan
b EXIMBANK e) United Kingdom
c HERMES f) France
d MITI
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TRADE FINANCE 3-69

(Continued)
Question 8: The correspondent banking system consists of:
_____ a) local banks that provide funding to each other.

_____ b) banks that provide guarantees and assume risks for their branches in
other countries.
_____ c) banks that perform services for other banks.
_____ d) on-line test keys that are used to verify customers’ signatures.
Question 9: Place an X in front of the products that are commonly used in correspondent
banking.
______Confirmation of letters of credit

______Open account
______Participations
______Nonsovereign funding
______Forfaiting
______Cash in advance transaction
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3-70 TRADE FINANCE
ANSWER KEY
Question 8: The correspondent banking system consists of:

c) banks that perform services for other banks.
Question 9: Place an X in front of the products that are commonly used in correspondent
banking.
X Confirmation of letters of credit

Open account
X Participations
X Nonsovereign funding
Forfaiting
Cash in advance transaction
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Unit 4
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UNIT 4: RISK AND COMPLIANCE
INTRODUCTION
Two particularly important considerations in international trade are the inherent risks in
this type of business and compliance with international rules, regulations, and laws. In
this unit, we identify the different risks that affect trade transactions, describe how
Citibank manages risk, and present the US rules, regulations, and laws requiring
compliance. Insurance programs that provide protection from the risks inherent in
international trade also are explained. The informed banker understands these elements,
how they affect international trade, and how to provide the safest and most appropriate
trade products to the customer.
UNIT OBJECTIVES
Upon completing Unit 4, you will be able to:
n Identify the risks for Citibank in trade transactions
n Recognize methods that Citibank uses to manage and transfer risk
n Recognize legal and regulatory obligations to which Citibank

must conform
n Understand the application of US sanctions, US anti-boycott

regulations, US export controls, and anti-money laundering
regulations
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4-2 RISK AND COMPLIANCE
RISKS FOR THE BANK
When trade is conducted between countries, a range of risks can

affect the success of the transaction. For example, changes in
economic or political conditions may affect the repayment of a loan.
In Units 2 and 3, we mentioned some of the risks associated with
trade services and trade finance. In this section, we will define, in
more detail, the credit, country, and other risks associated with
international trade (Figure 4.1).
CREDIT COUNTRY OTHER

RISK RISK* RISK
Lending Political Image
Convertibility Product
Direct
Operational /
Transfer
Contingent Systems
Legal and
Regulatory
Counterparty
Documentation
Presettlement
Performance
Settlement
Figure 4.1: Categories of trade-related risk
* NOTE: According to the Citicorp Core Credit Policy (C.C.C.P.) (revised June,
1997), Convertibility Risk and Transfer Risk are both known as Cross-
Border Risk.
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RISK AND COMPLIANCE 4-3
Credit Risk
Customer- Credit risk (also known as commercial risk) is a customer-related risk

related risk that reflects the customer’s ability to fulfill all obligations to the Bank.
(An obligation is the responsibility to pay a sum of money or perform
some act when due.) The possibility that a borrower may be unable
to repay a loan on time or in full, resulting in a financial loss for the
Bank, constitutes a credit risk. Credit risk for the Bank falls into two
categories: lending and counterparty.
Lending Risk
Lending risk involves extensions of credit and/or credit-sensitive

products (loans and overdrafts) where the Bank takes the full risk for
the entire life of the transaction. The two types of lending risk are
direct and contingent.
Not settled Direct lending risk is the possibility that customer obligations will
on time not be settled on time. Direct lending risk occurs in products such as
loans, overdrafts, credit cards, and residential mortgages. One trade
product that incurs direct lending risk is bankers’ acceptances. The
risk exists for the entire life of the transaction.
Potential Contingent lending risk is the possibility that potential customer
obligations obligations will become actual obligations and will not be settled
become actual
on time. Contingent lending risk occurs in such products as letters
obligations
of credit and confirmations of letters of credit.
Counterparty Risk
A counterparty is a customer with whom the Bank has a contract to

simultaneously pay agreed values at a stated future date. The risk
that a counterparty may default occurs either before the settlement
date or at maturity of the contract.
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Default before Presettlement risk (PSR) is the risk that a counterparty with whom
settlement date the Bank trades may default on a contractual obligation to the Bank
before the settlement date of the contract. Two conditions are
required for the Bank to recognize a loss on a contract:
n Counterparty defaults (or declares bankruptcy)
n Contract has positive market value to the Bank
Presettlement risk is measured in terms of the potential replacement

cost — the potential economic consequences to the Bank — if a
defaulted contract has to be replaced.
Default on Settlement risk occurs on the maturity date when the Bank
settlement date simultaneously exchanges funds with a counterparty but cannot verify
that payment has been received until after the Bank’s side
of the transaction has been delivered.
In today’s international banking environment, the different time

zones between countries make it difficult to achieve a simultaneous
exchange between counterparties. If the Bank delivers its side of
the transaction, but does not receive delivery, it is exposed to direct
lending risk. In this situation, at least 100% of the principal is at
risk. The risk may be larger than 100% if there has been an adverse
price fluctuation for the Bank between the contract price and the
market price.
Country (Political and Cross-Border) Risk
In addition to customer-related credit risk, the particular country /

countries involved in an international trade transaction present risks
to the Bank.
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Political or Country risk is the possibility that the country in which the Bank
economic has business dealings may experience internal instability that
instability
reduces the offshore lender’s ability to collect in a timely manner.
Economic problems, political disturbances, or sovereign actions
within a country may make it impossible to get money or physical
assets out of that country. In some cases, it may become impossible
to convert local currency into a foreign currency. Country risk
includes political (sovereign) and cross-border (transfer and
convertibility) risk.
Political (Sovereign) Risk
Government Political (sovereign) risk is the possibility that the actions of a

actions or sovereign government (e.g., confiscation, expropriation or
independent
nationalization) or independent events (e.g., wars, riots, civil
events
disturbances) affect the ability of customers in that country to meet
their obligations to Citibank. Political risks are most significant in
transactions between a developed and an emerging-market country.
Transfer Risk
Inability to move Transfer risk exists in any transaction in which the borrower may be
funds unable, due to legal or other barriers, to transfer funds in the foreign
currency of payment to the place of payment when its obligation in
that currency matures.
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Convertibility Risk
Inability to Convertibility risk exists in any transaction in which legal or

exchange local regulatory barriers may prevent the borrower from converting his/
currency for
her local currency into the foreign currency required for payment
foreign currency
when the obligation in that currency matures. Convertibility risk
is inherent in any transaction that requires a flow of funds through
an exchange control barrier such as a country’s central bank.
This risk does not refer to devaluation of currency; rather, it reflects

the risk that the local currency will be inconvertible. Less-developed
countries usually are short of hard currencies. Therefore, an importer
may experience delays or an inability to convert the local currency to
the currency of the exporter for payment.
Example For example, let’s say that Egypt has accumulated French Francs
locally as a result of a prior trade transaction and wants to use
these funds to pay a multinational construction company for a
local construction project. Although the deal is denominated in
French Francs, a liquid currency which can be hedged, an Egyptian
bank involved in the transaction runs the risk associated with its
responsibility for getting the money out of Egypt. (The Egyptian
government may create a transfer risk situation if the government
prohibits the transfer of French Francs out of the country.)
Note that when an overseas branch of Citibank does business in

that country, there is no convertibility risk if the trade finance is
funded locally (e.g., use of hard currency from local deposits).
There would have been cross-border risk if the transaction had been
funded offshore (e.g., a loan from an International Banking Facility
to the branch).
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Other Risks
Credit and country risk are the two primary risks the Bank deals
with in international trade transactions. Other risks that must be
considered include image, product, operational / systems, legal and
regulatory, documentation, and performance risk.
Image Risk
Damage to Image risk is the possibility that some activity of the Bank or one
the Bank’s of its representatives damages the reputation of Citibank. One way
reputation
to protect the Bank is to maintain confidentiality at all times! In
addition, Citibank avoids financing products or services, such as
medicines and weapons, that may damage the Bank’s reputation.
Trade products that may produce image risk include letters of credit,
bankers’ acceptances, documentary collections, and bank-to-bank
reimbursements.
Bank-to-bank reimbursement is a trade product that is used when

the letter of credit transaction between the applicant and beneficiary
from different countries is denominated in a third-country currency,
usually US dollars. The reimbursing bank pays the advising /
negotiating bank in the currency stated in the letter of credit and
based on the reimbursement authorization issued by the issuing /
opening bank. The reimbursing bank charges a fixed fee to either
the issuing / opening bank or the beneficiary and represents a
valuable source of income for Citibank.
Product Risk
Faulty or Product risk is the risk that the structure of a certain trade product or
inadequate service is inadequate or faulty. Letters of credit, bankers’ acceptances,
trade product
documentary collections, and bank-to-bank reimbursements are trade
or service
products that have this risk. Guidelines and quality standards for
handling trade transactions help alleviate product risk.
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Operational / Systems Risk
Failure of Operational / systems risk refers to risks associated with the

internal / functional aspects of the products. This risk is high in trade
external
transactions due to reliance on the manual examination of documents
processing
systems and bills and the use of technology.
Example Operational / systems risk may be internal or external to the Bank.
For instance, in a money transfer system there is a risk associated
with an external system. When the Bank transfers funds by wire,
it may use private international communications systems such as
the Society for Worldwide International Financial
Telecommunications (SWIFT). There is always a risk that a
disruption of services may prevent or delay the transfer.
Legal and Regulatory Risk
Noncompliance Many legal and regulatory factors affect trade transactions. These
with regulations include foreign currency laws, local legal lending limits, US
sanctions, and US anti-boycott regulations and taxes. (We look
at some of these compliance issues later in this unit.) When a
transaction does not comply with all applicable laws and regulations,
the Bank may face civil, criminal, and administrative proceedings.
Trade products that carry legal and regulatory risk include: letters of
credit, bankers’ acceptances, documentary collections, and bank-to-
bank reimbursements.
Documentation Risk
Incorrect or Written instruments such as legal forms, receipts, and applications

unenforceable are required to enforce the Bank’s rights under contracts or
documentation
transactions. Documentation risk is the possibility that these
instruments are incorrect, incomplete, or unenforceable.
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Performance Risk
Failure of Performance risk is the possibility that an exporter may fail to

exporter to perform under the contract established with the importer. For
perform
example, if an exporter does not deliver critical parts or sends
unacceptable parts, the importing manufacturer may be unable to
produce his or her final product. The exporter’s performance failure
affects the importer’s ability to generate cash from the sale of goods
and repay his or her obligation to Citibank.
Risks in a Trade Finance Transaction
You have read about the risks associated with trade transactions. As
you continue with the following example of a simple trade finance
transaction, try to identify some of the risks Citibank will incur.
Example An exporter in Italy receives an advance payment of US $7MM from
Citibank, New York, for goods that will be shipped to a US importer
beginning in nine months. The US importer agrees to pay the
principal amount in US dollars to Citibank, NY upon receipt of the
shipments. The exporter agrees to pay the interest by converting
Italian Lira into US dollars through the local Citibank branch, which
will remit the interest payments to Citibank, NY.
Shipments to the importer begin in nine months and take place over
a period of two months. For each shipment received, the importer
has thirty days to remit the corresponding payment to Citibank, NY.
In the meantime, the exporter pays Citibank, NY, 10% per annum
interest on the balance due. This rate is a function of the risks
associated with the transaction and the cost of mitigating the risks.
For Citibank, the risks associated with this transaction are:
n Credit Risk: Risk that the exporter is unable to produce the

goods or pay the interest on the balance due and the risk that
the importer refuses or is unable to pay the principal amount.
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n Political (Sovereign) Risk: Risk that the exporter is

unable to export due to local government actions such as
confiscation, expropriation, or nationalization
n Convertibility Risk: Risk that the exporter is unable to

convert local currency to US dollars to pay interest on the
balance due
n Legal and Regulatory Risk: Risk that the importer is

unable to clear goods through customs for import due to
quotas or failed Food and Drug Administration (FDA)
inspection
RISK MANAGEMENT
You have seen that international business primarily involves credit

and country risks. Assessing and undertaking commercial risk is
the traditional role of banks and, as you learned in Unit 3,
banks have established standard practices for determining the
creditworthiness of customers. Banks that finance international
trade also must analyze the country risk of the obligor’s country or
countries involved in the transaction. In this section, we will look
at the process Citibank uses to establish risk allocations for target
market countries and describe some of the techniques Citibank uses
to manage this risk.
Allocating Cross-Border Risk
Control unit Citibank manages country risk through its branch network. The
Country Senior Credit Officer (CSCO) and the branch in a country
represent the control unit for that country. If there is no branch in a
particular country, the nearest division office becomes the control
unit. For example, Citibank Nairobi serves as the control unit for
Kenya and for the other English-speaking countries in the region
where there is no branch office.
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Cross-border The CSCO is responsible for assessing the political and economic
allocations risk of the particular country or region. Based on that assessment,
for country /
the CSCO proposes to the Citibank Head Office a specific cross-
region
border allocation for the country. The CSCO’s proposal includes a:
n Suggested limit on the total amount of cross-border

business which Citibank should do with that country
n Description of the recommended type of cross-border business

For example, the CSCO may recommend that the Bank confirm
letters of credit from a country, but should refrain
from any direct lending to the country.
n Recommendation for tenors attached to each type of business
Control unit Regardless of where a transaction originates, Citibank limits the

manages limit amount and type of business that can be done cross border with
any particular country. The local control unit in each country
manages that limit. For example, if a Relationship Manager in New
York has a customer who wants payment under a confirmed letter of
credit for exports to Argentina, the control unit in Buenos Aires must
approve the transaction. This approval process is called allocating
cross border.
A comparison with a standard line of credit for companies or

individuals may help you understand how this allocation is managed.
A company or individual has pre-established credit limits based
on its financial condition. Once a company has reached its pre-
established credit limits, no new transactions are possible until some
portion of the line has been repaid. In the case of country risk, the
limits are based on an analysis of political and economic conditions
of a country, rather than on the balance sheet fundamentals of a
company or individual.
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Business Citibank’s ability to generate new business worldwide often strains

restricted these cross-border limits. The Bank potentially can originate more
by limits
transactions with companies wanting to do business in countries
with cross-border limits than it is capable of serving based on risk
allocation alone.
Example For example, the control unit in Brazil set a total cross-border
limit of $600 million for 1995. This means that companies outside
Brazil who wanted Citibank to participate in their Brazilian trade
transaction would have been unable to use Citibank if the total
of the Brazilian deals on Citibank’s books worldwide equaled
$600 million.
This tension between Citibank’s ability to generate new business

and restrictions resulting from cross-border limits has led to the
development of risk transferring techniques. In the next section,
we define and illustrate the risk transfer process.
RISK TRANSFER
Shift of country Risk transfer essentially involves finding ways to shift the country
and/or (political and cross-border) and/or commercial risks of international
commercial
trade. The goals of risk transfer are to (1) help our customers do
risks
business in countries which present unique opportunities and
specialized potential problems and (2) earn significant fees without
exceeding Citibank’s own risk constraints.
Risk Transfer Through Syndication
Example: To help you understand the risk transfer process, let’s look at an
syndication example that illustrates how Citibank uses syndication to handle
a deal that exceeds the cross-border limit for a country.
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A British company wants to export tea to Egypt. Due to the cross-

border risk associated with the deal, the exporter wants payment
under a confirmed letter of credit. Citibank is asked to confirm the
letter of credit, but the amount exceeds the cross-border limit
established for Egypt.
Recall that syndication (discussed in Unit 3) is the process of

transferring risk by splitting the risk into several parts and finding
investors who want to share that risk. Without some transfer of risk,
Citibank cannot effect the transaction. By bringing other investors
into the transaction, Citibank is able to accept the business.
In this case, Citibank asks five banks to share the cross-border

risk (transfer and convertibility risk), with each taking a different
percentage of the total in return for a proportionate share of the
fee for providing the letter of credit. In addition, Citibank takes a fee
for originating the deal and bringing it to the investors. If the issuing
(Egyptian) bank defaults for political reasons, each bank pays only
the portion of the letter of credit amount which it agreed to accept.
Transfer of Cross-border deals typically separate the credit risk from the cross-
cross-border border risk of the deal. Citibank usually keeps the commercial risk
risk
and syndicates the cross-border risk. Let’s see how this works.
Silent Risk transfer syndications may be “silent” or “open.” In a silent
syndications syndication, the customer does not know that there are other
investors in the transaction. Citibank accepts the risk of the entire
transaction and then sells pieces of the deal to other banks. Citibank
also sets the fees for the deal. Citibank bears the counterparty and
documentation risk. If Citibank sells a portion of the deal to a bank
which then defaults on its portion of the deal, Citibank is responsible
for that amount. The advantage to Citibank is that it receives a fee
for committing the funds and then sells the deal at a spread in order
to retain a portion of the fees that are paid to the other banks.
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Open In an open syndication, the investing banks act as a consortium.

syndication The lead bank manages the transaction, but all the banks are
disclosed to each other and to the customer. The customer must
assess the counterparty risk of each participating bank because the
customer, rather than Citibank, bears the risk. If one of the banks
defaults on its obligation, the customer bears the loss. Citibank is
not responsible for the whole transaction, even though it may be the
lead bank that arranged for the syndicate.
Investors in Risk Transfer Transactions
We have already mentioned one transfer risk technique, syndication.

In this section, we will examine other techniques in the context of
the parties investing in risk. These parties include banks, insurance
companies, export credit agencies, and other investors.
Banks
Preferred Banks represent about 50% of the market for risk transfer. They are
investors for the preferred investors in risk transfer transactions because they tend
syndications
to evaluate deals in the same way as Citibank. Other banks also have
similar documentation needs and approaches to investment. As we
discussed earlier, banks invest in risk through syndications.
Insurance Companies
Write policies Like banks, insurance companies are significant investors in the risk
transfer market, accounting for about 40% of the total. Insurance
companies, however, differ from banks in the way they invest in
risk. They invest by writing policies in which there is a beneficiary
who submits a claim in the event of a default.
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For example, suppose that Citibank accepts the country risk of a

deal in a less developed country and transfers that risk through an
insurance policy. In the event of default for political reasons covered
under the policy, Citibank will make a claim on the insurance
company and receive payment.
The field of trade-related insurance addresses trade credit risk as

well as country risk.
Trade credit risk Trade credit insurance is used to protect receivables from a
wide range of risks, including the actions of private obligors and
sovereign governments. Trade credit insurance provides financial
protection against political instability, regional or global economic
problems, and natural disasters that may affect goods in transit.
Country risk Country risk insurance is used to protect against losses resulting
from actions or inaction of a sovereign government. Country risk
insurance is not a financial guarantee since it does not cover
commercial risk. For example, it may be used when cross-border
exposure becomes a constraint to the trade transaction. Country
risk insurance covers:
n Currency inconvertibility and/or non-transfer

A government blocks conversion or transfer of currency
(This is not devaluation risk.)
n Contract frustration
A government entity defaults on or blocks the deal
n Confiscation, expropriation, nationalization (CEN)
A government seizes the investment
n Unfair calling guarantee
A government unfairly calls the performance bond
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The insured must maintain confidentiality about the insurance.

Claims are payable after a specified “waiting period.” We describe
below two such insurance providers: CITI and Lloyds of London.
CITI Citicorp International Trade Indemnity, Inc. (CITI) is a Citicorp
business that provides trade-related insurance (political risk, trade
credit risk, and marine cargo). CITI’s customers include importers,
exporters, contractors, manufacturers, financial institutions, and
insurance intermediaries. Anyone who has a stake in the flow of
capital and commerce across borders can benefit from the services
offered by CITI.
Lloyds of Lloyds of London, a 300-year old association in London, originally
London provided marine insurance. Its members — composed of merchants,
ship owners, underwriters, and brokers — underwrite policies for
each other. It is the largest insurance marketplace in the world.
Lloyds of London provides:
n Direct insurance (property / casualty)
n Indirect insurance or reinsurance

(country risk, transportation)
n Catastrophe reinsurance
Export Credit Agencies (ECAs)
You learned in Unit 3 that most developed countries have

government agencies that promote exports, particularly exports to
emerging-market countries. The export credit agencies (ECAs) use
either guarantees or insurance to help the exporting company cover
the commercial risk of the overseas importer and the country risk
of the importer’s country.
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Typically, Citibank originates a transaction and then contacts the

relevant ECA to arrange some form of risk transfer (insurance or
guarantee). The ECA accepts a majority portion (but not all) of the
risk and the transaction proceeds. The Bank structures these deals.
One of Citibank’s strengths is its ability to interact with all of the
key ECAs in order to ensure the success of these transactions.
Example Here is an example of the process. A US exporter wants to sell
capital equipment to Venezuela. The exporter — a Citibank
customer — requests that Citibank confirm the letter of credit for the
equipment. Since Citibank does not want to accept the entire country
risk (perhaps it will exceed its Venezuelan cross-border limit),
Citibank requests cross-border guarantees from the US EXIMBANK.
EXIMBANK issues the guarantee for 85% of the country risk,
leaving Citibank with 15%. In the event of default for political
reasons, Citibank will retrieve from EXIMBANK the 85% portion
that has been guaranteed. The remaining 15% is Citibank’s risk.
Other Investors — Forfaiting
As we saw in Unit 3, forfaiting involves the sale without recourse of

a cross-border receivable from an exporter. Essentially, forfaiting is
a technique that transfers to investors the commercial and country
risk of the overseas buyer, the obligor. The commercial risk may be
mitigated somewhat by a bank guarantee on the paper (although the
investor now bears the bank’s risk rather than the importer’s risk).
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Primary investors in the forfait market are merchant banks, forfaiting

houses (specialists in trading these investments), and forfaiting
departments of banks. These investment houses typically establish
networks of secondary investors who reside in the country of the
obligor. Because local investors often are more comfortable with
their local political, transfer, and/or convertibility risks than someone
from another country may be, these secondary investors are more
likely to buy paper that originates locally. The importer may be
able to get longer terms through forfaiting than with other forms
of finance, because forfaiting transfers risk to secondary investors
who find the risk of a particular country attractive.
Example of Risk Transfer / Risk Management
Let’s examine a situation where Citibank satisfies a customer’s

export financing needs while maintaining an acceptable risk
exposure.
Export Finance: Suppose a US supplier (exporter) has a US$15 million contract to
Short term sell products to a government-owned buyer in a developing country
whose import regulations require that foreign suppliers grant 360-
day terms. The US exporter, however, is unwilling to take the risk
of possible non-payment of the resulting trade receivables.
Risk analysis In this situation there is the country risk associated with the overseas
government which may delay payment at maturity. There is also the
commercial risk that the buyer will default because the obligations
of the government-owned entity are not, in this situation, backed by
the full faith and credit of the country.
There are three ways that Citibank may satisfy the financing needs
of the exporter.
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Option One
Assumption First, let’s assume that Citibank’s in-country branch is willing to

take the commercial risk of the buyer but is unable to allocate cross-
border (political) exposure for the full amount of the transaction.
Solution On behalf of Citibank’s customer (the exporter), Citibank obtains
an insurance policy from EXIMBANK to cover 90 to 95 percent of
the country risk. (Depending on the country, the coverage may be
less than 90% or it may be unavailable.) The remaining country risk
exposure could be covered through a cross-border allocation, a trade
facility established through debt rescheduling, or recourse to the
exporter. Retaining only an acceptable amount of risk, Citibank then
purchases the discounted receivables from the exporter.
Option Two
Assumption Another option exists if the exporter is willing to grant a 360-day

credit to the buyer. The exporter may be willing to take all of the
commercial risk because s/he believes the buyer to be a reputable
corporation in its field and can earn a return on the financing that
justifies taking the risks. The exporter, however, wants to avoid
political risk exposure for the full amount of the transaction.
Solution In this case, Citibank can arrange insurance coverage through
Citibank International Trade Indemnity (CITI) covering 95 percent
of the country risk in the transaction. The exporter, however, must
retain the remaining 5 percent exposure. Notice that Citibank is
providing structuring rather than financing support and, as a result,
this solution provides fee income without having to meet Return
on Assets (ROA) criteria.
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Option Three
Assumption / Finally, let’s assume that EXIMBANK coverage is unavailable for

solution this country or tenor. CITI coverage may be available for 95% of
the country risk, but the exporter wants to eliminate country and
commercial risks altogether. Citibank’s in-country branch is
willing to assume commercial risk for the entire transaction and
has cross-border capacity to cover the remaining five percent of
the country risk.
You have been introduced to the types and goals of risk transfer.
We conclude this section with a discussion of its advantages.
Advantages of Risk Transfer
Risk transfer provides three primary advantages to Citibank.
1. Increased market share and risk capacity

Example For example, Brazil’s cross-border limit in 1995 of $600 million
was insufficient to meet the demand of Citibank customers who
wanted protection from the country risks associated with
Brazilian trade. Through risk transfer techniques such as
syndication, Citibank was able to do twice the amount of
business it could have transacted, given the $600 million limit. In
this case, the total portfolio of Brazilian deals which Citibank
originated in the first quarter of 1995 was $1.2 billion.
2. Building a positive image and reputation in a particular market

Example Syndications, especially silent syndications, allow Citibank to
arrange very large transactions that bolster the Bank’s reputation
and lead to other originations. An example is a very large capital
project costing several hundred million dollars and lasting a
number of years. In such a case, Citibank transfers both the
country and commercial risk in order to arrange deals where the
amount of risk is beyond the capacity of any one bank.
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3. Leveraged returns
Example An example helps illustrate the advantage of leveraged returns.
Kenyan risk is generally priced in the market at about 4% per
annum. If Citibank keeps all of a deal involving Kenya, the Bank
earns a 4% return on the country risk. By transferring some of
the risk, the Bank earns 4% on the retained portion, management
and advisory fees, and the “skim” that represents the difference
between the fees paid by the customer and the amount paid to
the syndicate members. The total revenue, as a is much greater
than the 4% the Bank would have earned by booking the entire
amount. (In order to earn the skim, the syndication must be
silent, which is true of most deals.)
Risk transfer also helps Citibank reduce the assets carried on its
balance sheet. Booking assets is not very attractive because it is
difficult to generate sufficient returns on those assets. (Expected
return on assets is discussed in Unit 5.)
SUMMARY
In this section, we defined credit risk and identified its sub-

categories, lending risk (direct and contingent) and counterparty
risk (presettlement and settlement), which are commonly associated
with a trade transaction.
We also identified several other risks associated with trade

transactions. The more common risks fall under the category of
country risk which includes political (sovereign) and cross-border
(transfer and convertibility) risks. Other risks to consider are image,
product, operational / systems, legal and regulatory, documentation,
and performance risks.
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Citibank assigns the Country Senior Credit Officer (CSCO) the

responsibility for evaluating country risk and establishing the cross-
border allocation for that country. Through bank syndication,
insurance policies, export credit agency guarantees, and forfaiting,
Citibank transfers risk to other investors and, therefore, improves its
balance sheet and market position relative to its risk limits.
You have completed the first section of Risk and Compliance. Please complete Progress
Check 4.1, then continue with the next section on “Compliance Issues.” If you answer
any questions incorrectly, please review the appropriate text.
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Question 1: Match each trade-related risk with its corresponding example.
a) Credit risk e) Operational / systems risk

b) Image risk f) Documentation risk
c) Performance risk g) Transfer risk
d) Political (sovereign) risk
_____ In the process of granting a loan to a company, the Bank requests a

signature on the promissory note. The person who signs the document is
unauthorized by the company to do so and the note becomes unenforceable.
_____ A customer of the Bank develops financial difficulties and is unable to

repay a loan from the Bank at the specified date.
_____ A potential customer requests financing for a project to develop a new

type of assault weapon.
_____ Telecommunications in the northeast part of the United States have been
disrupted, making it impossible to transfer funds electronically.
_____ The buyer’s country has experienced civil disturbances that affect the
buyer’s ability to meet his/her obligations to the Bank.
_____ A swimsuit manufacturer receives defective fabric from an overseas

supplier and is unable to produce swimsuits in time for the summer season.
_____ Due to a shortage of dollars in the Egyptian central bank, an Egyptian

importer is unable to pay the US supplier in US dollars as specified by
the contract.
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ANSWER KEY
Question 1: Match each trade-related risk with its corresponding example.
a) Credit risk e) Operational / systems risk

b) Image risk f) Documentation risk
c) Performance risk g) Transfer risk
d) Political (sovereign) risk
f In the process of granting a loan to a company, the Bank requests a

signature on the promissory note. The person who signs the document is
unauthorized by the company to do so and the note becomes unenforceable.
a A customer of the Bank develops financial difficulties and is unable to

repay a loan from the Bank at the specified date.
b A potential customer requests financing for a project to develop a new

type of assault weapon.
e Telecommunications in the northeast part of the United States have been

disrupted, making it impossible to transfer funds electronically.
d The buyer’s country has experienced civil disturbances that affect the
buyer’s ability to meet his / her obligations to the Bank.
c A swimsuit manufacturer receives defective fabric from an overseas

supplier and is unable to produce swimsuits in time for the summer season.
g Due to a shortage of dollars in the Egyptian central bank, an Egyptian

importer is unable to pay the US supplier in US dollars as specified by
the contract.
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(Continued)
Question 2: Citibank’s exposure to cross-border risk is managed by:
_____ a) the Head Office.

_____ b) each Country Senior Credit Officer in its branch network.
_____ c) product managers.
_____ d) the Society for Worldwide International Telecommunications.
Question 3: Investors willing to share the political risk of a Citibank syndication are
helping the bank reduce its exposure to:
_____ a) credit risk.

_____ b) regulatory risk.
_____ c) country risk.
_____ d) commercial risk.
Question 4: Guarantees are a risk transfer technique provided to Citibank by:
_____ a) export credit agencies.

_____ b) insurance companies.
_____ c) Citicorp International Trade Indemnity, Inc.
_____ d) Lloyds of London.
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ANSWER KEY
Question 2: Citibank’s exposure to cross-border risk is managed by:
b) each Country Senior Credit Officer in its branch network.
Question 3: Investors willing to share the political risk of a Citibank syndication are
helping the bank reduce its exposure to:
c) country risk.
Question 4: Guarantees are a risk transfer technique provided to Citibank by:
a) export credit agencies.
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(Continued)
Question 5: Place an X on the line in front of the types of credit risk.
_____ Political risk

_____ Direct lending risk
_____ Transfer risk
_____ Legal and regulatory risk
_____ Contingent lending risk
Question 6: The types of risks found in a trade transaction are defined below. Write the
risk category beside its definition. Be as specific as possible and include
sub-categories where appropriate.
__________ The actions of a government or independent events may affect the ability
of a customer of the Bank to meet his or her obligations to the Bank.
__________ The possibility that an activity of the Bank or one of its representatives
may damage the reputation of the Bank.
__________ One of the written instruments necessary for the trade transaction may be
incomplete, incorrect, or unenforceable.
__________ The chance that a possible customer obligation will become an actual
obligation and will not be settled on time.
__________ The probability that a country’s central bank will not allow a flow of funds
out of the country to complete the transaction.
__________ The risk that a transaction does not comply with all relevant regulations.
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ANSWER KEY
Question 5: Place an X on the line in front of the types of credit risk.
Political risk
X Direct lending risk
Transfer risk
Legal and regulatory risk
X Contingent lending risk
Question 6: The types of risks found in a trade transaction are defined below. Write the
risk category beside its definition. Be as specific as possible and include
sub-categories where appropriate.
Political The actions of a government or independent events may affect the

(sovereign) ability of a customer of the Bank to meet his or her obligations to
the Bank.
Image The possibility that an activity of the Bank or one of its representatives
may damage the reputation of the Bank.
Documentation One of the written instruments necessary for the trade transaction may
be incomplete, incorrect, or unenforceable.
Lending
(contingent The chance that a possible customer obligation will become an actual
lending) obligation and will not be settled on time.
Transfer The probability that a country’s central bank will not allow a flow of
(cross-border) funds out of the country to complete the transaction.
Legal
(regulatory) risk The risk that a transaction does not comply with all relevant regulations.
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(Continued)
Question 7: Place a T in front of the true statements and an F in front of the false
statements.
_____ a) “Country risk” is the possibility that a borrower may not be able to
repay a loan on time.
_____ b) “Lending risk” is a type of credit risk.
_____ c) “Product risk” is the risk that imported products may be defective.
_____ d) “Documentation risk” is the risk that documents required to complete
the trade transaction are incorrect.
_____ e) “Country risk” includes political and transfer risk.
Question 8: Political risks are most significant in transactions between companies in:
_____ a) two developed countries.

_____ b) countries with freely convertible currencies.
_____ c) a developed and an emerging-market country.
_____ d) countries with local legal lending limits.
Question 9: The descriptions of two risk transfer techniques are found below. Write
the name of the risk transfer technique beside its description.
_______________ The risk of a transaction is split into several parts and shared
by investors willing to accept a portion of the risk in return for
a portion of the fee.
_______________ Risk is transferred to overseas investors who purchase exporters’

receivables without recourse.
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ANSWER KEY
statements.
F a) “Country risk” is the possibility that a borrower may not be able to

repay a loan on time. (This is credit risk.)
T b) “Lending risk” is a type of credit risk.
F c) “Product risk” is the risk that imported products may be defective.
(Product risk happens when the structure of a certain trade product
is faulty or inadequate)
T d) “Documentation risk” is the risk that documents required to complete
the trade transaction are incorrect.
T e) “Country risk” includes political and transfer risk.
Question 8: Political risks are most significant in transactions between companies in:
c) a developed and an emerging-market country.
Question 9: The descriptions of two risk transfer techniques are found below. Write
the name of the risk transfer technique beside its description.
Syndication The risk of a transaction is split into several parts and shared by
investors willing to accept a portion of the risk in return for a
portion of the fee.
Forfaiting
(other investors) Risk is transferred to overseas investors who purchase exporters’
receivables without recourse.
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(Continued)
Question 10: Risk transfer enables Citibank to finance transactions that:
_____ a) do not conform to US legal requirements.

_____ b) do not meet the Bank’s credit criteria.
_____ c) cannot be sold in the forfait markets.
_____ d) exceed the total cross-border allocation for a particular country.
Question 11: Identify three parties that are able to provide insurance against political
risks associated with international trade transactions.
_____ a) Citicorp International Trade Indemnity, Inc. (CITI)

_____ b) Citibank, Nairobi
_____ c) Lloyds of London
_____ d) Export Import Bank of the United States (EXIMBANK)
_____ e) SWIFT
_____ f) Citibank, New York
Question 12: The purpose of Citibank’s cross-border risk allocation is to:
_____ a) limit the amount and type of international business that can
be done with any country.
_____ b) transfer a portion of the risk to other investors.
_____ c) ensure that the risk is acceptable in forfait markets.
_____ d) earn a portion of fees paid to syndicate banks.
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ANSWER KEY
Question 10: Risk transfer enables Citibank to finance transactions that:
d) exceed the total cross-border allocation for a particular country.
Question 11: Identify three parties that are able to provide insurance against political
risks associated with international trade transactions.
a) Citicorp International Trade Indemnity, Inc. (CITI)
c) Lloyds of London
d) Export Import Bank of the United States (EXIMBANK)
Question 12: The purpose of Citibank’s cross-border risk allocation is to:
a) limit the amount and type of international business that can

be done with any country.
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COMPLIANCE ISSUES
We mentioned earlier that one of the risks inherent in international

trade stems from the need to comply with legal and regulatory
requirements.
Conforming In general terms, compliance is the act of conforming to a rule or
to a rule or demand. At Citibank, we must conform not only to high ethical
demand
standards, but to legal and regulatory obligations in the United
States and other countries.
These rules and regulations include:
n Statutes and regulations adopted by a governmental regulatory

body
n Decrees and orders written by any court that has authority

over a Citicorp business or entity
n Ethical standards described in the Citicorp Policy Manual
Compliance issues in the trade business include US sanctions, US

anti-boycott regulations, US export controls, and rules concerning
anti-money laundering activities. (We examine each of these in the
pages that follow.) Different Bank activities are concerned with
different compliance issues.
n In the Transaction Services area, specifically in Trade,

Citibank employees need to know about US sanctions,
US anti-boycott rules, US export controls, and rules
concerning anti-money laundering activities.
n In the Cash Management area, an awareness of rules

concerning anti-money laundering activities is required.
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Responsibility Compliance is a personal responsibility. Each Citibank employee is

of each Citibank held accountable for all compliance-related activities; s/he must be
employee
familiar with the rules, regulations, and ethical standards related to
his or her assignment. Each Citibank employee is provided with the
appropriate level of compliance training specific to his/her job
assignment and must follow the requirements stated in his/her
group’s compliance program.
Conflict of When a conflict of law issue occurs, it is important to analyze and
law issues deal with it quickly. Accounts and assets located outside the United
States are subject to local governmental laws and regulations. Both
US laws and local laws must be obeyed, but sometimes these two
sets of laws conflict.
Example For example, when local laws permit (or require) normal trading and
financial relations with countries (or individuals) that are subject to
US sanctions, conflicts of law occur. When such a controversy or
conflict occurs, it is necessary to seek help from a supervisor. If the
problem cannot be resolved, the compliance officers and legal
counsel should be consulted. Remember, Citibank’s policy is to
comply with US law and local laws. If a conflict between US law
and local laws occurs, a satisfactory solution must be found.
Let us now look at four trade business compliance issues: sanctions,

anti-boycott laws and regulations, export controls, and anti-money
laundering laws and precautions.
US Sanctions
Blocking of a A sanction is an economic measure adopted by one or several

government’s countries to force a nation that is violating international law to
assets
discontinue the offending behavior. Sanctions generally require a
freeze or blocking of the sanctioned government’s assets. Trade with
the country is also prohibited. Sanctions may affect the following
trade products: letters of credit, documentary collections, bankers’
acceptances, and bank-to-bank reimbursements.
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The United States government occasionally adopts sanctions against

the governments of certain countries — and sometimes against their
citizens. These sanctions are imposed under the authority of one of
the following:
n Trading with the Enemy Act

n International Emergency Economic Powers Act
n United Nations Participation Act
Sanction Administration in the US
Sanctions are administered according to regulations issued by the

US Department of Treasury’s Office of Foreign Assets Control
(OFAC).
OFAC lists The Office of Foreign Assets Control publishes extensive lists of
“specially designated nationals” (SDNs) — persons or companies
considered to represent the governments of sanctioned countries.
The OFAC also publishes a list of “specially designated terrorists”
(SDTs) and of “specially designated narcotics traffickers” (SDNTs).
The assets of anyone included in any of the three lists – SDNs,

SDTs, and SDNTs – also must be blocked, even if they are located
outside the “blocked” country. Because of the complexity of these
regulations, it is important to consult with your group’s counsel or
the Legal Affairs Office if a question arises concerning the assets
of blocked countries or of anyone included in any of the three lists.
The Compliance Officer has a list of blocked countries as well as
the lists published by the OFAC on the SDNs, SDTs and SDNTs.
Blocking Citibank must block accounts and assets if they:
accounts
n Belong to a blocked entity
n Are going to a blocked destination
n Are from a blocked destination
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When the blocked name is an existing customer of the Bank, the

existing accounts must be blocked. All documents (checks, bills of
lading, etc.) must be seized and kept as blocked items. No trade may
be conducted until permission is obtained from the OFAC. Local
licenses do not satisfy US law.
If the blocked entity does not have an account with Citibank,

a special “blocked” interest-bearing account must be created.
These accounts cannot be debited without a license from the US
government. However, credits can and must be made. Citibank
is not allowed to return funds to the remitter.
Reporting Requirements
All units maintaining blocked accounts or transactions must keep

complete, up-to-date records. Reports must be submitted to the
OFAC at specified intervals and sometimes on demand. Reporting
is usually done by Group Counsels or by the Legal Affairs Office.
Penalties
Civil penalties of up to $250,000 may be imposed for violation or

evasion of the regulations (for example, helping a customer avoid
the effect of the sanctions). If the violation or evasion is intentional,
the maximum fine can be $1,000,000 and/or a prison term of up to
twelve years. Severe violations may cause the loss of a franchise.
US Anti-Boycott Laws and Regulations
Request not to A boycott is an explicit or implied request not to do business with

do business certain persons or companies in countries that are friendly to the
United States. The most well-known example is the boycott of
Israel by Arab and Islamic countries.
US companies are not allowed to comply with boycott requirements

that have been imposed by governments, persons, or entities. The
Export Administration Act (EAA) of 1977 and the Tax Reform
Act of 1976 prohibit this type of activity.
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The US anti-boycott laws and regulations apply particularly to trade

situations. However, they may apply to other situations, such as the
hiring process, choosing business partners, or business opportunities.
Boycott request A Citibank subsidiary may receive a boycott request. If this situation
occurs, for example, in a clause of a letter of credit, Citibank should
decline to participate in the transaction unless the clause is removed
or satisfactorily changed.
Citicorp’s participation, or request to participate, in a boycott must

be reported directly to the Commerce Department. Under Section
999 of the Internal Revenue Code, boycott requests also must be
reported annually with Citicorp’s federal tax return.
Penalties
The Export Administration Act (EAA) imposes civil fines of up to

$10,000 for each violation of US anti-boycott laws and regulations.
Implementing and not reporting a boycott clause equals two
violations. Criminal fines are up to $50,000 or, in the case of an
export transaction, five times the value of the exported goods and/or
imprisonment for up to five years. In addition, export privileges or
the right to finance exports may be revoked or suspended. Violation
of these laws may require the payment of a penalty — which may
damage the Bank’s reputation.
Discovering Noncompliance Issues
To discover noncompliance with anti-boycott policies, look for the

following in trade transaction-related contracts:
n Origin of manufactured goods
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n Blacklisted status of any party
n Eligibility of a carrier vessel to enter the ports of a country

or group of countries
n Prohibited shipments on certain vessels and limitations on

their routes
n Business relationships with certain countries that request

participation in a boycott
Examples of For example, letters of credit may contain a clause certifying that the
noncompliance goods are “not of Israeli origin” or that the vessel carrying the goods
clauses
“will not stop at Israeli ports.” Citibank must go back to the bank
that issued the document and negotiate a deletion or change of the
offending clause. Citibank must report to the US government the
original clause that was believed to be a “request” to participate in
the boycott.
Another example is a clause requiring “provision of a certificate

stating that the vessel carrying the goods is not blacklisted.”
Citibank must go back to the issuing bank and request deletion of
the clause. Because this type of clause is prohibited under both the
Export Administration Act of 1977 and the Tax Reform Act of 1976,
reports must be filed with the US Department of Commerce and the
US Department of Treasury.
The proper procedures for handling non-conforming situations

are explained in the Anti-Boycott Compliance Manual. You may
obtain this manual from the local anti-boycott compliance officer or
from the Legal Affairs Office. Anti-boycott laws apply to Citibank
branches in the United States and overseas as well as Citicorp’s
domestic and international subsidiaries and affiliates.
We have examined the reporting requirements and penalties relating

to US sanctions and US anti-boycott laws. We will now look at the
third compliance issue, US export controls.
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US Export Controls
High technology The export of high technology or strategic goods from the United
or strategic States to other countries and/or the re-export of US technology from
goods
one country to a third country are subject to US export controls for
all countries. Citibank and its worldwide branches become involved
when they are asked to finance the production of goods or the export
of goods through a letter of credit.
Examples of high technology or strategic goods are computers,

airplanes, arms-related technology, some chemicals, software, and
encryption devices. Citibank has to be especially cautious when US
technology is re-exported from Country X to Country Y.
The export control compliance process must include checking the

lists of individual parties included in the following listings published
by the US Department of Commerce:
n Missile Tech & Chemicals / Biological
n Debarred Parties
n Table of Denial List
Whenever the transactions contain names that appear on the lists,

they must not be processed. The Trade Advisory Unit and the
Business Unit Compliance Officer should be consulted for further
guidance.
It is Citibank’s policy that the Credit Policy Committee must review

and approve any transaction involving the shipment of military
equipment, military parts, or armaments.
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Before exporting, the exporter must obtain a validated export license

for high technology or strategic goods from either the US
Department of Commerce Office of Export Administration (OEA) or
the US Department of State. Some licenses require reporting, but this
usually
is the responsibility of the exporter and not of Citibank.
Penalties
Intentional violations carry a maximum penalty of five times the

value of the export, or $1,000,000, whichever is greater, and prison
terms of up to ten years. An additional civil penalty includes the
cancellation of export privileges which would prevent Citibank from
participating directly or indirectly in the export of strategic goods
for which approval from the US Department of Commerce or the
US Department of State is required.
Anti-Money Laundering
Transfer from Money laundering is a term used to describe the process of

illegal sources concealing the existence, illegal source, or illegal application of
to legitimate
income. It is the investment or transfer of money flowing from
channels
illegal sources into legitimate channels so that the original sources
cannot be traced. Banks and other financial institutions unwittingly
may be involved in the transfer, deposit, or investment of money
that comes from illegal activity. Trade products that unintentionally
may facilitate money laundering activities include letters of credit,
documentary collections, bankers’ acceptances, and back-to-back
reimbursements.
The Money Laundering Process
There are three independent activities in the money laundering

process.
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n Placement is the physical action of placing bulk cash

proceeds.
n Layering separates the proceeds of criminal activity from

their origins through layers of complex financial transactions.
n Integration is the act of providing what appears to be a

legitimate explanation for the illicit proceeds.
A successful money laundering operation will assure that no “paper

trail” connects these three events.
The US government has passed two laws that create currency

reporting obligations: the Bank Secrecy Act (BSA) and the Money
Laundering Control Act (MLCA).
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Bank The Bank Secrecy Act requires banks to file reports and keep
Secrecy Act records for five years on matters that are useful in investigations
of criminal, tax, and regulatory violations. An amendment to this
act grants a bank regulator the right to revoke a US bank’s charter,
license, and/or deposit insurance if convicted of money laundering
crimes.
An important BSA report is the Currency Transaction Report

(CTR). Citicorp and all of its entities in the United States must file
a CTR with the Internal Revenue Service for every cash deposit or
withdrawal over $10,000. Citicorp has established a global policy
that requires the monitoring of large cash transactions. Outside of
the United States, Citicorp recognizes local law requirements for
reporting cash transactions to local authorities.
Money The Money Laundering Control Act makes money laundering a
Laundering federal crime and defines the criminal offenses that are part of
Control Act
the money laundering process. A criminal offense occurs when a
person knowingly conducts, or attempts to conduct, transactions
using funds derived from illegal activities. The MLCA applies to
US citizens and enterprises acting outside US borders, such as
Citicorp and Citibank, N.A.
“Know-your- The “know-your-customer” policy is an important part of the
customer” policy anti-money laundering program. It requires financial institutions
to monitor new and existing accounts to help identify suspicious
activities conducted by their customers.
Avoiding Problems
In order for Citibank to avoid being used to launder money, we

should:
n Determine the true identity of all customers that request

the Bank’s products and services
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n Identify customers that seek to conduct significant

business transactions as well as those customers using
safe-custody facilities
n Establish transaction profiles for each customer to help

predict the types of transactions that are consistent with
the customer’s profile
To avoid problems, it is important to be updated continually on

US sanctions and US anti-boycott regulations and to know the
customer and his/her business plans. The compliance procedures
for Latin America, the Middle East, and Africa require a Basic
Information Report (BIR) for all new account openings, regardless
of whether or not the customer is from a high-risk company.
UNIT SUMMARY
At the beginning of Unit 4, we discussed the risks that have the

greatest effect on trade transactions. We described the process used
by Citibank to assess and manage country (political and cross-
border) risk. Based on a risk assessment, the control unit for each
country establishes a limit on the amount and type of cross-border
business Citibank is able to do with that particular country. To
exceed its self-imposed limits, Citibank uses a variety of risk transfer
techniques that increase its risk capacity. These include syndication
of risk to other banks, insurance policies, guarantees or insurance
arranged through export credit agencies, and the sale of risk to third-
party investors through the forfait market.
We identified two agencies that provide insurance for trade

transactions: CITI and Lloyds of London. Trade credit insurance
and country risk insurance were discussed. Not only do you need
to recognize the different types of risk associated with international
trade, you also must be aware of the types of insurance that have
been developed to reduce those risks.
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We learned about Citibank’s obligation to conform to the laws and

regulations of the United States and other countries. It is Citibank’s
policy to comply with both US laws and local laws. When conflicts
occur, a satisfactory solution should be found that maintains
Citibank’s integrity locally and in the United States. In the event that
we cannot reach a satisfactory solution, Citibank will always comply
with US laws. Supervisors, compliance officers, and legal counsel
are available to offer the trade officer any assistance necessary to
resolve compliance issues.
The trade officer must understand US anti-boycott laws, US

sanctions, and US export controls because they affect the flow of
goods and services in the global marketplace. If these regulations and
their reporting requirements are not properly followed, serious
penalties may result.
We discussed the money-laundering process and reporting

requirements. In order to avoid involving Citibank in money
laundering activities, the trade officer must know the customer’s
business.
You have completed Unit 4, Risk and Compliance. Please complete Progress Check 4.2
to test your understanding of the concepts and check your answers with the Answer Key.
If you answer any question incorrectly, please reread the corresponding text to clarify
your understanding. Then, continue to the final unit of this workbook, Identifying
Customers’Needs and Pricing Solutions.
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Directions: Determine the correct answer(s) to each question. Check your answers with
the Answer Key on the next page.
Question 1: Place an X in front of four obligations with which Citibank must comply.
_____ a) Boycott requirements that have been imposed by a foreign government
_____ b) Trade boycott against Israel by Arab and Islamic countries
_____ c) Economic measures against a country that is violating international law
_____ d) Rules regarding placement, layering, and integration of cash proceeds
_____ e) Guidelines of the Trade Advisory Unit
_____ f) US government prohibition of boycott participation
_____ g) US Export Controls
Question 2: A boycott is:
_____ a) an economic measure adopted by the United States to block the assets
of a country’s government.
_____ b) an explicit or implied request not to do business with certain persons

or companies.
_____ c) a specific category of regulations developed to protect the domestic

market from foreign competition.
_____ d) a quantitative restriction on the import of an article into the United

States.
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ANSWER KEY
Question 1: Place an X in front of four obligations with which Citibank must comply.
c) Economic measures against a country that is violating

international law
d) Rules regarding placement, layering, and integration of
cash proceeds
f) US government prohibition of boycott participation
g) US Export Controls
Question 2: A boycott is:
b) an explicit or implied request not to do business with certain persons

or companies.
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(Continued)
Question 3: When Citibank blocks the account of a specially-designated national, it is

complying with:
_____ a) US sanctions.
_____ b) US anti-boycott laws.
_____ c) US export controls.
_____ d) the Bank Secrecy Act.
Question 4: The trade officer must know which products are considered “strategic” by
the US government in order to comply with:
_____ a) US sanctions.
_____ b) US anti-boycott laws.
_____ c) US export controls.
_____ d) the Bank Secrecy Act.
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ANSWER KEY
Question 3: When Citibank blocks the account of a specially-designated national, it is

complying with:
a) US sanctions.
Question 4: The trade officer must know which products are considered “strategic”
by the US government in order to comply with:
c) US export controls.
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(Continued)
Question 5: A license to export strategic or high technology must be obtained from the:
_____ a) US Department of Transportation.

_____ b) Interstate Commerce Commission.
_____ c) Securities Exchange Commission.
_____ d) US Department of Commerce.
Question 6: The blocking of a government’s assets is an economic measure that is

intended to:
_____ a) influence the behavior of a government that performs illegal acts

according to international law.
_____ b) create a balance of trade between two nations.
_____ c) correct the illegal behavior of citizens in countries that are official
enemies of the US.
_____ d) force an alteration of that government’s trade policies.
Question 7: Which two laws create currency reporting obligations?
_____ a) International Emergency Economic Powers Act

_____ b) Bank Secrecy Act
_____ c) Money Laundering Control Act
_____ d) US Criminal Code
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ANSWER KEY
Question 5: A license to export strategic or high technology must be obtained from the:
d) US Department of Commerce.
Question 6: The blocking of a government’s assets is an economic measure that is

intended to:
a) influence the behavior of a government that performs illegal acts

according to international law.
Question 7: Which two laws create currency reporting obligations?
b) Bank Secrecy Act

c) Money Laundering Control Act
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(Continued)
Question 8: The “know your customer” policy is a requirement of which compliance

issue?
_____ a) US export controls
_____ b) US anti-boycott
_____ c) Anti-money laundering
_____ d) US sanctions
Question 9: One requirement of the Bank Secrecy Act is:

_____ a) a report on all transactions with customers outside the US.
_____ b identification of the true identity of all customers that request the
Bank’s products and services.
_____ c) a CTR filed with the IRS for every cash deposit / withdrawal over
$10,000.
_____ d) a “paper trail” to connect the three events of the money laundering
process.
Question 10: An opening bank in Russia issues a letter of credit with 100% cash
collateral for confirmation from Citibank, NY. After receipt of the
confirmed letter of credit, the beneficiary requests that Citibank, NY
cancel the letter of credit. As a result, Citibank, NY must return the
cash collateral to the opening bank in Russia. However, the opening
bank instructs Citibank, NY to transfer the funds to a third party located
in Cuba. What compliance issues may arise from the opening bank’s
new instructions?
_____ a) Anti-money laundering
_____ b) US anti-boycott
_____ c) US export control
_____ d) US sanction
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ANSWER KEY
Question 8: The “know your customer” policy is a requirement of which compliance

issue?
c) Anti-money laundering
Question 9: One requirement of the Bank Secrecy Act is:
c) a CTR filed with the IRS for every cash deposit / withdrawal
over $10,000.
Question 10: An opening bank in Russia issues a letter of credit with 100% cash
collateral for confirmation from Citibank, NY. After receipt of the
confirmed letter of credit, the beneficiary requests that Citibank, NY
cancel the letter of credit. As a result, Citibank, NY must return the
cash collateral to the opening bank in Russia. However, the opening
bank instructs Citibank, NY to transfer the funds to a third party located
in Cuba. What compliance issues may arise from the opening bank’s
new instructions?
a) Anti-money laundering
d) US sanction
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Unit 5
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UNIT 5: IDENTIFYING CUSTOMERS’NEEDS
AND PRICING SOLUTIONS
INTRODUCTION
Your understanding of the trade environment, trade services and finance, and their related
risk and compliance issues will enable you to identify and develop new trade-related
business for Citibank. In this final unit, we describe the information-gathering process
that helps identify a prospective or current customer’s trade-related banking needs. In
addition, we explain key pricing benchmarks and provide guidelines for pricing a product.
We conclude with a discussion of the procedure for submitting a proposal to a customer.
This unit contains a large amount of reference material that will be useful in the future.
Keep that in mind as you read through the unit. Feel free to duplicate certain sections for
use as quick references.
UNIT OBJECTIVES
After completing Unit 5, you will be able to:
n Recognize questions that are used to identify customers’ needs

n Identify benchmarks that apply to pricing
n Recognize guidelines used when pricing solutions
n Recognize the structure of offering letters
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5-2 IDENTIFYING CUSTOMERS’NEEDS AND PRICING SOLUTIONS
THE INFORMATION GATHERING PROCESS
When a customer approaches Citibank with a business deal or

opportunity, we want to obtain sufficient information about the
customer’s business to determine his/her needs. This information,
combined with knowledge of the trade environment and trade
services, enables us to develop a solution that will meet our
customer’s needs. In the process, we are able to create new business
opportunities for Citibank.
Existing Customers
Information in If the customer currently does business with Citibank, some

customer’s file information already may be in the customer’s file. For example, if
the customer buys raw materials or products on a regular basis from
international suppliers and sells to international buyers, the Bank
should have a list of these suppliers and buyers. The file also should
indicate the total volume of imports and exports as well as the
payment options used for settling international trade transactions.
Other internal In addition, you may obtain information from the following internal
sources of sources:
information
n Trade reports, available from the trade product manager
n Country trade reports on imports and exports, usually

kept by product managers
n Industry analysis and research undertaken by the credit

area with the objective of analyzing credit information
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IDENTIFYING CUSTOMERS’NEEDS AND PRICING SOLUTIONS 5-3
n Information on the customer’s business revenues

(documented in the customer’s Basic Information Report
[BIR] which Citibank prepares for each customer) and
product / customer revenues (available through various
reports, such as the product and account profitability
reports, generated by Financial Control – FINCON)
n Statistics on trade volumes, provided by the customer

and kept by the Relationship Manager or the Product
Manager
n Pricing pattern for the customer — examine previous

Credit Approvals (CAs) which contain all terms and
conditions of credit proposals
n Balance sheet (e.g. Does the customer have debt? If

yes, what is the amount? Is it in US dollars? What is
the maturity date?)
n Previous call plans and call reports
You should talk to the Relationship Manager and Product Specialists

who presently work with the account as well as to those who had
been previously assigned to the account. They are important sources
of information because they can relate past experiences with that
customer to reinforce any written information.
New Customers
When the relationship with the customer is new, the Relationship

Manager and the Product Manager’s focus in the first meeting is
to assess the customer’s trade business. (Prior to any meeting, you
should prepare a detailed call plan based on your information-
gathering research so that you can demonstrate your knowledge
of the customer’s business.)
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In the first meeting, ask questions to gather current facts and

background information. You also should explore any problems,
difficulties, and dissatisfactions the customer may have experienced
in order to identify areas where Citibank services can help.
To understand the customer’s business, you must gather information

about his/her product(s), clients and suppliers and their possible
financing needs, the customer’s own financing needs, and current
trade practices. Try to identify any extraordinary risks as well as
customer service issues that may provide opportunities to satisfy
his/her needs and build the relationship. The following sets of
questions will help facilitate this information-gathering process.
Customer’s The questions below help you obtain information about the
product mix customer’s product(s).
n What is the customer’s product offering? Is there a single

basic product? Are there other related products?
n Is all of the customer’s production sold locally? If the answer

is “yes,” the customer is not exporting. Otherwise, proceed
with the next question.
n What is the customer’s sales mix between local and

international buyers? What is the product mix of the exports?
n What percentage of sales over the last two years were

domestic? What percentage were exports? What will the
product mix be for the next year? For the next two years?
Will it grow, decline, or remain stable?
The information provided by these questions will help determine if

the customer is taking advantage of a temporary market opportunity
or is committed to foreign trade. This information is important for
pricing our solutions. Customers committed to foreign trade are more
price sensitive and efficient since they must compete in the global
marketplace.
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Customer’s The second series of questions concentrates on our customer’s

client (buyer) client and its relationship with Citibank. This information is used
to identify new business opportunities for Citibank with our
customer’s client.
n Who are the customer’s principal clients (buyers) abroad?
n Does the customer know if these buyers are Citibank

customers?
n Would the customer object if Citibank investigated the

possibility of meeting the needs of both parties?
Financing needs The third set of questions focuses on business opportunities relative
of the customer’s to the financing needs of the customer’s client.
client
n Is the customer offering financing terms to his/her buyers? If
the answer is “yes,” to what buyers and under which terms?
n Would it be beneficial to the customer to offer an extension

of current financing terms as part of the sales approach to
the buyer?
n Which financing terms would the customer expect to offer

(e.g., tenor, price)?
n Would the customer offer financing terms to all of its

buyers or only to some of them? Who are they and in which
countries are they located? How would the customer plan
to obtain the financing (letter of credit)?
n If the buyer’s risk is unacceptable to Citibank, is the customer

prepared to accept the discount with recourse? This means
that if the buyer does not pay, Citibank’s customer will be
liable for payment at maturity.
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Customer’s The next set of questions focuses on the customer’s suppliers.

suppliers
n Does the customer purchase all supplies in the country?
If the answer is “yes,” proceed to the question below.
Otherwise, move to the next bulleted question.
When the customer purchases supplies locally, are the

supplies manufactured locally, or are they imported and
then purchased from local representatives?
• If the answer to either of these questions is “yes,” has

the customer considered importing supplies directly?
• If the customer does not import directly because of
policy decisions or other technicalities, are there plans
to make changes? If there are, record this information
for follow-up during the next visit.
• If the customer does not import directly because of
purchasing terms, what payment terms will encourage
him or her to consider direct imports?
n Who are the customer’s largest suppliers? Be sure to get
this information for each product.
n In what countries are the suppliers located?
n Do the suppliers provide financing terms? Do the terms

meet this customer’s needs?
n Are the offshore suppliers also Citibank’s customers? If the

answer is “no,” ask if the customer objects to the bank’s
investigating the possibility of serving the needs of both
parties.
Other financial So far, we have questions for collecting information on our

needs customer’s products, the customer’s client and possible financing
opportunities, and the customer’s suppliers and possible financing
opportunities. The purpose of the next two questions is to identify
any other financial needs of the customer.
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n Does the customer need additional financing? If the answer

is “no,” investigate the supplier’s financing costs. Citibank
may be able to offer better financing.
n Which tenor is the customer seeking? If the tenor is

acceptable to the customer, investigate the amount needed,
payment schedule, etc.
Customer’s At this point, the Relationship Manager and/or Product Manager

current trade should know about the customer’s buying and selling processes,
practices
any offshore suppliers, and its financing terms. The next series of
questions focuses on the customer’s current trade practices.
n How many banks are involved in processing the customer’s

trade transactions and trade financings?
n How does the customer pay for imports? Are there any
offshore Demand Deposit Accounts (DDAs)?
n Does the customer collect the payments for the exports

locally and/or through an offshore DDA (e.g., NY, London)?
n Does the customer operate on open account, documentary

collections, or letters of credit basis?
n In terms of documentary collections and letters of credit,

do we have information on:
• Total annual volume?

• Number of trade transactions?
• Local banks used?
• Export credits the customer may be receiving (find
out from where, which banks are involved, and the
payment terms)?
• Pricing (including fees and minimum commission)?
Extraordinary The purpose of the next question is to identify any extraordinary
risks risks that might affect the Bank.
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n Does the customer plan any business expansion or new

investments that may raise medium-term financing for
capital goods?
Customer The final questions focus on customer service, which is always

service part of our ongoing efforts in assessing our customer’s needs.
n What are some of the trade-related needs that the customer

feels are not being properly serviced or that could be
improved?
n Is the customer satisfied with the way we provide services?

Are we fulfilling our customer’s expectations in terms of
timely and accurate services?
n Is there any other information the customer could provide

that would enable us to improve our services and add
value to our customer relationship?
Once the information-gathering process is completed, the next step

is to structure a solution that meets the customer’s needs and also
is profitable for the Bank. The structure of the solution is based on
Citibank’s product offerings.
KEY PRICING BENCHMARKS
Basic benchmarks that the Bank defines for a country and/or a

region, plus data from the market, must be considered in pricing the
solution that has been structured for the customer. These benchmarks
include:
n Minimum return on cross-border risk
n Expected return on assets
n Revenue to expense ratio
n Market quotations for similar risks
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Minimum Return on Cross-Border Risk
The movement of funds across borders introduces potential

difficulties in terms of currency management, exchange regulations,
taxation, and timing. Restrictions on moving funds out of a country
may occur as the result of economic problems, political instability,
or sovereign actions within the country. Citibank must assess the
size of cross-border risk (transfer and convertibility risks) associated
with each transaction and the amount the Bank needs to make on a
transaction in order to obtain a return on the risk.
Example: For example, in a pre-export financing, the seller (exporter) has a
Size of cross- firm contract of sale and needs financing to acquire and prepare
border risk
goods for shipment. The seller obtains a loan from the bank in the
importer’s country to prepare and ship the goods to the importer.
The importer will now have to repay the loan directly to the lending
bank in its country. This financing has a lower cross-border risk
because the proceeds from the importer are applied locally for the
repayment of the loan.
Consider now an import financing, where the buyer (importer) is

purchasing goods under a sight letter of credit and needs financing
to meet the required payment under the credit. There is a higher
cross-border risk because local funds must be converted into hard
currency and transferred offshore in repayment. These differences
are reflected in the size of the margin and the sublimits for the
different types of transactions.
Remember, Citibank in each country / region is assigned a cross-

border limit on the amount of funds that may carry cross-border risk.
Within each overall limit are sublimits for each type of product and
tenor. For instance, the cross-border trade limit for Brazil may be
$200MM, with $150MM designated for short-term trade (e.g.
$100MM for pre-export financing and $50MM for import financing)
and $50MM allocated to medium-term trade (e.g. $40MM for pre-
export financing for up to two years and $10MM for import
financing between 2 and 3 years).
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Expected Return on Assets
Measure use The second factor to consider in pricing is the expected return on
of assets to assets. This is the total shareholder equity calculated as a percentage
generate
of total assets. The return on assets ratio measures the Bank’s
earnings
performance in using assets to generate earnings. Banking laws in
all countries require a minimum assets-to-capital ratio.
The ratio is affected when assets are booked at a very low margin.
Citibank may be required to increase capital before it can book
additional assets when revenues do not increase the net worth in
proportion with the growing assets.
At the corporate level, the expected return on assets is implied in

the budget through the expected level of assets. At the country
level, the expected return on assets is implied through a minimum
return. Balance sheet ratios indicate the wealth of a company. It is
important for Citibank to keep a healthy return on assets ratio to
remain attractive to shareholders and investors.
Revenue-to-Expense Ratio
Expenses The revenue-to-expense ratio is another factor in pricing a product.

incurred to Externally, the Bank’s efficiency is measured by rapid and low-cost
produce
satisfaction of customer needs. Internally, efficiency is measured by
revenues
the amount of expenses incurred to produce a predefined level of
revenues.
Example For example, Citibank is trying to achieve a net revenue-to-expense
ratio of 4:1 (four dollars in revenues for each dollar spent). This net
figure represents a complex mix of products which includes labor-
intensive products such as trade transactions. The ratio for trade
products usually does not exceed 1.5:1 (one and a half dollars in
fees for each dollar in expenses). The less labor intensive products,
such as capital markets, can achieve a 10:1 ratio. When determining
price, it is important to consider all the processing that is required to
support a product.
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Market Quotations for Similar Risks
Monitor Citibank’s involvement in local markets requires constant

current market monitoring of current market conditions, which are used as a
conditions
benchmark to review, update, and optimize the Bank’s pricing.
Example For example, Citibank may decide that the minimum return on cross-
border risk is 4% per annum and that the Bank must charge a fee of
at least $2,000 for an import letter of credit to maintain an
acceptable revenue-to-expense ratio. If the market moves to a 3%
per annum spread and a $500 fee, the Bank can either lower its
prices or risk losing the business.
An alternative may be to improve the pricing by reducing the

costs associated with fees. This alternative involves a higher level
policy decision, possibly requiring a change in market strategy
followed by a strong, clear, accurate action plan.
At this stage, the product is defined and key benchmarks of pricing

are analyzed. Now, you must determine the right price to quote to
the customer.
PRICING GUIDELINES
Risk Identification
In simple terms, pricing is the placement of a dollar value on the

risks involved in a transaction. It is necessary to identify and
quantify the different risks associated with a transaction in order
to determine the price.
Questions that The following questions will help to identify the risks:
identify risk
n Is country risk involved?
n Is credit (commercial) risk involved?
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n Is a third-party risk involved?

(e.g., the confirmation of an export letter of credit)
n Is this a one-time quotation?

(e.g., a pre-export financing to be disbursed the
following week)
n Is the risk extended over a period of time?

(e.g., a quotation of $40MM of pre-export financing
to be disbursed within the next seven months)
The time element is particularly important in emerging economies

due to the high volatility of market prices. If the Bank sets the price
too low and market prices increase, the Bank may lose money. If the
price is too high, the customer may take his/her business elsewhere.
If volatility is high or the spread (interest increment charged over

LIBOR) is expected to increase, the quotation may be given with
the condition that the rate may be adjusted if market rates go over
“X”% of the quotation. Both parties would have to negotiate the
rate adjustment.
General Guidelines
Key points Use the following guidelines as a reference for pricing. They
to consider include the key points to be considered for the most commonly
used transactions.
Documentary Collections, Transfers, and Payment

Orders
For documentary collections, funds transfers, and payment orders:
n Quote a flat fee (e.g., $15 or $20 for a funds transfer) for
multiple, low-value operations. The fee works as a minimum
commission but, from a sales point of view, it is easier to
explain to the customer.
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n Quote a commission (e.g., 0.1%) with a minimum (e.g.,

$80 per item) when the value per transaction and number
of transactions is unknown, or very large, or when the
customer has a large volume of transactions with a wide
range of values.
When pricing the minimum commission, consider internal
costs (e.g., cost of handling the documentary collections, cost
of funds transfer, cost of payment order) which vary and
fluctuate from country to country. The Product Manager in
each country has this information.
n Use innovative pricing models, such as the global
commission, when the Bank knows the customer’s
business very well.
n Consider how much the customer currently is paying for
this product.
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Import Letters of Credit
For import letters of credit, the following considerations should be

addressed:
n ALADI — Does the letter of credit involve sovereign

exposure or is it an ALADI letter of credit? For ALADI there
is no cross-border risk since it is equivalent to a letter of
credit with local currency. The seller is paid in its country’s
local currency and the buyer pays in its country’s local
currency.
n “All-in” Quote — The “all-in” quote includes correspondent

bank charges. It is important to know the fees charged by the
correspondent banks since more customers are requesting
this type of quote.
n Global Finance MIS — This reporting allows the capture of

all customer-related revenues at a local level, irrespective of
the country from which it is collected, as well as the
corporation as a whole.
For an import letter of credit, the local branch, as the issuing
bank, charges for the commercial and country risks which
are implicit in the transaction. Additionally, Citibank abroad
receives advising, confirmation, and export credit negotiation
fees. As a result, the country’s local branch trade business
unit will be looking at the offshore revenue as “customer
revenue” not collected locally. This revenue assignment
should not be used to reduce the fees collected from the
importer for the risks Citibank is assuming locally.
n Out-of-pocket expenses — Who is going to pay the out-of-

pocket expenses (e.g., telexes, faxes, couriers, postage)? Are
they included in the pricing? If these expenses are included,
the customer should be notified that the quotation is free
and clear of any further charges. If these expenses are not
included in the quotation, the customer should be informed
that s/he will be charged for them.
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n “Flat fee” or per annum (p.a.) — The price for opening an

import letter of credit can be quoted either as a flat fee or on
a per annum basis. In the case of a flat fee, the customer will
pay a fixed percentage, e.g. 3%, of the total amount of the
letter of credit independent of its tenor. The correspondent
bank’s expenses may, or may not, be quoted as part of this
fixed fee structure. For instance, a bank that opens an import
letter of credit in the amount of $100M may charge a flat
fee of 3%, but does not include the correspondent bank’s
expenses. The issuing bank’s charge to the applicant would
be $100M 5 0.03 = $3M.
If we quote on a per annum basis, the calculation of the

charge will be based on the amount, spread, and tenor of the
transaction. For instance, if a bank charges 3% per annum
for a letter of credit for $100,000, and the validity period is
90 days plus 180 days of deferred payment, the total tenor
for this transaction will be 270 days.
The calculation of the charge for this transaction will be

(100,000 5 0.03 5 270) / 360 = 2,250.
The correspondent bank’s charges may be treated

independently unless we have some kind of agreement on
the cost to be charged by them.
Export Letters of Credit
When pricing export letters of credit, use the following guidelines:
n Advise and negotiation — If the credit is a large one with

multiple shipments and/or negotiations, the bank should
clearly state the number of negotiations included in the
quotation and the pricing for each additional negotiation.
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n Confirmation fees — It is important to know the bank

and the location of the confirming bank. There could be
a different quotation when a letter of credit is issued by
a different branch. The product managers can provide
assistance with this type of situation.
n Transferable L/C — The fee for a transferable letter of

credit should be indicated, even if it is a nominal fee.
n “All in” for the importer — When the opening branch

requests a quotation, items included in the quotation should
be stated. Charges, if any, that are to be collected separately
or based on volume (such as the negotiations) should also
be priced.
Trade Finance
In the trade finance area, the following information will help to

determine pricing.
n When LIBOR? — LIBOR is quoted when the tenor is fixed

(e.g. import financing). Prepayment of transactions priced on
LIBOR incurs a penalty fee plus the LIBOR differential for
the remaining period (charged by the treasury).
We further explain this in the example that follows.
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Example For instance, suppose a customer obtains $100M of import financing

for 180 days at 7.75% p.a. (LIBOR 5.75% p.a. plus a spread of 2.0%
p.a.). As a result, the bank’s treasury borrows funds from the money
market at 5.75% p.a. interest rate for 180 days. However, if the
customer decides to prepay the loan in 90 days, s/he may face two
opposing scenarios. If LIBOR for the remaining 90 days of the loan
is lower, i.e. 5.25% p.a., the treasury stands to lose 0.5% p.a. (5.75%
p.a. – 5.25% p.a.) since it borrowed at a higher rate from the local
money market and now the market is offering a lower rate. The
LIBOR differential of 0.5% p.a. will have to be charged back to the
customer: (100M 5 90 5 0.005) / 360 = $1.25M. On the other hand,
if LIBOR for the remaining 90 days
is the same (e.g. 5.75% p.a.) or higher, the treasury gains from the
transaction and will not charge any LIBOR differential to the
customer.
n When Prime? — The prime rate is quoted when the

repayment is tied to an event where the date cannot be
specifically determined — for example, a pre-export
financing. Revenue comes from the difference between the
pool rate (equivalent to LIBOR) and the prime plus spread.
The prime rate changes on a daily basis and may be lower
or higher than LIBOR.
n Guarantees and collateral — The risk of guarantees and

the value of collateral must be considered in the pricing.
n Market rates — How do Citibank’s rates compare to

current market rates?
n Innovation — The customer’s business should be reviewed

with the Product Manager to uncover tax advantages. Tax
savings to the customer may improve the bank’s price. Be
innovative!
n Floating and fixed rates — Part of the period may

be quoted based on a fixed rate (e.g. LIBOR) and the
remainder of the period based on the equivalent prime
rate (floating rate).
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Example Suppose a customer requests a 180-day pre-export financing in

which the total rate for 150 days is 7% p.a. (LIBOR 4% p.a. plus 3%
spread) and the remaining 30 days at prime* (6.5% p.a.) plus 1%
spread. During the first 150 days, the customer pays a fixed rate
of 7% p.a. of the amount of the loan. For the remaining 30 days, the
customer pays a floating rate since the prime varies on a day-to-
day basis. On Day 1 of the 30 days, the prime rate is 6.5% p.a., but
on Day 2 it could be 7% p.a., Day 3 7.15% p.a., and so on. If the
prime rate ends higher at the end of the 30 days, the customer pays
more for the loan than the initial rate quoted for the first 150 days.
* In this case, the prime is 6.0% p.a., not 6.5% p.a. — or the spread is 0.5% p.a. You must have the same
total rate of 7.00% p.a.
The idea is that when you price to the customer, you prepare the quotation based on current rates and the
differential; i.e.:
Day 1: LIBOR = 4.00% p.a., Prime = 6.50% p.a., and Spread = 3.00% p.a.
You will quote LIBOR plus spread: 4 + 3 = 7.00% p.a. for the first 150 days
For prime, we also have to achieve the 7.00% p.a.; so, the loan will be booked at prime plus spread:
6.5% p.a. + 0.50% p.a. = 7.00% p.a.
Both the customer and the bank run the risk of prime’s variation. If the prime goes up, the customer pays
more than expected for the loan; if the prime goes down, the bank gets less than expected.
n Bundled with transactions — For example, an attractive

L/C fee may be quoted if subsequent financing is to be
provided by the Bank. Take into account the aggregate
when more than one product is involved.
Selling Trade Paper
When selling trade papers (e.g. drafts, banker’s acceptance), it is

important to consider the following:
n Participations — The percentage of the Bank’s participation,

as well as the risks involved (country and/or commercial),
should be stated.
n Forfaiting — The quotation for selling the paper is what the

Bank will receive for the period accrued as of the date of sale.
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n Selling Export Credit Agencies (ECAs) — The market price

varies if a full comprehensive guarantee has been obtained.
The structured trade finance coordinator can guide the trade
officer through the process. Usually the paper is sold by the
United States or European distribution teams at Citibank who
are more acquainted with the market.
PRESENTING THE OFFER TO THE CUSTOMER
Once you have structured and priced the solution, you are ready to
present the proposal to the customer. In this section, we examine the
format and content of the initial letter sent to the customer — called
an “indicative offer.” It is an explanation of the Bank’s proposal
and not a commitment to provide financing. The indicative offer is
sometimes confirmed by a second letter, the “firm offer.”
Format of the To begin, it is important to use the correct stationery with the most
initial letter recent letterhead. The language should be direct and concise. Every
number must be checked to ensure that it is correct. All of the
conditions must be stated in the letter. Copies should be made
and distributed to all persons involved in the implementation and
delivery of the proposal.
Here is an explanation of the contents of the indicative offer letter

that can be found in the sample in Figure 5.1. A sample of a firm
offer may be seen in Figure 5.3.
Format of the Heading — The heading of the offering letter should include
indicative letter the date and the department from which the offer originates.
If the letterhead is printed, only the date is required.
Addressee — The offering letter must be addressed to the

correct person and department in the company to which the
offer is being made. If necessary, copies may be made for other
departments or persons involved in the transaction.
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Situation — A brief description of the situation should be in

the letter. For example, “During our meeting last Monday, we
discussed your need to export a certain amount of . . .”
Proposal statement — It is important to state that the letter is

a proposal. It will be effective and binding whenever signed
and agreed to by the customer or an authorized person from the
Bank.
Terms and conditions — The letter must state precise details on

the terms and conditions of the offer, such as tenor, pricing, and
legal vehicles involved. The price must include the costs, the
base rate for computing the interest, whether or not an advance
payment is required, and any other issues that relate to the price
and cost of the offering. This information may be included in the
body of the letter or in the Annex to the letter (see Figures 5.2
and 5.4).
Acceptance procedure — The letter must explain the procedure

for accepting the offer, important deadlines or milestones,
documents required, etc.
Signature — The offering letter must be signed by the

Relationship Manager or Product Manager. (Send a copy to
the Manager that did not sign the letter.)
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January 20, 1999
(Name and Title)

Tractores Butterfly
Address
City, State ZIP
Dear Mr. or Ms.:
At our last meeting, January 15, 1999, you stated that you were looking for an adequate
alternative of funding for your production of farm tractors for export. Your monthly
production is 30 farm tractors for the local market and 40 for export.
We discussed alternatives to the financing of raw materials for the production of 40

farm tractors. At this time, we would like to present a feasible option. Considering your
requirements, we think the most suitable product for your company is pre-export financing.
The enclosed terms and conditions are presented on an indicative basis only and are
subject to our own internal credit approvals and the current market situation at the time
of the contemplated financing. This proposal is not a commitment to provide financing.
It is an indication of the terms and conditions which we believe might be attractive based
on the current market situation. The availability of these terms and conditions depends on
the financial condition of Tractores Butterfly, the market, and political and regulatory
conditions at the time of any potential commitment.
If you agree with the attached terms and conditions, please sign and return a copy of
this letter of acknowledgment. This proposal expires on January 30, 1999, unless renewed
in writing.
We would appreciate the opportunity to work closely with you on this transaction and look
forward to hearing from you.
Yours sincerely,
Product Manager
cc: Relationship Manager
Figure 5.1: Indicative offer letter
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ANNEX
Summary of Indicative Terms and Conditions
Borrower / Exporter: Tractores Butterfly
Lender: Citibank N.A. or any of its subsidiaries or affiliates
Purpose: Financing for the production of 40 farm tractors for export
Type of Facility: Pre-export finance

Short-term facility
Principal Amount: Up to USD 1,200,000
Tenor: Up to 180 days
Interest Rate: 6 months LIBOR plus a margin of 2.25% per annum, payable
at maturity
Documentation: Promissory Note subscribed to by the borrower corresponding

to the repayment of principal and interest
Taxation: All amounts payable under the Facility will be paid free and
clear of all present and future taxes, withholding, duties, or
other deductions whatsoever.
Governing Law: New York
Figure 5.2: Annex to the indicative offer
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January 20, 1999
Name and Title

Tractores Butterfly
Address
City, State ZIP
Dear Mr. or Ms.:
You have requested Citibank to explore the possibility of arranging financing for the
production of 40 farm tractors for export.
In response to your request, we are pleased to confirm our offer, subject to your acceptance
of the enclosed summary of indicative terms and conditions, on the basis of which Citibank
N.A., or any of its affiliates and subsidiaries (“Citibank”), might be in the position to arrange
financing for the above project.
Please confirm your acceptance of the present offer by returning to us a copy of this letter by
close of the business day January 30th, 1999, at which time this offer shall otherwise expire.
We look forward to hearing from you.
Yours sincerely,
Figure 5.3: Firm offer letter
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ANNEX
Summary of Indicative Terms and Conditions
Borrower / Exporter: Tractores Butterfly
Lender: Citibank N.A. or any of its subsidiaries or affiliates
Purpose: Financing for the production of 40 farm tractors for export
Type of Facility: Pre-export finance

Short-term facility
Principal Amount: Up to USD 1,200,000
Tenor: Up to 180 days
Interest Rate: 6 months LIBOR plus a margin of 2.25% per annum,

payable at maturity
Documentation: Promissory Note subscribed to by the borrower corresponding

to the repayment of principal and interest
Taxation: All amounts payable under the Facility will be paid free and
clear of all present and future taxes, withholding, duties, or
other deductions whatsoever.
Governing Law: New York
Figure 5.4: Annex to firm offer
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UNIT SUMMARY
An important factor in developing trade-related business is to

recognize the needs of our existing customers and potential
customers. We began this unit by describing the internal sources for
information regarding existing customers. We also recommended a
series of questions for interviewing new customers. The questions
focused first on the customer’s business and then on the customer’s
clients and suppliers. The objective is to identify the customer’s
needs in order to structure the best solution to meet those needs.
We considered the factors that affect pricing: minimum return on

cross-border risk, expected return on assets, revenue to expense
ratio, and market quotations for similar risks. We discussed risks that
affect product pricing and presented guidelines for pricing the
different products. Finally, samples of letters for submitting and
confirming a proposal to the customer were explained and presented.
You have completed Unit 5, Identifying Customers’Needs and Pricing Solutions. Please
complete the Progress Check to test your understanding of the concepts and check your
answers with the Answer Key. If you answer any question incorrectly, please reread the
corresponding text to clarify your understanding.
After finishing the Progress Check, you will have completed this course on Basics of
Trade Services and Trade Finance. Congratulations! You may wish to duplicate several
sections of this unit to serve as quick references or reminders when you prepare to
interview new customers, work through the pricing process, and prepare the offer to
the customer. Good luck!
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þ PROGRESS CHECK 5
Directions: Determine the correct answer(s) to each question. Check your answers with
the Answer Key on the next page.
Question 1: Match each type of information about a potential customer with its internal
Citibank source. Write the number of the source on the line next to the type
of information.
_____ a) Industry analysis and research 1) Credit area
_____ b) Statistics on trade volumes 2) Trade product management unit
_____ c) Country trade reports 3) FINCON
_____ d) Product / customer revenues 4) Relationship or product manager
Question 2: An interview with a prospective customer occurs and questions are asked
to identify the prospect’s needs. Match the type of information the banker
is trying to uncover with the following questions. Write the number of the
type of information on the line next to the questions. You may use a number
more than once.
_____ a) What does the customer sell? How much is sold locally?
How much is exported?
_____ b) Does the customer purchase all supplies within the country?
_____ c) Does the customer offer financing terms to his/her buyers?
_____ d) Who are the customer’s offshore buyers?
_____ e) How does the customer pay for imports?
_____ f) How many banks does the customer use to process trade transactions?
_____ g) Does the customer feel that there are any trade-related needs that are
not being properly addressed?
1) Customer’s current trade practices
2) Product mix
3) Suppliers
4) Customer’s client
5) Financing to the customer’s client
6) Customer service
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ANSWER KEY
Question 1: Match each type of information about a potential customer with its internal
Citibank source.
1 a) Industry analysis and research 1) Credit area
4 b) Statistics on trade volumes 2) Trade product management unit
2 c) Country trade reports 3) FINCON
3 d) Product / customer revenues 4) Relationship or product manager
Question 2: An interview with a prospective customer occurs and questions are asked
to identify the prospect’s needs. Match the type of information the banker
is trying to uncover with the following questions. Write the number of the
type of information on the line next to the questions. You may use a number
more than once.
2 a) What does the customer sell? How much is sold locally? How much
is exported?
3 b) Does the customer purchase all supplies within the country?
5 c) Does the customer offer financing terms to his/her buyers?
4 d) Who are the customer’s offshore buyers?
1 e) How does the customer pay for imports?
1 f) How many banks does the customer use to process trade transactions?
6 g) Does the customer feel that there are any trade-related needs that are
not being properly addressed?
1) Customer’s current trade practices

2) Product mix
3) Suppliers
4) Customer’s client
5) Financing to the customer’s client
6) Customer service
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þ PROGRESS CHECK 5
(Continued)
Question 3: Identify the key benchmark associated with each of the following situations.
Write the number of the benchmark next to the situation.
_____ a) The banker evaluates current market conditions before pricing an
import letter of credit.
_____ b) The product most suitable for the customer is labor intensive for
the Bank.
_____ c) In a foreign exchange transaction, regulations may prohibit the
conversion of local funds to hard currency.
_____ d) If Citibank wants to book more assets, it may have to put up additional
capital.
1) Minimum return on cross-border risk

2) Expected rate of return on assets
3) Market quotations for similar risks
4) Revenue-to-expense ratio
statements.
_____ a) When pricing collections, transfers, or payment orders, quote a flat
fee for a large number of transactions.
_____ b) It is necessary to know if an import letter of credit involves sovereign
exposure.
_____ c) A local bank should reduce pricing for customers when it receives
offshore fees as “customer revenue” not collected locally.
_____ d) When the export credit is a large one with multiple negotiations, roll
the costs for each negotiation into one quoted figure.
_____ e) Use LIBOR when the tenor is fixed.
_____ f) When selling trade paper, the quotation for a forfait is what the bank
will receive for the period accrued as of the date of the sale of the paper.
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ANSWER KEY
Question 3: Identify the key benchmark associated with each of the following situations.
Write the number of the benchmark next to the situation.
3 a) The banker evaluates current market conditions before pricing an

import letter of credit.
4 b) The product most suitable for the customer is labor intensive for
the Bank.
1 c) In a foreign exchange transaction, regulations may prohibit the
conversion of local funds to hard currency.
2 d) If Citibank wants to book more assets, it must put up additional capital.
1) Minimum return on cross-border risk

2) Expected rate of return on assets
3) Market quotations for similar risks
4) Revenue-to-expense ratio
statements.
F a) When pricing collections, transfers, or payment orders, quote a flat

fee for a large number of transactions.
T b) It is necessary to know if the import letter of credit involves sovereign
exposure.
F c) A local bank should reduce pricing for customers when it receives
offshore fees as “customer revenue” not collected locally.
F d) When the export credit is a large one with multiple negotiations, roll
the costs for each negotiation into one quoted figure.
T e) Use LIBOR when the tenor is fixed.
T f) When selling trade paper, the quotation for a forfait is what the bank
will receive for the period accrued as of the date of the sale of the paper.
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þ PROGRESS CHECK 5
(Continued)
Question 5: The proposal is submitted to the customer via the offering letter. Which
of the following are included in the letter?
_____ a) Date and address of the department that is making the offer
_____ b) Letter should be addressed to the president of the company
_____ c) Explanation of the correct procedure for accepting the offer
_____ d) Base interest rate
_____ e) Letter must be printed on letterhead from the legal department
Question 6: A Peruvian exporter is selling textiles to Germany in the amount of USD

50 MM per annum. The export sales are cyclical and occur from May to
September. The exporter needs funds to produce the goods to be exported,
for an amount of USD 15 MM for 270 days. The Citibank branch in Peru
approved the credit, and the Relationship Manager (RM) confirmed the line
of credit with funds to be disbursed at LIBOR (6.0% p.a.) plus 2.0% p.a.
spread. The exporter may be able to repay part or all of the loan after the
first 180 days by using the proceeds from the shipments made during the
export cycle. What pre-export financing arrangement will best meet the
exporter’s needs? Assume that PRIME is 6.5% p.a.
_____ a) 180 days at LIBOR plus 2.00% p.a., 90 days at Prime plus 1.5% p.a.
_____ b) 270 days at LIBOR plus 2.00% p.a.
_____ c) 270 days at Prime plus 2.00% p.a.
_____ d) 270 days at Prime plus 1.50% p.a.
_____ e) 180 days at LIBOR plus 2.00% p.a.; 90 days with LIBOR differential
charged back to the customer if LIBOR rates go up.
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ANSWER KEY
Question 5: The proposal is submitted to the customer via the offering letter. Which
of the following are included in the letter?
a) Date and address of the department that is making the offer
c) Explanation of the correct procedure for accepting the offer
d) Base interest rate
Question 6: A Peruvian exporter is selling textiles to Germany in the amount of USD

50 MM per annum. The export sales are cyclical and occur from May to
September. The exporter needs funds to produce the goods to be exported,
for an amount of USD 15 MM for 270 days. The Citibank branch in Peru
approved the credit, and the Relationship Manager (RM) confirmed the line
of credit with funds to be disbursed at LIBOR (6.0% p.a.) plus 2.0% p.a.
spread. The exporter may be able to repay part or all of the loan after the
first 180 days by using the proceeds from the shipments made during the
export cycle. What pre-export financing arrangement will best meet the
exporter’s needs? Assume that PRIME is 6.5% p.a.
a) 180 days at LIBOR plus 2.00% p.a., 90 days at Prime plus 1.5% p.a.
This is the best alternative considering that the customer will be able to
repay after the first 180 days, because he has a fixed rate for the first
180 days, and has the volatility of the Prime rate only from day 181 to the
actual repayment date. Also, he does not have a prepayment fee, since he
is financing the second part at prime. The problem with answer (b) is the
prepayment penalties for the last 180 days, when the customer will be
applying the funds received for his exports.
Answer (c) is not the solution because of the spread. When we quote the
relation between Prime and LIBOR to customers, it must result in the same
total rate for the financing — in this case, 8.00% p.a. Unless specifically
stated
in the documentation, the rate is agreed for both periods beginning on Day
One.
You may have considered answer (d), but it is only partially correct in best
meeting the exporter’s needs because the exporter (in fact, both the bank
and the customer) is running the prime volatility for the whole period, instead
of only for those days from Day 181 to the actual repayment date.
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þ PROGRESS CHECK 5
(Continued)
Question 7: Which one of the following statements is true?
_____ a) For ALADI letters of credit, pricing must take into account the
added cross-border risk.
_____ b) For import letters of credit, an “all-in” quote includes correspondent
bank charges.
_____ c) For low-value, multiple funds transfers, a commission rate with a
minimum price should be quoted.
_____ d) Prime rate should be quoted when the tenor is fixed.
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ANSWER KEY
Question 7: Which one of the following statements is true?
b) For import letters of credit, an “all-in” quote includes correspondent

bank charges.
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Appendices
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APPENDIX A
GLOSSARY
Acceptance Time draft or bill of exchange that represents a promise

made by the buyer to honor the instrument at maturity. An
acceptance is created when the drawee places the word
“accepted” across the face of a draft, followed by the date
and signature of the acceptor.
Acceptance Component of acceptance financing cost which

Commission Rate compensates the bank for its assumption of credit risk
and covers the administrative costs of the transaction
Acceptance Discount to the face value of a draft in a banker’s

Discount Rate acceptance financing. This component of acceptance
financing represents the bank's charge for the use of funds
as well as the rate earned by the bank or an investor.
Acceptor Party that agrees unconditionally to pay the draft at

maturity
Advising Bank A bank in the beneficiary’s country — usually a

correspondent of the issuing bank — through which the
issuing bank communicates the credit to the beneficiary
All-In Quote A quotation to a customer that includes all fees charged by

the banks involved in a trade transaction, both local and
correspondent banks.
All-In Rate An interest rate quoted to a customer that contains all the
elements of the bank’s costs and profit built into that rate.
It is the total return the bank earns, and effectively
measures the customer’s true cost.
Allocating Citibank approval process for amount and type of business

Cross Border that can be done “cross border” with any particular country
Analysis Certificate Document used for mineral or chemical purchases to verify

the percentage of each component
Applicant Party (importer) that arranges for a Letter of Credit to be

issued
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A-2 GLOSSARY
Asociación Latino- Organization of Latin American countries that provides

Americana de members with a source of financing for Latin American
Integración (ALADI) intraregional trade
Assignment Instructions of the beneficiary to the paying bank to pay

of Proceeds all, or a portion of, the proceeds of a Letter of Credit to
a third party (assignee)
Aval Unconditional and irrevocable guarantee established
by signing a promissory note or bill of exchange. By
signing the note, the bank or other party commits itself to
pay should the drawee default.
Bank Secrecy US law that requires banks to file reports and keep records
Act (BSA) for five years on matters that are useful in investigations
of criminal, tax, and regulatory violations
Banker’s Time draft drawn by the buyer on a bank and accepted by

Acceptance the bank which will pay another party a stated amount on
a predetermined future date. In a banker’s acceptance,
payment at maturity is assured by a bank.
Bank-to-Bank A trade product that is used when the letter of credit

Reimbursement transaction between the applicant and beneficiary from
different countries is denominated in a third-country
currency, usually US dollars
Basic Information Document used for all new account openings in Latin
Report (BIR) America to indicate that the bank has followed the know-
your-customer policy, and that dealing with the customer
constitutes an acceptable, minimal risk
Beneficiary Party in whose favor the credit is issued (e.g. exporter

or seller). The beneficiary can draw funds from the
paying bank.
Bid Bond Instrument designed to ensure that the tenderer (e.g.,

supplier) will honor its commitment to a buyer when
bidding for a construction or supply contract
Bill of Exchange Unconditional order written from one person (the drawer)
to another person (the drawee), directing the drawee to
pay a certain sum at “sight,” or at a fixed or future date
to be determined, to the payee.
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GLOSSARY A-3
Bill of Lading Transportation or shipping document, issued by the

transportation company when moving goods, that provides
evidence of receipt of goods for shipment, a contract for
transportation, and documentary evidence of title on goods
Bond Instrument designed to ensure commitment made by one

party (the bank) to another party (the obligee) pledging to
cover for financial loss caused by the act of default of a
third party (the obligor – the bank’s customer)
Boycott Explicit or implied request by a company or individual

not to do business with certain persons or companies
Bundled with Pricing which takes into account the aggregate of products
Transactions sold to the customer
Buyer’s Credit A financing arrangement under which a lending bank in the

Financing supplier’s country lends directly to the buyer, or to a bank
in the buyer’s country, to enable the buyer to make
payments due to the supplier under the contract. The loan
is insured by an export credit agency, and the lending bank
usually receives a subsidy from its ECA.
Cash in Advance Payment method in which the seller receives cash from the
buyer before goods are shipped or services are rendered
Certificate Document that states where goods were manufactured or

of Origin grown
Channels The time required for preparation for shipment, transport,

of Trade receipt, and resale of goods
Citicorp A Citicorp subsidiary that underwrites trade-related

International Trade insurance (political risk, trade credit risk, and marine
Indemnity, Inc. (CITI) cargo) for Citicorp entities, corporate and bank customers,
and other entities who participate in the flow of capital
and commerce across borders
Clean Risk One hundred percent risk that one party has honored its
part of the deal and cannot withdraw payment before the
counterparty goes bankrupt and defaults
Commercial A fixed rate; typically the rate in effect at the time the ECA
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A-4 GLOSSARY
Interest Reference approves the export transaction as eligible for its support
Rate (CIRR)
Commercial Billing document issued by the seller and addressed to

Invoice the buyer that gives a description of the goods or services,
price, charges, etc.
Commercial Risk Possibility that the borrower is unable to generate sufficient

local currency to purchase the necessary amounts of
foreign currency to repay the financing
(see Credit Risk)
Compliance Compliance is the act of conforming to a rule or demand.

In banking, the term refers to conformance with legal
and regulatory obligations in the countries of business.
Confirming Bank The bank which, under instruction in a Letter of Credit,

adds its own irrevocable undertaking to that of the
issuing bank and assumes the ultimate obligation to
pay on the Letter of Credit
Consignee Importer or agent responsible for paying for goods if and

when they are sold
Consignment A method of payment for goods where the title of the

goods remains with the supplier / manufacturer until they
are sold by an agent or third party
Contingent Possibility that potential customer obligations will

Lending Risk become actual obligations and will not be settled on time
Contract Primary type of private insurance coverage for the

Frustration commercial and country risks of international trade; covers
non-payment resulting from specific country risks
Convertibility Risk Risk which exists in any transaction in which legal or

regulatory barriers prevent the borrower from converting
its local currency into the foreign currency required for
payment when the obligation in that currency matures.
Possibility that a local currency will not be convertible
to the currency needed to make payment to an exporter.
Correspondent A bank that provides services to another bank, including

funds transfers, trade transactions, and financings. In order
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GLOSSARY A-5
Bank to operate appropriately, at least one of them should hold

an account in the other one.
Counterparty Customer with whom the bank has a contract to

simultaneously pay agreed values at a stated future date
Counterparty Risk Possibility that a counterparty may default on a contract
Country Risk Possibility that the counterparty’s country may experience

political or economic instability that makes it impossible to
get money or physical assets out of that country (See also
Cross-Border Risk)
Country Risk Insurance issued to protect against losses resulting from

Insurance actions or inaction of a sovereign government
Credit Line Maximum amount that a bank’s customer is entitled to

borrow during any period of time. This amount enables
that customer to initiate various loan transactions as long
as their total amount does not go over, at any time, the
limit amount under the customer’s credit line.
Credit Risk Possibility that a borrower will be unable to repay a loan on

time or repay it in full (also known as Commercial Risk)
Cross-Border Risk A form of Country Risk (also includes Political

[Sovereign], Transfer, and Convertibility Risk)
Currency One of the reports required under the Bank Secrecy Act
Transaction (BSA) which Citicorp and all of its entities in the US must
Report (CTR) file with the Internal Revenue Service for every cash
deposit or withdrawal over $10,000
Deferred Payment See Payment, Deferred
Demand Deposit Account in which the depositor may withdraw funds when
Account (DDA) s/he wishes (on demand)
Deposit / Relending A funding mechanism for ECA-supported export financing

wherein the ECA lends to the bank which, in turn, relends
to a borrower-buyer (importer)
Direct Lending A funding mechanism for ECA-supported export financing

wherein the ECA lends directly to the buyer (importer);
therefore, there is no finance earning opportunity for the
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A-6 GLOSSARY
banks
Direct Lending Risk Possibility that customer obligations will not be settled
on time. It occurs in such products as loans, overdrafts,
credit cards, and mortgages.
Discrepancy Any variation or difference between the requirements of

the credit and what appears on the documents presented
for negotiation
Document Against The release of title documents to the buyer upon

Acceptance (D/A acceptance of a time draft
Collection)
Document Against The release of title documents to the buyer upon payment
Payment (D/P of a sight draft
Collection)
Documentary Collection method in which the goods are shipped to the

Collections buyer, and the bank retains custody of the title documents
and delivers them to the buyer when the buyer pays for
the goods or commits itself for the payment
Documentation Possibility that written instruments connected to a contract

Risk or transaction are incorrect, incomplete, or unenforceable
Draft A signed order by one party (the drawer) addressed to

another (the drawee) directing the drawee to pay a
specified sum of money to the order of a third person,
the payee (See Bill of Exchange)
Drawdowns Scheduled payments to be made to the borrower which are

set by the lending bank
Drawee The party on whom a bill of exchange, or draft, is drawn

and from which payment is expected. The drawee may
be an individual, a corporation, or a bank.
Drawer One who signs a draft or bill of exchange (usually the

seller, or beneficiary of a Letter of Credit)
EC See “European Community”
Eligible Banker’s Banker’s acceptance that meets certain criteria established

Acceptance by the US Federal Reserve Bank so that the issuing bank
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GLOSSARY A-7
does not have to maintain reserves against it
Endorsed / A signature on the back of a negotiable instrument made

Endorsement primarily for the purpose of transferring the rights of the
holder to another person
Eurodollars Currency in US dollars deposited in a bank outside the US

such as a foreign bank, an overseas bank of a US bank, or
an International Banking Facility
European Group of European countries that have joined together

Community (EC) to establish a common market which assures the free
movement of people, goods, services, and capital
Expiration Date The final date upon which conforming drafts and/or
documents under a Letter of Credit may be presented
to a bank for negotiation or payment
Export Legislation that imposes civil fines for violations of US

Administration anti-boycott laws and regulations
Act (EAA)
Export Credit Government agency that provides preferential financing

Agency (ECA) rates and terms for loans to foreign companies who buy
from local exporters
Export Financing Financing provided to the exporter (seller) for the period
between shipment of goods and receipt of payment from
the importer (buyer)
Export-Import Export credit agency of the US government that provides

Bank of the United credit support when competitive private financing is
States (EXIMBANK) unavailable. Its programs include guarantees, insurance,
and direct extensions of credit.
Exports Goods or services that a country sells to other countries
Firm Offer Letter confirming an indicative offer
Fixed Rate Remains constant for the life of the financing

of Interest
Floating Rate Adjusted periodically, usually semi-annually, on dates when

of Interest repayment installments of the loan principal are due
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A-8 GLOSSARY
Foreign Risk resulting from purchasing or selling goods at a price

Exchange Risk denominated in a currency other than that of the purchaser
or seller
Forfaiting Technique whereby the seller (exporter) can offer short-

or medium-term financing to an overseas buyer by selling
the buyer’s promissory notes, usually without recourse,
at a discount to a forfaiter. The forfaiter, in turn, sells the
notes in the secondary market. Also known as “a forfait.”
General Agreement Organization of over 100 member countries with a set of

on Tariffs and bilateral trade agreements created to abolish quotas and
Trade (GATT) reduce tariff duties among participating nations
Guarantee Written promise to carry out another party’s obligation in

the event of default
Guaranteed Loan Loan for which repayment is guaranteed by another party

other than the borrower
Guarantor Party who extends a guarantee
ICC International Chamber of Commerce
Image Risk Possibility that an activity of the bank, or one of its

representatives, will damage the reputation of Citibank
Import Financing Financing provided to the importer (buyer) so it can meet

its obligations with the exporter
Imports Goods and services that a country buys from other

countries
Indicative Offer Initial offering letter sent to a customer
Inspection Document issued by an independent third party when an

Certificate outside inspection is called for in the merchandise contract
Insurance A title document indicating proof of ownership by an

Document organization or individual with the rights to claim for
compensation in the event of damage or loss of
merchandise
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GLOSSARY A-9
Interest Make-Up A funding mechanism for ECA-supported export financing

wherein the ECA compensates a lending bank for the
difference between its cost of funding plus spread and
the fixed interest rate on the loan to the borrower
Interest Rate Percentage that the bank charges the customer for using
borrowed funds, usually quoted on an annual basis
Interest Rate Risk Possibility that the interest rate at which the seller borrows
to cover the period between shipment of goods and receipt
of funds may rise to the point where the transaction may
become unprofitable
International Bank A legal, financial entity of the World Bank which makes
for Reconstruction market-rate loans to newly industrialized countries by
and Development borrowing in the world capital markets
(IBRD)
International Separate group of accounts set up by a US bank, or a US

Banking branch of a foreign bank, to record international banking
Facility (IBF) transactions. An IBF is located in the US and may offer
deposits denominated in currencies other than the dollar
International A legal, financial entity of the World Bank which extends

Development assistance to the poorest developing countries on lenient
Association (IDA) terms (e.g., interest-free loans), largely from resources
provided by its wealthier members
International An affiliate of the World Bank, it is the world’s largest

Finance multilateral organization specifically structured to provide
Corporation (IFC) loans to — and equity investments in — private companies
in emerging markets
International A publication by the International Chamber of Commerce

Standby Practices (ICC) that provides guidelines for parties / participants in
(ISP) standby letter of credit transactions.
Inventory Financing provided to the exporter (seller) so it may hold

Financing readily marketable staples in storage and complete the
sale of these staples to an importer (buyer) within the
exporter’s country or overseas; the goods serve as
collateral for the loan
Irrevocable A term placed on an instrument to indicate that it can

only be amended or terminated prior to its expiration
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A-10 GLOSSARY
date with the consent of each party
Issuing or Bank that opens (issues) the credit at the request of its
Opening Bank customer (importer)
Know-Your- Policy that requires financial institutions to monitor

Customer Policy new and existing accounts to help identify suspicious
customer activity
Legal and Possibility that the bank may face civil, criminal, and
Regulatory Risk administrative proceedings because a transaction fails
to comply with all applicable laws and regulations
Lending Risk A category of credit risk which involves extensions

of credit and/or credit-sensitive products (loans and
overdrafts) where the bank takes the full risk for the
entire life of the transaction
Letter of Credit A method of payment for goods or services. Instrument

issued by a bank in favor of a beneficiary (seller) by which
the bank substitutes its own creditworthiness for that of
the applicant (e.g. buyer)
Letter of Credit, Two independent Letters of Credit used jointly to facilitate

Back-to-Back the purchase of the same goods
Letter of Credit, A letter of credit intended as a payment method for goods

Commercial or services
Letter of Credit, An irrevocable Letter of Credit to which another bank,

Confirmed usually in the country of the exporter, has added its
irrevocable commitment to honor drafts and documents
Letter of Credit, A revolving letter of credit is cumulative when the letter of

Cumulative credit becomes re-available as to amount or quantity. Any
portion not utilized may be accumulated for later use
depending upon the wording in the Letter of Credit
Letter of Credit, Letter of Credit opened by an overseas bank on behalf of

Export an overseas importer (buyer) in favor of a local exporter
as payment for local goods purchased
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GLOSSARY A-11
Letter of Credit, Letter of Credit opened by a local bank on behalf of a local

Import importer (buyer) in favor of an overseas exporter (seller)
to secure payment for foreign goods purchased
Letter of Credit, Letter of Credit that cannot be canceled or changed

Irrevocable without the consent of the issuing bank, confirming bank
(if the L/C is confirmed), and the beneficiary (seller)
Letter of Credit, Letter of Credit under which the issuing bank’s obligation
Negotiable extends to the drawer of the draft or any bona fide holder
thereof
Letter of Credit, See “Red Clause”

Red Clause
Letter of Credit, Letter of Credit that can be canceled or changed by the

Revocable issuing bank at any time, without notifying or obtaining
the consent of the buyer
Letter of Credit, Letter of Credit that, by its terms, renews its value over
Revolving a given period, either automatically or by amendment
Letter of Credit, A standby Letter of Credit secures a transaction or the

Standby performance of another party. A standby L/C is often used
in place of performance bonds or payment guarantees.
Letter of Credit, Letter of Credit under which the issuing bank’s obligation
Straight extends only to the Beneficiary
Letter of Credit, Letter of Credit that allows the beneficiary to transfer the
Transferable credit to a second beneficiary
Letter of Guarantee Written promise to carry out another party’s obligation in

the event of default. The letter of guarantee is the Middle
Eastern counterpart of a standby letter of credit
Leverage Power in a negotiation
Leveraged Returns Realizing greater revenue through use and management

of third party liabilities (credit) in a silent syndication deal
to transfer some of the risk
LIBOR London Interbank Offer Rate, interest cost to a bank to

obtain a deposit in the Eurodollar market
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A-12 GLOSSARY
Line of Credit The maximum amount which a customer is entitled to

borrow from a bank at any given time. This amount
allows a bank’s customer to undertake several lending
transactions as long as their total amount does not exceed,
at any given time, the amount granted under the line of
credit.
Lloyds of London 300-year old insurance association located in London
Macroeconomics The study of the economy as a whole, as opposed to

“microeconomics” which is the study of an individual firm,
commodity, or consuming unit
Money Laundering Investment or transfer of money from illegal sources into

legitimate channels so that the original source of the funds
cannot be traced
Money Laundering US law that makes money laundering a federal crime and
Control Act (MLCA) defines criminal offenses that are considered part of the
money laundering process
Multilateral Institutions established by governments whose purpose

Agencies (MLAs) is to maintain orderly international financial conditions and
to provide capital and advice for economic development,
particularly in those countries that lack
such resources to do it themselves. The World Bank is
an example of a multilateral agency.
Multilateral An affiliate of the World Bank which was established

Investment to encourage foreign direct investment in emerging
Guarantee market countries by providing investment guarantees
Agency (MIGA) and advisory services
Negotiable A term placed on an instrument (draft, Letter of Credit, or

other document) which allows the title to be transferred
from owner to owner by endorsement, usually evidenced
by the use of the words “order of” or “to the order”
Negotiable Instrument such as a bill of exchange, check, or promissory

Instrument note used as a payment device in international trade
Negotiating Bank A bank, usually unnamed in the Letter of Credit, which

elects to “negotiate” (purchase documents from, and
advance funds to, the beneficiary) against presentation
of the documents required by, and complying with, the
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GLOSSARY A-13
Letter of Credit terms. Negotiation may be made with

or without recourse.
Nonsovereign Loan made to a Citibank branch for subsequent relending

Funding to a local private borrower with an agreement that states
that the branch is obliged to repay the loan / deposit unless
some measure imposed by the local government prevents
funds from leaving the country
Nontariff Barrier Measure that restricts imports
North American 1994 agreement to facilitate the flow of goods and capital
Free Trade between the United States, Canada, and Mexico by
Agreement (NAFTA) creating a free trade zone among their territories
Offering Letter Letter containing a structure and price proposal
Office of Foreign US Dept. of Treasury office which publishes extensive lists

Assets Control of specially designated nationals, terrorists, and narcotics
(OFAC) traffickers whose assets must be blocked, even
if located outside the “blocked” country
Offshore Vehicle See Vehicle, Offshore
On Consignment A method of payment for goods where the title to goods

remains with the supplier / manufacturer until they are sold
by an agent or third party
Open Account Payment method in which the seller finances the buyer by
shipping the goods without receiving payment or a written
promise to pay.
Open Syndication Risk transfer technique in which the investing banks act
as a consortium and are disclosed to each other and to
the customer
Operational / Possibility of a systems (technology) or manual error which

Systems Risk may be internal and/or external to the bank
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A-14 GLOSSARY
Organization International organization of industrialized, market-

for Economic economy countries
Cooperation and
Development (OECD)
Overseas Private US government agency whose primary objective is

Investment to insure or guarantee US investment overseas in the
Corporation (OPIC) emerging markets
Packing List Document that indicates the contents of a package

being shipped
Pacto Andino Andean Pact, a 1969 agreement among Ecuador,

Colombia, Chile, Bolivia, and Venezuela to form a
Latin American common market within that region
Participation Trade financing structure with correspondent bank(s)

assuming a certain percentage of Citibank’s exposure
to the country and commercial risk of the borrower
Paying Bank Bank named in the Letter of Credit as the bank which
will pay, without recourse, upon receipt of documents
in compliance with the Letter of Credit terms
Payment, Deferred A Commercial Letter of Credit payable on a specified

future date. The beneficiary may present the complying
documents at an earlier date, but the Commercial Letter of
Credit is payable only on the specified future date
Payment, Sight A Commercial Letter of Credit is payable at sight when the

beneficiary presents the complying documents and if the
presentation takes place on or before the expiration of the
Commercial Letter of Credit
Performance Bond Instrument designed to ensure that the contractor (e.g.,

supplier) will perform and execute the contract in
accordance with all its terms and conditions
Performance Risk Possibility that an exporter may fail to perform under

the contract established with the importer
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GLOSSARY A-15
Political Possibility that the actions of a sovereign government

(Sovereign) Risk (e.g. nationalization or expropriation) or independent
events (e.g. wars, riots, civil disturbances) may affect
the ability of customers in that country to meet their
obligations to Citibank
Pre-Export Financing provided to the exporter (seller) with a firm

Financing contract sale in order to acquire and prepare goods for
shipment
Pre-Payment Pre-export financing offered by Citibank Brazil for

of Exports manufacturing expenses associated with goods to be
exported. Funding is advanced from an offshore vehicle,
the principal repaid by the importer, and interest repaid
by the exporter to the funding entity.
Pre-Settlement Possibility that a counterparty may default on a contractual

Risk (PSR) obligation to the bank before the settlement date of the
contract
Prime Rate Most favorable interest rate charged by a commercial bank

on short-term loans to its most creditworthy customers
Product Risk Possibility that the structure of a trade product or service

(e.g. Letter of Credit) is inadequate or faulty
Project Financing Financing, usually provided by multilateral agencies,

with the intention of bringing economic value to an
importer’s country. Such financing is extended on the basis
of projected cash flows instead of traditional forms of
collateral. Cash flows from the financed project are
expected to pay the interest and repay the principal
amount which originally supported the project.
Promissory Note A written promise committing the signer (borrower) to

pay a certain amount to the payee (lender) at a future date,
usually with interest
Quality Certificate Document that verifies that the merchandise to be shipped

agrees with the quality standards requested for that
product
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A-16 GLOSSARY
Quota Restriction on the quantity of specific products that can

be imported and exported
Receivables Amounts owed to a company
Recourse A term used on a negotiable instrument to indicate that

the drawer, or endorser, is liable to subsequent holders
for payment at maturity
Red Clause A provision in a Letter of Credit that provides for the

advance of funds to the beneficiary prior to the
presentation of the stipulated documents
Return on Assets Measure of the bank’s performance in using assets to

generate earnings independent of the financing of those
assets
Revocable A term placed on an instrument to indicate that it can

be modified or canceled without prior agreement from
each party
Risk Transfer This strategy involves the identification and use of

techniques for shifting the political and/or commercial risks
of international trade
Sanctions Economic measure adopted by one or several countries

to force a nation that is violating international law to
discontinue the offending behavior
Secured Loan Loan agreement that provides security to the bank by

means of pledged collateral
Security Document which links the collateral to a loan or credit

Agreement facility
Settlement Risk Possibility that the bank will deliver funds on the settlement
date of a contract, but not receive payment
Shipping Transport, commercial, and any official documents which

Documents are required by the exporter’s and importer’s countries to
certify the shipment of goods
Shipping Terms See Terms, Shipping
Sight Draft Draft payable upon proper presentation to the drawee
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GLOSSARY A-17
Sight Payment See Payment, Sight
Signature Books Security measure used by banks to verify customers’

signatures
Silent Syndication Risk transfer syndication in which the customer does not
know that there are other investors in the transaction
Society for A private international communication system used by the

Worldwide banks to transfer funds by wire
International
Financial
Telecommunications
(SWIFT)
Southern Cone Agreement between Argentina, Brazil, Paraguay, and

Common Market Uruguay to create a common market for the member
(MERCOSUR) countries
Sovereign Risk See “Political Risk”
Specially Person or company considered to represent the

Designated governments of sanctioned countries
National (SDN)
Standby Letter of Instrument that functions as a form of protection to cover

Credit, Guarantee performance, financial or non-financial obligation, under a
Type contract. It protects the beneficiary in the event that the
bank’s customer fails to perform under a contract which is
independent of the Letter of Credit
Standby Letter of Instrument that serves as a payment mechanism when an

Credit, Payment underlying obligation is due, typically in connection with
Type the repayment of money, including any instrument
evidencing an obligation to repay borrowed money (e.g.
promissory note)
Storage Financing Financing provided to US sellers for the storage of readily

marketable staples while their sale to US or foreign buyers
is completed
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A-18 GLOSSARY
Supplier Credit A financing arrangement under which the supplier agrees

Financing to accept deferred payment terms from the buyer, and
funds itself by discounting or selling the bills of exchange
or promissory notes so created with a bank in its own
country. Payment is guaranteed by an insurance policy
from an export credit agency.
Surety Bond Instrument designed to ensure financial compensation to

the buyer if the supplier does not perform contractually as
agreed
Syndication Loan made by several banks or lenders that form an

association to assume the responsibility and share the
risks of the loan
Tariff Tax placed on imported goods
Tenor The length of time a bill is drawn to run before

presentation for payment. The time between the date of
issue or acceptance of a note or draft and the maturity
date.
Term Loan Loan with a maturity greater than one year
Terms, Payment The terms under which a seller and buyer agree that the
exchange of goods for payment shall take place. Open
account, cash in advance, Letter of Credit, consignment,
and documentary collection are examples of common
payment terms.
Terms, Shipping Shipping terms stating, in abbreviated form, where the

seller’s responsibility for the goods ends and where the
buyer’s begins; i.e. F.O.B. (Free On Board)
Test Keys Security measure used by banks to establish authenticity of

instructions from bank to bank in a correspondent
relationship
Time Draft A draft payable at a fixed or determinable future date

after presentation to the drawee
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GLOSSARY A-19
Title Document A legal document indicating proof of ownership by an

organization or individual of a certain merchandise
Trade Acceptance A time draft drawn by the seller of goods on the buyer,
and accepted by the buyer, for payment at a specified
future date. In a trade acceptance, payment of the time
draft is not assured by a bank.
Trade Agreement Agreement between two or more countries concerning the

buying and selling of each country’s goods and services
Trade Credit Protects against political instability, the possibility of

Insurance regional or global economic problems, and natural disasters
Transfer Risk Possibility that a borrower is unable, due to legal or

other barriers, to transfer funds in the foreign currency
of payment to the place of payment when its obligation
in that currency matures
Transport A title document indicating proof of ownership by an

Document individual or organization toward the merchandise
described within the document; all types of documents
evidencing shipment or dispatch of goods, e.g. bill of
lading, air waybill
Uniform Customs A publication of the ICC that explains the responsibilities

and Practice for of merchants and bankers in the operation of Letters of
Documentary Credit
Credits (UCP)
Uniform Rules for A publication of the International Chamber of Commerce

Collections (URC) (ICC) that provides guidelines for parties / participants
involved in collections transactions
Unsecured Loan Loan not backed by a pledged collateral or security

agreement. Unsecured loans are granted on the financial
strength and reputation of the borrower.
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A-20 GLOSSARY
Usance Period Length of time allowed for payment
Vehicle, Offshore Facility used for booking international trade transactions.

It is not a separate banking entity, but a separate group of
accounts or bookkeeping systems set up by a US bank or a
US branch of a foreign bank to record international
banking transactions
Warehouse See “Inventory Financing”

Financing
Warehouse Receipt Title document stating that a warehouse company is

holding a certain quantity of a specific commodity. The
company will continue to hold these goods until the
warehouse receipt is exchanged for the merchandise.
Weight List Document that indicates the total gross and net weights
of the cargo
With Recourse Term used on an instrument or endorsement to indicate

that the drawer or endorser is liable to subsequent holders
for payment at maturity
Without Recourse Term used on a negotiable instrument to indicate that the

drawer or endorser is not liable to subsequent holders for
payment at maturity
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Index
Appendix B
INDEX
A
Acceptance 2-17, 2-36, 2-37, 3-12, 3-24— 3-29, 3-32, 5-20
Acceptance Commission Rate 3-26, 3-27
Acceptance Discount Rate 3-26
Acceptor 3-24
Advising Bank 2-31, 2-34, 2-35, 2-44— 2-46, 2-52, 2-53, 2-57, 4-7, 5-14
Aging Certificate
All-In Quote 5-14, 5-33, 5-34
All-In Rate 3-27, 3-45
Allocating Cross Border 3-54, 4-10, 4-11
Analysis Certificate 2-78
Applicant 2-31, 2-32, 2-34, 2-35, 2-37, 2-40, 2-42, 2-43, 2-45, 2-46,
2-48, 2-49, 2-51— 2-53, 2-56— 2-58, 3-25, 4-7, 5-15
Asociación Latino-Americana 1-10, 1-12, 5-14
de Integración (ALADI)
Assignment of Proceeds 2-39, 2-41, 2-42
Aval 3-24, 3-31— 2-33, 2-35
B
Bank Secrecy Act (BSA) 4-41, 4-42
Banker’s Acceptance 2-74, 3-1, 3-23, 3-25— 3-29, 3-34, 3-36, 3-41, 3-55, 3-60, 4-
3, 4-7, 4-8, 4-34, 4-41, 5-18
Bank-to-Bank Reimbursement 4-7, 4-8, 4-34
Basic Information Report (BIR) 4-43, 5-3
Beneficiary 2-31, 2-32— 2-49, 2-51— 2-53, 2-55— 2-58, 2-73, 3-25, 3-
36, 3-48, 4-7, 4-14
Bid Bond 2-48, 2-55, 2-56, 2-65, 2-66, 2-69, 2-70
Bill of Exchange 2-73, 2-74, 2-78, 3-24, 3-29, 3-31, 3-33, 3-48
Bill of Lading 2-75, 2-78
Bond 2-49, 2-50, 2-54, 2-55, 2-56, 2-65, 2-66, 2-69
Boycott 4-1, 4-8, 4-33, 4-34, 4-36— 4-39, 4-43, 4-44
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B-2 INDEX
B (Continued)
Bundled with Transactions 5-18
Buyer’s Credit Financing 3-47, 3-53, 3-54
C
Cash in Advance 2-3— 2-5, 2-9, 2-18
Certificate of Origin 2-77
Channels of Trade 3-27
Citicorp International Trade 3-51, 3-54, 4-16, 4-19, 4-20, 4-43
Indemnity, Inc. (CITI)
Clean Risk 3-54
Commercial Interest Reference 3-45
Rate (CIRR)
Commercial Invoice 2-12— 2-14, 2-75, 2-77, 2-78
Commercial Risk 1-16, 2-4, 2-5, 2-10, 2-11, 2-16, 2-17, 2-39, 2-43, 2-45,
2-51, 2-53, 3-24, 3-46, 3-51, 3-53, 3-54, 3-56— 3-60, 4-3,
4-10, 4-12, 4-13, 4-15— 4-20, 5-12, 5-14, 5-18
Compliance 2-35, 2-45, 4-1, 4-8, 4-33, 4-34, 4-39, 4-43, 4-44, 5-1
Confirming Bank 2-31, 2-32, 2-35, 2-38— 2-40, 2-44— 2-46, 2-52, 2-53, 2-57,
3-57, 5-16
Consignee 2-9— 2-11
Consignment 2-3, 2-9— 2-11, 2-18
Contingent Lending Risk 4-2, 4-3, 4-21
Contract Frustration 3-52, 4-15
Convertibility Risk 2-56, 3-3, 3-59, 4-2, 4-5, 4-6, 4-10, 4-13, 4-18, 4-21, 5-9
Correspondent Bank 2-55, 3-1, 3-55— 3-60, 5-14, 5-15
Counterparty 4-3, 4-4, 4-13
Counterparty Risk 3-8, 4-14, 4-21
Country Risk 1-13, 1-16, 2-4, 2-7, 2-9, 2-17, 2-39, 2-43— 2-45, 2-51— 2-53,
2-57, 2-58, 3-3, 3-6, 3-29, 3-34, 3-35, 3-41, 3-42, 3-44, 3-46,
3-51— 3-54, 3-56— 3-60, 4-2, 4-4, 4-5, 4-7, 4-10— 4-12,
4-15— 4-22, 4-43, 5-12, 5-14, 5-18
Country Risk Insurance 4-15, 4-43
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INDEX B-3
C (Continued)
Credit Line 3-7, 3-11, 4-11
Credit Risk 2-4, 2-5, 2-9— 2-11, 2-16, 2-42— 2-45, 2-51— 2-53, 2-57, 3-5,
3-26, 3-28, 3-29, 3-34, 3-35, 3-42, 3-46, 3-52, 4-2— 4-4, 4-7,
4-9, 4-10, 4-13, 4-15, 4-16, 4-21, 5-12
Cross-Border Risk 2-1, 2-7, 2-8, 2-10, 2-11, 2-16, 2-39, 2-57, 3-3, 4-2, 4-4— 4-6,
4-10— 4-13, 4-21, 4-43, 5-9— 5-11, 5-14, 5-25
Currency Transaction 4-42
Report (CTR)
D
Deferred Payment See “Payment, Deferred”
Demand Deposit Account (DDA) 5-7
Deposit / Relending 3-43, 3-44, 3-60
Direct Lending 1-13, 3-43, 4-11
Direct Lending Risk 4-2— 4-4, 4-21
Discrepancy 2-33
Document Against Acceptance 2-14, 2-15, 3-13
(D/A Collection)
Document Against Payment 2-3, 2-9, 2-12, 2-13, 2-15— 2-18, 3-24, 4-7, 4-8,
(D/P Collection) 4-34, 4-41, 5-13
Documentary Collections 2-3, 2-9, 2-12, 2-13, 2-15— 2-18, 3-24, 4-7, 4-8,
4-34, 4-41, 5-13
Documentation Risk 4-2, 4-7, 4-8, 4-13, 4-21
Draft 2-6, 2-12— 2-15, 2-17, 2-37, 2-38, 2-45, 2-53, 2-73, 2-
74, 2-78, 3-23— 3-26, 3-28, 3-31, 3-32, 3-35, 3-52, 3-
53, 5-18
Drawdowns 3-7
Drawee 2-73, 3-24, 3-33
Drawer 2-73, 3-26
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B-4 INDEX
E
EC See “European Community”
Eligible Banker’s Acceptance 3-13, 3-27, 3-28
Endorsed / Endorsement 2-17, 2-49, 2-76
Eurodollars 3-4, 3-5, 3-15
European Community (EC) 1-1, 1-5— 1-7, 1-9
Expiration Date 2-32, 2-41
Export Administration Act (EAA) 4-37, 4-38
Export Credit Agency (ECA) 1-1, 1-6, 1-12, 1-13, 1-15, 1-17, 3-10, 3-23, 3-36, 3-41—
3-55, 3-60, 4-14, 4-16, 4-17, 4-22, 4-43, 5-19
Export Financing 1-13, 1-15, 3-1, 3-9— 3-13, 3-23, 3-25, 3-36, 3-41, 3-43,
3-46, 3-48, 3-50— 3-52, 3-55, 3-58, 3-60, 4-18, 5-22— 5-24
Export-Import Bank of the 3-43, 3-50, 3-54, 4-17, 4-19, 4-20
United States (EXIMBANK)
Exports 1-1, 1-5, 1-6, 1-12, 1-13, 1-17, 2-7, 2-45, 3-41, 4-11, 4-16,
4-37, 5-2, 5-4, 5-7
F
Firm Offer 3-32, 5-19, 5-23, 5-24
Fixed Rate of Interest 3-4, 3-5, 3-34, 3-42, 3-44, 3-45, 5-17, 5-18
Floating Rate of Interest 2-8, 3-4, 3-5, 3-44, 3-45, 5-17, 5-18
Foreign Exchange Risk 1-16, 2-7, 2-8, 2-10, 2-11, 2-16, 2-17, 2-43, 2-45, 2-51, 2-53, 2-
57, 2-58
Forfaiting 3-1, 3-23, 3-29— 3-36, 3-41, 3-53— 3-55, 3-59, 3-60, 4-17,
4-18, 4-22, 4-43, 5-18
G
General Agreement on Tariffs 1-5, 1-10, 1-11
and Trade (GATT)
Guarantee 1-8, 1-11— 1-13, 1-15, 2-39, 2-47, 2-48, 2-54, 2-56, 3-24,
3-29— 3-31, 3-33, 3-35, 3-42, 3-44, 3-46— 3-48, 3-50, 3-51,
3-53, 3-54, 3-60, 4-15— 4-17, 4-22, 5-17, 5-19
Guaranteed Loan 3-6
Guarantor 3-6, 3-30, 3-35
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INDEX B-5
I
ICC 1-2, 2-18, 2-33, 2-34
Image Risk 4-2, 4-7, 4-21
Import Financing 3-11, 3-13, 3-52, 3-58, 5-10, 5-16, 5-17
Imports 1-4, 1-5, 1-12, 1-13, 2-7, 2-9, 5-2, 5-6, 5-7
Indicative Offer 5-19, 5-21— 5-24
Ineligible Banker’s Acceptance 3-27, 3-28
Inspection Certificate 2-77, 2-78
Insurance Document 2-6, 2-75, 2-76, 2-79
Interest Make-Up 3-43— 3-45, 3-50, 3-60
Interest Rate 1-13, 2-8, 3-4— 3-6, 3-14, 3-25, 3-31, 3-35, 3-42, 3-44, 3-45, 3-
54, 3-60, 5-17, 5-22, 5-24
Interest Rate Risk 2-8, 2-16, 2-17, 3-35
International Bank for 1-14
Reconstruction and
Development (IBRD)
International Banking 3-4, 3-8, 3-12, 3-58, 4-6
Facility (IBF)
International Development 1-14
Association (IDA)
International Finance 1-14, 1-15
Corporation (IFC)
International Standby Practices 2-33
(ISP)
Inventory Financing 3-11, 3-14
Irrevocable 2-32, 2-38, 2-47— 2-49, 2-57, 3-31
Issuing or Opening Bank 2-31— 2-35, 2-37— 2-46, 2-51— 2-54, 2-57, 2-58, 4-7, 4-13,
4-38, 5-14— 5-16
K
Know-Your-Customer Policy 4-42
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B-6 INDEX
L
Legal and Regulatory Risk 3-28, 4-2, 4-7, 4-8, 4-10, 4-21, 4-33
Lending Risk 3-3, 4-2— 4-4, 4-21
Letter of Credit 2-31— 2-44, 2-46— 2-48, 2-51, 2-52, 2-56— 2-58, 2-73,
2-74, 2-76, 3-13, 3-25, 3-34, 3-56, 3-57, 3-60, 4-7, 4-13,
4-17, 4-37, 4-39, 5-5, 5-10, 5-14— 5-16
Letter of Credit, Back-to-Back 2-39— 2-41
Letter of Credit, Commercial 2-1, 2-33— 2-37, 2-39, 2-42, 2-45, 2-47, 2-58, 3-58
Letter of Credit, Confirmed 2-32, 2-38, 2-39, 2-43, 2-51, 2-57, 2-58, 3-57, 3-58, 3-61, 4-
11, 4-13, 4-17
Letter of Credit, Cumulative 2-39
Letter of Credit, Export 2-46, 5-12
Letter of Credit, Import 2-46, 5-11, 5-14, 5-15
Letter of Credit, Irrevocable 2-32, 2-37— 2-40, 2-47— 2-49, 2-57
Letter of Credit, Negotiable 2-37, 2-38
Letter of Credit, Red Clause See “Red Clause”
Letter of Credit, Revocable 2-32, 2-47— 2-49, 2-57
Letter of Credit, Revolving 2-39
Letter of Credit, Standby 2-1, 2-33, 2-47— 2-53, 2-56, 2-58
Letter of Credit, Straight 2-37
Letter of Credit, Transferable 2-39, 2-41, 2-42
Letter of Guarantee 2-54, 2-56, 3-33
Leverage 2-1, 2-3, 2-5, 3-54
Leveraged Returns 4-21
LIBOR 3-5, 3-44, 3-45, 5-13, 5-16— 5-18, 5-22, 5-24
Line of Credit 3-7, 3-11, 4-11
Lloyds of London 3-51, 4-16, 4-43
M
Macroeconomics 1-9, 3-51
Money Laundering 4-1, 4-33, 4-34, 4-41, 4-42, 4-44
Money Laundering Control Act 4-41, 4-42
(MLCA)
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INDEX B-7
M (Continued)
Multilateral Agencies (MLAs) 1-1, 1-6, 1-12— 1-15, 1-17, 3-41, 3-50, 3-51, 3-55, 3-61
Multilateral Investment 1-14, 1-15

Guarantee Agency (MIGA)
N
Negotiable 2-17, 2-76, 3-28, 3-30, 3-31
Negotiable Instrument 2-17, 2-18, 2-74
Negotiating Bank 2-37, 2-38, 2-44— 2-46, 2-57, 2-74, 4-7
Nonsovereign Funding 3-57— 3-59, 3-61
Nontariff Barrier 1-3— 1-5, 1-17
North American Free Trade 1-5, 1-6, 1-8
Agreement (NAFTA)
O
Offering Letter 5-1, 5-19, 5-20
Office of Foreign Assets 4-35, 4-36

Control (OFAC)
Offshore Vehicle See “Vehicle, Offshore”
On Consignment 2-3, 2-9— 2-11, 2-18
Open Account 2-3, 2-4, 2-6— 2-9, 2-18, 3-13, 5-7
Open Syndication 4-14
Operational / Systems Risk 2-16, 2-18, 2-40, 2-43— 2-45, 2-52, 2-53, 2-57, 3-28, 4-2,
4-7, 4-8, 4-21
Organization for Economic 3-49, 3-50

Cooperation and Development
(OECD)
Overseas Private Investment 1-15, 1-16
Corporation (OPIC)
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B-8 INDEX
P
Packing List 2-77
Pacto Andino 1-5, 1-6, 1-9, 1-10, 1-17
Participation 1-8, 3-57, 3-60, 3-61, 5-18
Paying Bank 2-31, 2-33, 2-35, 2-37, 2-40, 2-42, 2-44— 2-46, 2-52, 2-53, 2-
57, 3-25, 3-26
Payment, Deferred 2-36, 2-67, 2-68
Payment, Sight 2-36, 2-67, 2-68
Performance Bond 2-48, 2-55, 2-56, 2-69, 2-70, 4-15
Performance Risk 4-2, 4-7, 4-9, 4-21
Political (Sovereign) Risk 2-1, 2-4, 2-5, 2-7, 3-3, 3-60, 4-2, 4-4, 4-5, 4-10— 4-12,
4-16, 4-18, 4-19, 4-21, 4-43, 5-9
Pre-Export Financing 3-11, 3-14, 3-28, 5-9, 5-10, 5-12, 5-17, 5-18, 5-21, 5-22, 5-
24
Pre-Payment of Exports 3-12
Presettlement Risk (PSR) 4-2, 4-4, 4-21
Prime Rate 3-4, 3-5, 3-28, 5-17, 5-18
Product Risk 4-2, 4-7
Project Financing 1-15, 3-41, 3-50, 3-51, 5-23
Promissory Note 2-6, 2-73, 2-74, 2-78, 3-7, 3-29— 3-33, 3-35, 3-36, 3-48, 3-
53, 3-58, 3-59, 5-22, 5-24
Q
Quality Certificate 2-77, 2-78
Quota 1-3, 1-5, 1-11, 1-17, 4-10
R
Receivables 2-43, 3-11, 3-14, 3-48, 4-15, 4-17— 4-19
Recourse 2-38, 2-53, 4-19
Red Clause 2-39, 2-40
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INDEX B-9
R (Continued)
Return on Assets 4-21, 5-9, 5-10, 5-25
Revocable 2-32, 2-47, 2-49, 2-50, 2-57
Risk Transfer 3-52, 4-12— 4-14, 4-17, 4-18, 4-20, 4-21, 4-43
S
Sanctions 4-1, 4-8, 4-33— 4-36, 4-39, 4-43, 4-44
Secured Loan 3-6, 3-13
Security Agreement 3-6
Settlement Risk 4-2, 4-4, 4-21
Shipping Documents 2-33, 2-47, 2-75, 2-78, 3-12, 3-33
Shipping Terms See “Terms, Shipping”
Sight Draft 2-13, 2-49, 2-74, 3-23
Sight Payment See “Payment, Sight”
Signature Books 3-56
Silent Syndication 4-13, 4-20, 4-21
Society for Worldwide 4-8
International Financial
Telecommunications (SWIFT)
Southern Cone Common Market 1-5, 1-6, 1-9
(MERCOSUR)
Sovereign Risk 2-4, 3-3, 4-5, 4-10
Specially Designated National 4-35
(SDN)
Standby Letter of Credit, 2-47, 2-48, 2-50, 2-69, 2-70
Guarantee Type
Standby Letter of Credit, 2-47, 2-49, 2-50, 2-69, 2-70
Payment Type
Storage Financing 3-13
Supplier Credit Financing 3-10, 3-11, 3-13, 3-47, 3-48, 3-50, 3-61, 4-12— 4-14, 4-20— 4-
22, 4-43
Surety Bond 2-48, 2-50, 2-51, 2-55
Syndication 3-6, 3-8
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B-10 INDEX
T
Tariff 1-3— 1-5, 1-7, 1-9, 1-10, 1-11, 1-17
Tenor 3-5, 3-12, 3-27, 3-28, 4-11, 4-20, 5-5, 5-7, 5-10, 5-15, 5-16, 5-
20, 5-22, 5-24
Term Loan 1-13, 1-16, 3-4, 3-6, 3-7
Terms, Payment 2-2, 2-3, 2-9, 2-32, 5-6, 5-8
Terms, Shipping 2-34
Test Keys 3-56
Time Draft 2-14, 2-15, 2-17, 2-37, 2-74, 3-24, 3-25, 3-36
Title Document 2-6, 2-12, 2-16— 2-18, 2-45, 2-75, 3-13
Trade Acceptance 3-24, 3-36
Trade Agreement 1-1, 1-5, 1-6, 1-10, 1-11, 1-17
Trade Credit Insurance 4-15, 4-43
Transfer Risk 2-57, 3-3, 3-4, 3-60, 4-1, 4-2, 4-5, 4-6, 4-14, 5-9
Transport Document 2-6
U
Uniform Rules for Collections 2-18
(URC)
Uniform Customs and Practice 2-33
for Documentary Credits (UCP)
Unsecured Loan 3-6
Usance Period 3-24
Vehicle, Offshore 3-4, 3-8, 3-12
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INDEX B-11
W
Warehouse Financing 3-13
Warehouse Receipt 3-13
Weight List 2-77
With Recourse 5-5
Without Recourse 2-31, 2-37, 2-38, 3-24, 3-29, 3-30, 3-33, 4-17
v01/20/99 v-2.1
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Basics of Trade Services and Trade Finance January 1999

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Basics of Trade Services

and Trade Finance

Basics of Trade Services

This workbook is the product of, and

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Unit 1: The Trade Environment (Continued)

Overseas Private Investment Corporation (OPIC) ............... 1-15

Unit 2: Trade Services

Unit 2: Trade Services (Continued)

Unit 3: Trade Finance

Pre-Export Financing................................................................................ 3-11

Export Finance: Structuring the Deal .................................................................. 3-52

Unit 4: Risk and Compliance

Unit 4: Risk and Compliance (Continued)

Risks in a Trade Finance Transaction ........................................................ 4-9

Unit 4: Risk and Compliance (Continued)

Avoiding Problems........................................................................ 4-42

Unit 5: Identifying Customers’Needs and Pricing Solutions

(This page is intentionally blank)

When you complete this workbook, you will be able to:

• Understand the global trade environment

• Recognize trade agreements, organizations, and other factors that

• Recognize the documents required for trade transactions

• Identify Citibank trade products and services

• Understand the role of correspondent banks and export credit agencies

• Identify the risks involved in trade transactions and understand how

• Recognize trade compliance issues and key regulations / legislation

Objectives – which point out important elements in the

Text – which is the “heart” of the workbook. This

Key Terms – which also appear in the Glossary. They

Instructional terms or phrases in the left margin which

þ Progress Checks – which do exactly what they say — check

In addition to these unit elements, the workbook includes:

Appendix A, Which contains definitions of all key terms

Appendix B, Which helps you locate glossary items in the

UNIT 1 – The Trade Environment

UNIT 2 – Trade Services

UNIT 3 – Trade Finance

UNIT 4 – Risk and Compliance

UNIT 5 – Identifying Customers’ Needs and Pricing Solutions

(This page is intentionally blank)

At Citibank, we strive to be the most competent, profitable, and innovative financial

When you complete Unit 1, you will be able to:

In the past, trade was conducted directly between countries. Today,

n Reinforce their individual strengths

n Strengthen their positions in the trade environment

To support the global interests of their customers, banks either have

Political issues (e.g. civil wars, riots, political unrest, and

Basic differences in the business philosophies of eastern and

When conducting business in the world marketplace, we must

Legal issues that affect business include licensing arrangements,

As we mentioned earlier, political, business, social, and legal issues

FACTORS THAT RESTRICT GLOBAL TRADE

Most countries appear to conform to international principles

n Discriminate, if they apply unequally to products of

n Retaliate, if they are designed to compel another country to

Example The tariff imposed on Japanese motorcycles is an example of a

Import- Nontariff barriers consist of a variety of measures that restrict

Export quotas are set for reasons of national defense, economic

FACTORS THAT PROMOTE GLOBAL TRADE

The current trend in international trade is to open markets that

n Trade agreements that were created to encourage

n Trade agreements / organizations (GATT and ALADI)

n Government and multilateral agencies (MLAs), through