Trade finance corresponds to monetary activities related to international and commercial trade. Since 1983, the concept has been under constant review and monitoring. The constituents of international trade finance goes from lending to insurance of letters of credits, insurance, export credit, to highly structured debt ECA financing and bonds.
Companies involved in international trade finance include banks and financiers, importers and exporters, export credit agencies, insurers and other service providers.
Defining Trade Finance
There are many definitions of trade finance online. It is often described as both science and a vague term that covers myriads of activities. Both are accurate, but only up to a certain extent. In one way, trade finance providers manage capital needed for international trade flow. However, in this science, there are many tools for financiers to use which determines how investments, cash, credit and assets can be utilised for the purpose of international trade.
In simple terms, international trade finance requires an exporter and an exporter to prepay for the goods. The importer, obviously, wants to reduce risks of trade by asking exporters to document that all goods are shipped. The importer’s bank assists the exporter by providing the letter of credit for payment upon presentation of specified documents like bills of lading. Thereafter, the exporter’s bank may request for a loan to the exporter depending on the contract. Documents used in this process depend entirely on the nature of transaction and evidence of performance, such as bill of lading.
Trade Finance Providers
Trade finance providers finance when both buyers and sellers assist them with trade cycle funding gap. Both buyers and sellers can choose trade finance as a type of risk mitigation. However, in order to make this effective, financiers require:
- Controlled use of funds, goods and sources of repayment
- Trade cycle visibility and monitoring through the transaction
- Security of goods and receivables
Trade finance providers help settle all conflicts between the importer and the exporter. An exporter has to mitigate payment risks from importer. It is also crucial to accelerate receivables. Contrarily, importer would want to mitigate risk of supply from the exporter and have the benefit of extending credit on payment.
International Trade Finance
Trade finance in banking works by integrating the divergent needs of exporters and importers. Exporters prefer that importers pay upfront for export shipment in order to avoid risks that importers take the shipment but deny paying for the same. However, if an importer pays upfront, the exporter may accept it but deny shipping the goods.
The only solution to this problem is that the importer’s bank provides a letter of credit to the exporter’s bank, which provides payment once exporter presents all the necessary documents proving that the shipment occurred, such as a bill of lading. Here, letter of credit guarantees that when the issuing bank receives a proof of the shipped goods, it would issue payment to the exporter.
Although international trade finance has existed for centuries, trade finance providers ensure advancement. The prevalence of trade finance in banking contributes to massive growth in international trade.