Trade Finance

- An International Finance Presentation

Group 2: Ayan Bose (07) Sunmeet Kaur (21) Tanushree Maheswari (31) Meenu Mittal (34) Devyani Pradhan (39) Ketan Shah (45)

Agenda
Export Facilities
Pre- Shipment Finance Post-Shipment Finance

Documentary Credit Documentary Collections

Clean Collections Documentary Collections

Factoring Forfaiting Foreign Exchange Contract Marine Cargo Insurance

Pre-Shipment Finance
Working capital finance extended to an exporter for the purchase of raw materials, processing, manufacturing, assembling and/or packing of goods meant for export. It is popularly known as packing credit.

Pre-shipment Finance - Forms

Pre-shipment finance is extended in the following forms : Packing Credit in Indian Rupee Packing Credit in Foreign Currency (PCFC)

Pre-Shipment Finance-Period of Advance

Depend upon the circumstances of the individual case, such as the time required for procuring, manufacturing or processing (where necessary) and shipping the relative goods / rendering of services. If pre-shipment advances are not adjusted by submission of export documents within 360 days from the date of advance, the advances will cease to qualify for concessive rate of interest to the exporter. RBI would provide refinance only for a period not exceeding 180 days.

Eligibility for Packing Credit

Available to all exporters, merchant exporters or export houses, manufacturer exporter, manufacturers of goods supplying to Export Houses An exporter should usually hold an export order or letter of credit in his own name to perform an export contract.
Exporter should not be in the caution list of RBI Running Account Holders are also eligible to this facility

Pre-Shipment Finance-Quantum of Finance

The advance should not exceed the FOB value of the goods or their domestic cost, which ever is less. Disbursement of Packing Credit: Advances should not be disbursed in lump sum amounts, instead they should be disbursed in a phased manner taking into account specific purpose and needs of the exporter, shipment schedules, production cycle and other aspects. Each packing credit sanctioned is to be maintained as separate account for the purpose of monitoring period of sanction and end-use of funds.

Pre-Shipment: Liquidation of Finance

Proceeds of bills drawn for the exported commodities on its purchase, discount etc. (conversion of pre shipment credit into postshipment credit). Repaid/prepaid out of balances in EEFC A/c

Pre-shipment Credit Foreign Currency (PCFC)

The Scheme is an additional window for providing preshipment credit. The objective is to make credit available to exporters at internationally competitive rates. It will be applicable to only cash exports. To enable the exporters to have operational flexibility, it will be in order for banks to extend PCFC in one convertible currency in respect of an export order invoiced in another convertible currency. For example, an exporter can avail of PCFC in US Dollar against an export order invoiced in Euro. The risk and cost of cross currency transaction will be that of the exporter.

Source of Funds for Banks

The foreign currency balances available with the bank in Exchange Earners Foreign Currency (EEFC) Account, Resident Foreign Currency Accounts RFC(D) and Foreign Currency (Non-Resident) Accounts (Banks) Scheme. Foreign currency borrowings Spread - The lending rate to the exporter should not exceed 1.00 percent over LIBOR excluding withholding tax. LIBOR rates are normally available for standard period of 1, 2, 3, 6 and 12 months. Banks may quote rates on the basis of standard period if PCFC is required for periods less than 6 months.Banks may collect interest on PCFC at monthly intervals against sale of foreign currency or out of balances in EEFC accounts or out of discounted value of the export bills if PCFC is liquidated.

PCFC- Period of Credit

The PCFC will be available for a maximum period of 360 days. Any extension of the credit will be subject to the same terms and conditions as applicable for extension of rupee packing credit and it will also have additional interest cost of 200 basis points above the rate for the initial period of 180 days prevailing at the time of extension. Further extension will be subject to the terms and conditions fixed by the bank concerned and if no export takes place within 360 days, the PCFC will be adjusted at T.T. selling rate for the currency concerned. For extension of PCFC within 180 days, banks are permitted to extend on a fixed roll over basis of the principal amount at the applicable LIBOR rate for extended period plus permitted margin 200 basis points over LIBOR

Liquidation of PCFC Account

PCFC can be liquidated out of proceeds of export documents on their submission for discounting/rediscounting under the EBR Scheme. Packing credit in excess of F.O.B. value- PCFC would be available only for exportable portion of the produce. In case of cancellation of export order, the PCFC can be closed by selling equivalent amount of foreign exchange against Rupee at TT selling rate prevalent on the date of liquidation.

Interest Rate

Source: RBI Master circular on Export Credit

POST SHIPMENT FINANCE

Post Shipment Finance

Post Shipment Finance is a kind of loan provided by a financial institution to an exporter or seller against a shipment that has already been made. Post shipment finance is provided to meet working capital requirements after the actual shipment of goods. Thus finance provided after shipment of goods is called post-shipment finance.

Features
Basis of Finance Post shipment finances is provided against evidence of shipment of goods or supplies made to the importer or any other designated agency Quantum of Finance Post shipment finance can be extended up to 100% of the invoice value of goods.

Contd..
Period of Finance short terms or long term, depending on the payment terms offered by the exporter to the overseas importer. cash exports:maximum period allowed for realization of exports proceeds is six months from the date of shipment

Types of Export Buyer's Credit

Post shipment finance can be provided for three types of export : Physical exports: Finance is provided to the actual exporter or to the exporter in whose name the trade documents are transferred. Deemed export: Finance is provided to the supplier of the goods which are supplied to the designated agencies. Capital goods and project exports: Finance is sometimes extended in the name of overseas buyer. The disbursal of money is directly made to the domestic exporter.

IMPORTANCE OF FINANCE AT POSTSHIPMENT STAGE:

To pay to agents/distributors and others for their services. To pay for publicity and advertising in the over seas markets To pay for port authorities, customs and shipping agents charges To pay towards export duty or tax To pay for freight and other shipping expenses To pay towards marine insurance premium, under CIF contracts. To meet expenses in respect of after sale service.

Contd
To pay towards expenses regarding participation in exhibitions and trade fairs in India and abroad. To pay for representatives abroad in connection with their stay board

FORMS/METHODS OF POST SHIPMENT FINANCE

Export bills negotiated under L/C: exporter can claim post-shipment finance by drawing bills or drafts under L/C necessary documents as stated in the L/C bank negotiates the bill and advance is granted to the exporter Advance against claims of Duty Drawback (DBK) DBK means refund of customs duties paid on the import of raw materials, components, parts and packing materials used in the export production. banks grants advances to exporters at lower rate of interest for a maximum period of 90 days.

Contd
Advance against Undrawn Balance:
leave small part undrawn for payment after adjustment due to difference in rates, weight, quality etc

Advance against Deemed Exports:

Specified sales or supplies in India are considered as exports and termed as deemed exports Credit is offered for a maximum of 30 days

Advance against Deferred payments:

In case of capital goods exports, the exporter receives the amount from the importer in installments spread over a period of time. advances at concessional rate of interest for 180 days.

Contd..
Advance against export on Consignment basis: Bank may choose to finance when the goods are exported on consignment basis at the risk of the exporter for sale and eventual payment of sale proceeds to him by the consignee. Advance against Undrawn Balance

Trade transactions handled by Banks:

Documents under Documentary Credit Documents not under documentary credit also known as Documentary Collections

 In international trade, the following methods of settling payment are the most common:
by cheque by transfer by collection by documentary credit (D/C), which is known also as a letter of credit (L/C)

What is a Documentary Credit

A written undertaking by a bank (Issuing Bank) Given to the seller (Beneficiary) Acting upon the request and instructions of a customer (the Applicant), To pay -:
at sight, or at a determinable future date up to a stated sum of money within a stated time limit, against stipulated documents, and in compliance with the terms and conditions

 By using a documentary credit, an exporter is certain of receiving payment at the agreed time, and of having a source of finance. The importer, who is the party arranging for the issue of the documentary credit, will often obtain advantages such as a reduction in price, a source of finance(credit) and prompt delivery.

Types of documentary credit

Irrevocable credits The vast majority of documentary credits is issued as irrevocable credits. According to the Uniform Customs and Practice for Documentary Credits, a credit will be revocable only if it is explicitly defined as revocable. An irrevocable credit cannot be revoked or amended without the consent of all the parties to it. Confirmed irrevocable documentary credits A confirmed irrevocable documentary credit is a documentary credit to which the advising bank has added its confirmation. By adding its confirmation to the credit the exporter's bank incurs an irrevocable obligation to pay against presentation of conforming documents. A confirmed irrevocable credit gives the exporter who presents conforming documents protection against political and financial risks arising from conditions in the importer's country, and assurance of payment for the goods supplied.

Two types of Collections

1. Clean collections
The collection of a financial document (such as a Bill of Exchange, Promissory note) only.

2.

Documentary consist of:

collections

which

Documents against payment Documents against acceptance

Documentary Collections
A documentary collection is an instruction from an exporter (seller or supplier) to a remitting bank (usually the exporters local bank) to collect payment immediately, or at a future date, from an importer (buyer) against delivery of the relevant commercial documents.

Documentary Collection
A- Outward Collections: The bank obtains payment of financial and/or commercial documentation from an overseas importer on behalf of an exporter. The exporter may or may not be a customer of the bank B-Inward Collections: The bank assists a correspondent bank abroad to obtain payment of Bills of Exchange or Promissory note or cheques from an importer on behalf of a foreign supplier. The importer may or may not be a customer of the bank.

Types of documents required

Financial Documents: A Bill Exchange, Promissory note, etc. of

Commercial Documents: A document of title such as Bill of Lading, invoice, insurance policy and possibly other documents such as Certificate of Inspection or Certificate of Origin

Which one is Riskier?

Documents against acceptance is Riskier than Document Against Payment. Under DP Seller keeps control of goods until buyer pays. If buyer refuses to pay, seller can
take the buyer to court,, or find another buyer in the importer's country,, or arrange for sales by auction ship back to sellers country..

Under DA
Buyer signs, promising to pay the bill at a fixed future date. Documents released. Seller effectively loses control of the goods from that point onwards and runs following risks:
buyer might refuse payment saying goods not to satisfaction or cheat or become insolvent.

Factoring

DEFINITION

Financial transaction business job sells its accounts receivable (i.e., invoices) third party (called a factor) discount in exchange for immediate money with which to finance continued business.

 The three parties directly involved are: the one who sells the receivable (client) , the debtor, and the factor. The receivable is essentially a financial asset associated with the debtor's liability to pay money owed to the seller A Factor is, a Financial Intermediary that buys invoices of a manufacturer or a trader, at a discount, and takes responsibility for collection of payments.

PROCESS INVOLVED
Client concludes a credit sale with a customer. Client sells the customers account to the Factor and notifies the customer. Factor makes part payment (usually up to 80% of invoice value) against account purchased, after adjusting for commission and interest on the advance. Factor maintains the customers account and follows up for payment. Customer remits the amount due to the Factor. Factor makes the final payment to the Client when the account is collected or on the guaranteed payment date.

CHARGES FOR FACTORING SERVICES

Factor charges Commission (as a flat percentage of value of Debts purchased) (0.50% to 1.50%) Commission is collected up-front. For making immediate part payment, interest charged. Interest is higher than rate of interest charged on Working Capital Finance by Banks. If interest is charged up-front, it is called discount.

TYPES OF FACTORING
Recourse Factoring Non-recourse Factoring Maturity Factoring Cross-border Factoring

RECOURSE FACTORING
Upto 75% factored. to 85% of the Invoice Receivable is

Interest is charged from the date of advance to the date of collection. Factor purchases Receivables on the condition that loss arising on account of non-recovery will be borne by the Client. Credit Risk is with the Client. Factor does not participate in the credit sanction process. In India, factoring is done with recourse.

NON-RECOURSE FACTORING
Factor purchases Receivables on the condition that the Factor has no recourse to the Client, if the debt turns out to be non-recoverable. Credit risk is with the Factor. Higher commission is charged. Factor participates in credit sanction process and approves credit limit given by the Client to the Customer. In USA/UK, factoring is commonly done without recourse.

MATURITY FACTORING
Factor does not make any advance payment to the Client. Pays on guaranteed payment date or on collection of Receivables. Guaranteed payment date is usually fixed taking into account previous collection experience of the Client. Nominal Commission is charged. No risk to Factor.

CROSS - BORDER FACTORING

It is similar to domestic factoring except that there are four parties, viz., a) Exporter, b) Export Factor, c) Import Factor, and d) Importer. It is also called two-factor system of factoring. Exporter (Client) enters into factoring arrangement with Export Factor in his country and assigns to him export receivables. Export Factor enters into arrangement with Import Factor and has arrangement for credit evaluation & collection of payment for an agreed fee. Notation is made on the invoice that importer has to make payment to the Import Factor. Import Factor collects payment and remits to Export Factor who passes on the proceeds to the Exporter after adjusting his advance, if any. Where foreign currency is involved, Factor covers exchange risk also.

FACTORING v/s BANK LOAN

The emphasis is on the value of the receivables (essentially a financial asset), not the firms credit worthiness. Factoring is not a loan it is the purchase of a financial asset (the receivable). A bank loan involves two parties whereas factoring involves three.

FORFAITING

Forfaiting is a mechanism by which the right for export receivables of an exporter (Client) is purchased by a Financial Intermediary (Forfaiter) without recourse to him. It is different from International Factoring in as much as it deals with receivables relating to deferred payment exports, while Factoring deals with short term receivables.

FORFAITING

(contd)

Exporter under Forfaiting surrenders his right for claiming payment for services rendered or goods supplied to Importer in favour of Forefaiter. Bank (Forefaiter) assumes default risk possessed by the Importer. Credit Sale gets converted as Cash Sale. Forfaiting is arrangement without recourse to the Exporter (seller) Operated on fixed rate basis (discount) Finance available upto 100% of value (unlike in Factoring) Introduced in the country in 1992.

MECHANICS OF FORFAITING

EXPORTER

IMPORTER

FORFAITER

AVALLING BANK

HELD TILL MATURITY SELL TO GROUPS OF INVESTORS TRADE IN SECONDARY MARKET

ESSENTIAL REQUISITES OF FORFAITING TRANSACTIONS

Exporter to extend credit to Customers for periods above 6 months.

Exporter to raise Bill of Exchange covering deferred receivables from 6 months to 5 years.

Repayment of debts will have to be guaranteed by another Bank, unless the Exporter is a Government Agency or a Multi National Company.

CHARACTERISTICS OF FORFAITING
Converts Deferred Payment Exports into cash transactions, providing liquidity and cash flow to Exporter. Absolves Exporter from Cross-border political or conversion risk associated with Export Receivables. Finance available upto 90% (as against 75-80% under conventional credit) without recourse. Acts as additional source of funding and hence does not have impact on Exporters borrowing limits. It does not reflect as debt in Exporters Balance Sheet. Provides Fixed Rate Finance and hence risk of interest rate fluctuation does not arise.

CHARACTERISTICS OF FORFAITING (contd.)

Exporter is freed from credit administration. Provides long term credit unlike other forms of bank credit. Saves on cost as ECGC Cover is eliminated. Simple Documentation as finance is available against bills. Forfait financer is responsible for each of the Exporters trade transactions. Hence, no need to commit all of his business or significant part of business. Forfait transactions are confidential.

COSTS INVOLVED IN FORFAITING

Commitment Fee:- Payable to Forfaiter by Exporter in consideration of forefaiting services. Commission:- Ranges from 0.5% to 1.5% per annum. Discount Fee:- Discount rate based on LIBOR for the period concerned. Documentation Fee:- documentation fees are also involved. Service Charges:- payable to Exim Bank.

FACTORING vs. FORFAITING

POINTS OF DIFFERENCE Credit Worthiness FACTORING FORFAITING

Factor does the credit rating inThe Forfaiting Bank relies case of non-recourse factoring on the creditability of the transaction Avalling Bank.

Services provided

Day-to-day administration of No services are provided sales and other allied services

Recourse

With or without recourse

Always without recourse

Sales

By Turnover

By Bills

Continued
Point of Difference FACTORING FORFAITING

Scrutiny

Service of Sale Transaction Upto 80%

Individual Sale Transaction Upto 90%

Extent of Finance Recourse

With or Without RecourseWithout Recourse

Term

Short Term

Medium Term to Long Term

STAGES INVOLVED IN FORFAITING: Exporter approaches the Facilitator (Bank) for obtaining Indicative Forfaiting Quote. Facilitator(Bank) obtains quote from Forfaiting Agencies abroad and communicates to Exporter. Exporter approaches importer for finalising contract duly loading the discount and other charges in the price. If terms are acceptable, Exporter Facilitator(Bank) for obtaining quote Agencies. Exporter has to confirm the Firm Quote. Exporter has to enter into commercial contract. Execution of Forfaiting Agreement with Forefaiting Agency. approaches the from Forfaiting

STAGES INVOLVED IN FORFAITING:- (contd..)

Forfaiter commits to forefait the BoE, only against Importer Banks Co-acceptance. Otherwise, LC would be required to be established. Export Documents are submitted to Bank duly assigned in favour of Forfaiter. Bank(Exporters) sends document to Importer's Bank and confirms assignment and copies of documents to Forefaiter. Importers Bank confirms their acceptance of BoE to Forfaiter. Forfaiter remits the amount after deducting charges. On maturity of BoE, Forfaiter presents the instrument to the Bank(Importer) and receives payment.

WHY FORFAITING HAS NOT DEVELOPED

Relatively new concept in India. Depreciating Rupee No ECGC Cover High cost of funds High minimum cost of transactions (USD 250,000/-) RBI Guidelines are vague. Very few institutions offer the services in India. Exim Bank alone does. Long term advances are not favored by Banks as hedging becomes difficult. Lack of awareness.

Foreign Exchange Contract

Definition
A foreign exchange contract is a firm and binding contract between the customer and the bank for the purchase or sale of a specific quantity of foreign currency at a rate of exchange fixed at the time of making the contract for performance by delivery and payment at an agreed future time.

Importance of this contract.

This is to protect the bank, for in the fluctuations in exchange rates the bank may lose money if it had bought or sold currency to meet the customer's requirements which is not subsequently taken up by him.

If exchange rates fluctuate it is possible for an exporter or importer who has transactions to carry out in foreign currencies to lose through movements in rates of exchange between the time of shipment of goods and the payment for them.

Forward exchange contract

Exchange risk can, however, be avoided if the merchant covers himself by taking out a forward exchange contract with his bank.
If currency value depreciate: Loss can be avoided as exporter will receive payment at a rate at the time of contract and not at present value. If currency value appreciate: Exporter would receive less for his currency under the forward contract than he would in the spot market. In this case exporter will loose the chance of making profit more.

Risk remains..
Customer may not be able to fulfill it.

Probable solution.
Consequently limits are required for this type of business and the customer's credit-worthiness should be evaluated like any other facility. Depending on the standing of the customer the bank may therefore ask for a cash margin equivalent to a certain percentage of the outstanding balance of the currency to be purchased or sold by the bank.

Cargo Insurance

Three types

Marine Cargo Insurance

Marine cargo insurance is the most common amongst all because a great majority of goods is transported by conventional ships or container liners. Removing the burden of risks from the shoulders of the goods owners. Without this protection, difficulties would arise between seller and buyer in their trading. Increased responsibilities may fall on carriers and freight charges would increase. Businessmen would be forced to think more carefully about every project.

Who should apply for insurance

Depending upon the terms of sales contract, insurance is either the responsibility of the exporter or the importer. Example:
CIF
Exporter is responsible to insure for the benefit of the buyer until goods arrive and are unloaded at the port of destination

FOB or CFR
Importer is responsible to insure from the time the goods are loaded on the seagoing vessel.

International trade insurance documents

The main documents are:

Insurance Policy Open Cover Policy Insurance Certificate

1.Insurance Policy
Once an insurance arrangement has been made, the insurance company will issue an Insurance Policy to show that the goods have been insured. An Insurance Policy gives complete details of the terms and conditions of the insurance arrangement.

2. Open Cover Policy

Where a trader imports/exports goods on a regular basis, he can take out what is known as an Open Cover Policy (OCP). An Open Cover Policy covers all shipments up to a ceiling limit per shipment and under the same terms and conditions. Under an OCP the insured must advise the insurance company of the details of each shipment and the premium is calculated upon the declared values.

3.Insurance Certificate
Once an OCP has been arranged the insured is automatically insured for each shipment, against the risks specified under the OCP. If anything happens, he will be reimbursed up to the amount agreed per shipment. The insured may be authorized to issue a pre-printed Insurance Certificate that essentially describes the shipment and makes reference to the Open Cover Policy, the actual written contract.

Institute Cargo Clauses

Institute Cargo Clause A Institute Cargo Clause B Institute Cargo Clause C Institute War Clauses (Cargo) Institute Strikes Clauses (Cargo)

Clause A
Goods Covered Perils Insured Exclusions Willful misconduct of Insured Ordinary leakage, loss in weight, wear and tear Insufficiency or unsuitability of packing Inherent vice Delay Insolvency or financial default of owner or charterer of vessel Un-seaworthiness of vessel if known War and Strikes Nuclear Fission

Manufactured goods, All risks of physical new machinery, loss of or damage to garments, goods. electrical packaged commodities, etc.

Clause B
Goods Covered Wheat, cement, glass sheets used machinery Perils Insured Fire or explosion Vessel being stranded, sunk or capsized Overturning or derailment of the land conveyance Collision of vessel or conveyance General average Jettison or washing overboard Earthquake, volcanic eruption or lightning Entry of sea, lake or river water into vessel craft hold in which the goods are located Total loss of package during loading onto or unloading from vessel or craft. Discharge of goods at port of distress Exclusions Same as Institute Cargo Clauses (A), plus deliberate damage Nuclear Fission

Clause C
Goods Covered Perils Insured Exclusions Same as Institute Steel, Fire or explosion timber, Vessel being stranded, sunk orCargo Clauses (A), plus deliberate loose grains (i.e. theft capsized Overturning or derailment of damage is unlikely). land conveyance Nuclear Fission Collision of vessel or conveyance General average Jettison Discharge of goods at port of distress

Institute War Clauses (Cargo)

This insurance covers loss of or damage to the goods caused by war, civil commotion, revolution, rebellion, capture or detainment, mines, torpedoes or bombs. It excludes:
Willful misconduct of insured Ordinary leakage, loss in weight, wear and tear Insufficiency or unsuitability of packing Inherent vice Delay Insolvency or financial default of owner or charterer of vessel Any claim on loss or frustration of the voyage Un-seaworthiness of vessel if known Nuclear Fission

Institute Strikes Clauses (Cargo)

This insurance covers loss of or damage to the goods caused by strikers, locked-out workmen, or persons taking part in labor disturbances, terrorists, riots or civil commotion. It excludes:
Willful misconduct of insured Ordinary leakage, loss in weight, wear and tear Insufficiency or unsuitability of packing Inherent vice Delay Insolvency or financial default of owner or charterer of vessel Loss or damage or expense arising from absence, shortage or withholding of labor Any claim on loss or frustration of the voyage War Un-seaworthiness of vessel if known Nuclear Fission

Thank You!