Financial instruments that are used by companies in the process of international trade & commerce.
Trade Finance makes it easier for importers and exporters to transact by covering all monetary products that banks and other institutions utilize to make trade transactions.
80-90% of world Trade relies on Trade Finance, says WTO.
It can help reduce the risk linked with global trade. The function is simply to introduce a third-party in transactions to improve payment and supply risk.
The parties involved in the process can be-
- Trade finance companies
- Importers and exporters
- Export credit agencies and service providers
Trade finance can be used to protect international trade from risks such as currency fluctuations, issues of non-payment, the creditworthiness of the parties involved.
To facilitate and safeguard the trade process there are various documents involved such as,
Letter of Intent: it is a written form of understanding but not a binding document, between all the parties, declaring preliminary commitment of one party to do business with another, outlining the major terms of the deal.
It is simply An Agreement to Agree, discusses potential points of the deal. One party present LOI to which other party either demand changes, counter, or draft a new document altogether.
Proof of Funds: A document that exhibits the ability of an entity to pay for a specific transaction.
Proof of funds can be:
· Bank statement
· Security statement or custody statement.
Information such as name & address, total balance amount, personnel’s signature is required in the PoF document.
To make sure that the buyer has the money plus the legal access to the fund from a verified authority.
Banks Confirmation Letter: The main purpose of a BCL is to assure a third party, generally seller that borrower has access to sufficient financial resources to complete a transaction.
Confirmation of Payee: This service from the bank helps to make sure that payments aren't sent to the wrong bank by checking the name on an account before a new order is set up.
In international Agro Trade, there are various modes of payment and payment terms such as:
1. Cash against Documents or Document against Payment (CAD or DP)- An arrangement in which an exporter commands the presenting bank to transfer the shipping and title documents to the importer only if the importer ultimately pays the accompanying bill of draft or exchange.
2. Documents against Acceptance (DA)- An arrangement within which the exporter commands a bank to transfer shipping and title documents to the importer, given that the importer accepts the accompanying bill of exchange or draft by signing it.
3. Letter of Credit (LC)- A Credit letter is a letter from a bank guaranteeing that an importer's payment to the exporter is going to be received at a given time and for the given price. Within the event that the importer (Bank’s customer) is unable able to form a payment on the imports, the bank is needed to cover the full or remaining amount of the imports. Usually, there are various sorts of Letter of Credit.
Uniform customers & practice for documentary credits are a set of rules on the use of letters of credit. Utilized by bankers & commercial parties in more than 175 countries around the world under Trade Finance.
It was published by the International Chamber of commerce that came into force on 1st July 2007. These are set of 39 rules or articles that Letter of Credit follows only if L/C states that IT IS SUBJECT TO UCP 600.
Divided into 4 sections:
- Definition & interpretations
2. Responsibility & obligations
3. The standard for Examination of Documents
4. Transferable credits & Assessments of proceeds
For a better understanding of UCP600, there are International Standard Banking Practice (ISBP) that illustrate standard practices to be followed when examining documents & letters of credit.
It describes how rules in UCP600 should be interpreted & applied in practice when dealing with trade documents such as invoice, transport & insurance documents, certificate of origin, etc.
There are various types of L/C such as commercial, transferable, non-transferable, revocable, irrecoverable, revolving, confirmed, unconfirmed, standby, etc.
The concept of confirmed L/C is a guarantee a borrower gets from the second bank along with the first letter of credit which decreases the risk of default for the seller. The second bank promises to pay the seller if the first bank fails to do so. It is an important form of LC because it is more secure for the seller as confirmation of two banks are involved and help the seller minimize credit risk.
Various institutions that provide for trade finance around the world such as Commerzbank, ANZ, Société Générale, Asseco, BNY Mellon, Shinhan, Tradeteq, Citi, Santander, Intesa Sanpaolo, Standard Chartered are among some.
Thus, in many ways trade finance help shape the basis of monetary aspects in the business with ease and convenience around the world.