If your business model just happens to require your company buy part of your solution from suppliers, before adding value and then selling the end product to your customer base, you’ll know how hard it is these days to expand your business by getting increased credit lines.
“Finance is the lubricant of commerce” – WTO
Trade finance (TF) is an important part of the transaction services offered by most international banks. But the problem is that Banks have been going through structural changes since the Global Financial Crisis in 2008/2009, and one of the outcomes has been that Banks have been focussing more on larger established customers and less on new entrants.
“I’ve Known Companies That Had Millions In Sales And Still Went Bankrupt – (Cash is “King”)” – James Spurway
To succeed in today’s global marketplace and win sales against foreign competitors, exporters must offer their customers attractive sales terms supported by appropriate payment methods. Getting paid in full and on time is the ultimate goal for each export sale, so an appropriate payment method must be chosen carefully to minimize the payment risk while also accommodating the buyer’s needs. For exporters, any sale is a gift until payment is received. Therefore, the exporter wants to receive payment as soon as possible, preferably as soon as an order is placed or before the goods are sent. For importers, any payment is a donation until the goods are received. Therefore, importers want to receive the goods as soon as possible but to delay payment as long as possible, preferably until after the goods are resold to generate enough income to pay the exporter.
Payments entail a significant portion of risk especially when executed cross-border and between relatively new trading partners. The need for exporters to formalize a commercial contract to allow maximum coverage of the risks to their exports is as important as knowing the different forms of trade finance available to conclude the transaction. These are classified into two main categories:
Bank-guaranteed trade finance (i.e., documentary trade)
– Letters of credit
Not-bank-guaranteed trade finance
– Open Account
– Cash in Advance
The most common and standardised form of bank-intermediated trade finance is a Letter of Credit (L/C). L/Cs mitigate payment risk by providing a framework within which a bank makes (or guarantees) the payment to an exporter on behalf of an importer, once delivery of goods is confirmed through the presentation of appropriate documentation.
In reality, L/Cs tend to be time-consuming and labour intensive to operate. They still predominate in trade between emerging market (EM) economies, but the number and the complexity of the ‘receivables’ and ‘payables’ involved in many modern-day international global supply chains, increasingly militates against their use.
Banks may also act to address working capital needs by providing trade finance loans to exporters and importers. In such cases, the loan documentation is linked either to an L/C, or to other financial instruments explicitly related to the underlying trade transaction.
A number of additional innovative trade finance techniques have been developed of late. For example, ‘bank payment obligations’ offer a similar degree of payment security to an L/C, but without the requirement physically to handle documentation relating to a trade contract. ‘Supply chain finance’, where banks automate documentary processing across entire supply chains, often providing credit via the discounting of receivables, is another growth area.
Trade finance versus inter-firm trade credit
The major alternative to bank trade finance is inter-firm credit extended between importers and exporters, commonly referred to as ‘trade credit’. This includes ‘open account transactions’, where goods are shipped in advance of payment, and ‘cash-in-advance transactions’, where payment is made before shipment. Inter-firm credit typically entails lower fees and more flexibility than does trade finance, but leaves firms shouldering more payment risk, and a greater requirement for working capital. As a result, trade credit is most common among firms that have a long-established commercial relationship, or are part of the same multinational corporation, and/or operate in jurisdictions that have sound legal frameworks for the collection of receivables.
A firm’s capacity to extend trade credit can be underpinned by the option, where available, to discount receivables, for example via ‘factoring’, and by access to bank and capital market finance that is not tied directly to trade transactions. Firms can further reduce payment risk by purchasing trade credit insurance. Trade credit insurance is also used by banks to hedge their own payment risks.
Size And Structure Of The Market
Unfortunately, there is no one single comprehensive source for measuring the magnitude, composition, and pricing dynamics of the trade finance market. That said, by drawing on numerous heterogeneous country statistics, IMF and World Bank analysis, survey data from trade associations, not least the International Chamber of Commerce (ICC) and the Society for Worldwide Interbank Financial Telecommunication (SWIFT), and resorting to considerable interpolation and inference, the BIS has estimated that trade finance directly underpins something in the region of one-third of global trade (or between $6.5trn and $8trn of transactions), with letters of credit covering about one-sixth of the total (or between $3.25trn – $4trn of transactions).
Most of the remainder is financed by inter-firm trade credit. Both inter-firm and bank credit providers also benefit from trade credit insurance, which covered nearly $1.7trn of global exports in 2011 and 2012. Overall, up to 90% of world trade is believed to rely on some sort of trade finance. However, the nature of trade finance varies widely from country to country and region to region: bank-intermediated products are primarily used to finance trade involving emerging market (EM) economies, especially those in Asia.
The higher usage of trade finance in Asia seems to reflect a range of factors, including distance from trading partners, product types, and the efficiency of local market practices. Academic studies suggest that trade finance is relied upon more heavily for trade covering long distances, newly formed trade relationships, and trade involving countries with weaker contractual enforcement, less-developed financial systems, and higher political risk. Yet other factors, such as historical preferences, legal frameworks, and regulatory differences also seem to exert an influence. Global banks provide about one-quarter to one-third of global trade finance, and almost half of their exposure is in emerging Asia. For the EM economies for which data are available, local banks account for the bulk of trade finance. Moreover, the share provided by local banks appears to have increased over recent years.
Trade finance in its totality appears to be even more dollar-denominated than global trade, with 80% of L/Cs, and a high proportion of other trade finance expressed in the US currency. Clearly, the ability of both global and local banks to provide trade finance is at risk if banks’ access to dollar funding comes under duress, as was the case at the depths of the 2008/9 global financial crisis. Over the past decade and a half, the expansion of the market for trade finance has tended to fall short of the growth of nominal trade in many economies. This is most apparent in the use of L/Cs.
The average maturity of funded loans, according to ICC data, is about 3½ months, with L/Cs and guarantees having slightly shorter maturities. There are some indications that maturities are somewhat longer in EMs, perhaps because use of trade finance loans as a substitute for working capital loans is more popular there.
The role of L/Cs in trade finance is evolving. ICC data suggest that L/Cs and guarantees now account for around half of the aggregate value of global banks’ trade finance exposures. Funded loans, mostly to importers and exporters make up the rest. Some 15% of global banks’ trade finance loans are to other banks, which enable the recipient banks to fund trade loans to exporters or importers. Overall, it is estimated that L/Cs support about 15% of global imports. The global volume of L/Cs amounted to some $2.8 Trillion in 2011 and 2012. Yet there are clear indications that L/Cs have gradually diminished in importance since 2000.
We offer a comprehensive solution to all SME’s who need help with finance to support their trading or manufacturing activities, and complete and ship their orders. It involves:
- An audit of existing receivable book to establish quality and average age
- Where required – introductions to Banks, Hedge Funds, Family Officers, Forfeiting Companies etc., that are open to discussing various forms of trade finance, trade credit or working capital supply.
- An audit of existing and historical Bank relationships
- An exploration of alternative forms of fund raising that might be feasible, including a discussion with the buyer about providing an advance payment for a portion of the purchase price
- A report with recommendations for the Founder and/or Board
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