International trade finance.
Since medieval times, banks have been involved in international trade. Today, the basic transaction service involves circumventing information costs and effecting payment in the required currency. The basic credit service involves financing the exporter until payment is received from the importer. This article provides an outline of the tools of traditional international trade payment and financing offered by banks.
One of the cheapest methods of payment is to sell on an open-account basis: The exporter sends shipping documents directly to the importer who pays the exporter, either upon arrival of the goods documents against payment (D/P), or on an agreed date thereafter - documents against acceptance of time drafts (D/A). Sale can also take place on a consignment basis, which is a similar process except the importer only pays the exporter after the goods have been sold or against advance payment.
Unlike payment in advance, selling on open account loads the credit risk and financing on the exporter, while selling on consignment adds market risk. In all three cases, banks get involved in the payment function only.
Trust is a crucial element in all of these methods. Generally, exporters would not want to ship goods without some sort of payment guarantee, while importers would not want to pay in advance for fear of goods not being shipped as specified. This calls for an intermediary to take care of the mutual risk exposure. As collection agents, banks receive documents from the exporter and forward them to a correspondent bank in the importer's country, which then hands over the documents against payment or acceptance of drafts.
Letters of credit
A bank's involvement increases if the exporter requires a letter of credit (L/C): The bank's written obligation to honour payment when certain conditions are satisfied. Trade L/Cs are issued by the importer's bank on behalf of the importer, and are advised by the exporter's bank in favour of the exporter. If an exporter is uncomfortable about the credit risk, it is possible to request that the L/C is confirmed by the advising bank. In other words, payment will be made by the latter even if it has not been received from the importer's bank, which likewise, is obliged to pay the exporter's bank regardless of whether or not it has been reimbursed by its client.
L/Cs are typically issued and advised via tested telex and shipment takes place within 90 days of the issuing date. Conformed documents must be presented by the beneficiary to the collection bank, normally the exporter's bank. Payment is made either once the documents have been accepted (sight), or at the end of an agreed period. L/C charges are usually split between the applicant and the beneficiary. Importers with a poor credit rating may have to maintain a cash collateral, the terms for which depend not only on their credit rating or that of the issuing bank, but also on the interest rate and foreign exchange differentials between their currency and that of the L/C.
Although straight L/Cs already cover a wide range of situations, more complex ones can be useful in certain situations. For example, revolving L/Cs cover multiple or continuous shipments of merchandise; back-to-back L/Cs enable a merchant to use a first L/C, issued in his favour by the importer, and to issue a second L/C in favour of his own supplier Transferable L/Cs, on the other hand, enable a merchant to assign the L/C proceeds to secondary beneficiaries and the terms and conditions of the transfer must be identical to those of the principal L/C, except for the amount. This process is more transparent and secure from a credit stand-point, than a back-to-back L/C.
Red, Green clause LCs
Red-clause L/Cs enable an exporter to obtain pre-shipment finance, which is a percentage of the L/C amount, from the advising bank. This occurs either by a simple written statement of purpose, a 'clean red clause', or by the exporter's providing specified documents. The advance is with full recourse to the issuing bank and to the importer.
Green-clause L/Cs serve the same purpose as red-clause credits except the exporter can only obtain advance payments if specified documents are produced with evidence that the goods are held to the order of the advising bank; the advance is with full recourse to the goods. This structure was the backbone of the 1992 oil pre-export facility arranged by Union Bank of Switzerland for Sonangol (Angola).
However, red- and green-clause L/Cs are not that widespread. In the case of importers, financing would more often be sought via extended payment terms, although this is not always the cheapest alternative because exporters will rightfully reflect their own financing costs in the contract price. For example, Malawi Petroleum's Petroleum Control Commission signed a contract for petroleum imports at unattractive prices because it insisted on 90-day payment terms. Importers can ask issuing banks to refinance the due amounts through conventional short-term advances or over-drafts.
To evidence extended payment terms, the exporter can issue bills of exchange addressed to and accepted by the importer, who commits to pay on demand or at a fixed or determinable future time, a certain sum to the exporter. This is a trade bill, drawn by one commercial party on another. The exporter can obtain financing by discounting the bill with a bank for an amount equal to the face value of the bill less interest costs and fees.
Once accepted by or drawn on a bank, a bill becomes the banker's acceptance (BA). The market for sterling BAs is governed by the Bank of England and the market for dollar BAs is governed by the Federal Reserve of the United States. Bills are eligible for discounting if, (i) they are accepted by eligible banks, (ii) have a maximum tenor of six months, (iii) ultimately relate to a trade transaction, and (iv) are self-liquidating. In practice, eligibility criteria are not always fully respected as Zimbabwe's Agriculture Marketing Authority demonstrated.
In the early 1990s, its large syndicated BA facilities were used more for balance-of-payment support than for pre-export financing of the country's main commodities. Why? Because anticipated export proceeds were significantly less than cumulative BA amounts. BAs offer fixed interest costs, often quite competitive, to maturity. But the market is restricted to eligible banks which, for large facilities, invite other banks on a risk-participation basis.
The forfeiting market
Bills of exchange can also be negotiated in the forfeiting markets provided they have been guaranteed by a bank, usually the importer's. In Africa, forfeit receivables mostly consist of deferred payments under L/Cs. Amounts typically range from $1m to $50m and maturities, from one year or less for most of sub-Saharan Africa, to two years in Ghana, Kenya and Zimbabwe, three to five years in North Africa and Egypt, and up to eight years in South Africa.
Spread above reference interest rates are slightly higher than those charged on short-term loans. Thus, a six-month forfeiting transaction would currently attract a spread of 0.625% per year for South Africa and a spread of 2.75% for Ghana. Forfeiting is without recourse to the exporter, with no more payment risk or administrative costs, and provides a 100% financing ratio, less interest costs and commitment fees. Forfeiting centres are based in Switzerland, Germany and Austria and, more recently, London as a secondary market.
Factoring is similar to forfeiting as it involves the assignment, by an exporter of receivables, on a nonrecourse basis against an advance payment. The process can involve reassigning such receivables to a correspondent factor in the importer's country, which collects payment from the importer and remits it to the export factor.
Advantages of factoring
Unlike forfeiting however, factoring does not require a bank guarantee, can be used by small exporters and covers small amounts and short maturities. Fees are reasonable, usually ranging from 0.75% to 2.5% of factored receivables. On the other hand, advances are only a percentage of the face value of the receivables, between 50% and 85%.
Although not active in Africa, in the past decade the factoring market has quadrupled its annual volume of business activity to $300bn, of which $20bn is for cross-border trade finance. Most business originates in the US and western Europe, particularly The Netherlands, France and Germany.
To conclude, exporters, traders and importers dealing with Africa can use a variety of instruments for their trade-related needs. The local bank should be in a position to assess the commercial and financial position of its client and recommend action accordingly.
In certain cases, raising financing is difficult, especially for importers or small operators. It is feasible however, if the bank devises a structure, such as using inventory or receivables, to increase its control over the floating assets of the borrower.
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|Title Annotation:||financing and payment tools|
|Author:||De Georgio, Emmanuelle Moors|
|Date:||Dec 1, 1996|
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