TOPIC: Processes & Instruments used in International trade finance

 Understanding international trade finance

 Questions to be answered before payment method selection
 Methods of payments
 Instruments used in international trade finance
 Conclusion
 International trade finance

 International finance is the set of relations for the creation and using of funds
(assets), needed for foreign economic activity of international companies and
countries (Suresh, 2000)
Trade finance (TF) is an important part of the transaction services offered by
most international banks. It is a payment instrument and at the same time
effectively manages the risks associated with doing business internationally
across boarders.
 As such, trade finance is an umbrella term that covers a variety of financial
techniques and instruments used by importers and exporters.
 Questions to be answered
According to Giovannucci (2002) the following questions should be answered
before selecting the payment method:

 Can the business afford the loss if it is not paid?

Will extending credit and the possibility of waiting several months for
payment still make the sale profitable?
Can the sale only be made by extending credit?
How long has the buyer been operating and what is his credit history?
Are there reasonable alternatives for collecting if the buyer does not meet his
obligations?
If shipments is made but not accepted can alternative buyers be found?
 Methods of payments
Terms of payment’ defines the obligations of both commercial parties in relation to the
payment, detailing not only the form of payment and when and where this payment shall be
made by the buyer, but also the obligations of the seller; not only to deliver according to the
contract, but also, for example, to arrange stipulated guarantees or other undertakings prior
to or after delivery (Grath, 2011).

Cash in advance before delivery;

Documentary letter of credit;
Documentary collection;
Bank transfer (based on open account trading terms);
Other payment mechanisms, such as barter or counter-trade.
 Open account terms

Most common methods of payment in international trade and many large

companies will only buy on open account
Goods delivered before payment is made by importer
Very risky method for the seller unless he has a long and favorable
relationship with the buyer or the buyer has excellent credit (Giovannucci,
2002).
Literally, it involves a form of short, but agreed, credit extended to the buyer,
in most cases verified only by the invoice and the specified date of payment
therein
 Cash in advance

The exporter receives the payment before ownership of the goods is

transferred.
This method eliminates the payment risk on the part of the exporter,
and all the risk is borne by the importer.
Receiving payment in advance before or in direct connection with the
actual shipment is the ideal situation for the seller, in terms of both
liquidity and commercial risk.
 The commercial Letter of Credit (LC)

 A letter of credit (LC) eliminates the risk to both parties

The letter of credit (LC) allows the buyer and Seller to contract a trusted
intermediary (a bank) that will guarantee full payment to the seller provided
that he has shipped the goods and complied with the terms of the agreed-
upon Letter (Giovannucci, 2002).
The LC is the most secure instrument available to international traders
(Crozet, Demir, & Javorcik, 2022).
This is a common form of payment, especially when the contracting parties
are unfamiliar with each other (Giovannucci, 2002).
 LC’s protect the seller against the buyer;

• Refusing to accept the shipment and the associated payment

obligations
• Refusing to pay for the goods received (fraud)
• Intentionally delaying the payment
• Disputing the terms of the contract (e.g. whether the goods are of
specified quality) in order to reduce the payment obligation
 LC’s…

On the disadvantageous side, the terms of an LC are very specific and
binding, if even the smallest discrepancies exist in the timing,
documents or other requirements of the LC the buyer can reject the
shipment
A rejected shipment means that the seller must quickly find a new
buyer, usually at a lower price, or pay for the shipment to be returned
or disposed.
 Documentary Collection

Also sometimes referred to as bank collection, is a method of payment where

the seller’s and buyer’s banks assist by forwarding documents to the buyer
against payment or some other obligation, often acceptance of an enclosed
draft (bill of exchange)
The role of the banks in a documentary collection is purely to present the
documents to the buyer, but without the responsibility that they will be
honoured by them
The collection contains no guarantee on behalf of the banks, which act only
upon the instruction of the seller, but it is nevertheless a demand against the
buyer, performed by a collection bank at their domicile, often their own bank
 Counter trade

According to Grath (2011) the word ‘counter-trade’ is in it a general

term, representing various types of connected transactions or
reciprocal arrangements that are linked to each other in a larger
structure, necessary for the completion of the individual transactions
So far, the assumption has been that goods are delivered against
payment, at sight or at a later date. But there are other forms of
transactions, where payment or settlement, wholly or partially, is
made in some other way.
 Counter trade techniques
The following terms are often used to describe the most common forms of alternative
trade transactions:
• Barter trades – with payment in other goods;
• Compensation trades – with payment partly in money but also in other goods or
services to balance the transaction, agreed between the parties;
• Repurchase agreements – in which payment is made through products, generated
by the equipment or goods delivered by the seller;
• Offset counter-trades – mostly with settlement in money, but with the transaction
being dependent on corresponding sales/purchase transactions to balance the
payment stream.
 Reasons for using counter trade techniques

• To enable trade to take place in markets which are unable to pay for
imports. This can occur as a result of a non-convertible currency, a
lack of commercial credit or a shortage of foreign exchange.
• To protect or stimulate the output of domestic industries and to help
find new export markets.
• As a reflection of political and economic policies which seek to plan
and balance overseas trade.
• To gain a competitive advantage over competing suppliers
 Instruments used in International trade finance

Foreign bills of exchange

Bank drafts and telegraphic transfers
Letter of credit
Telegraphic transfers
 Conclusion
An international trade transaction, no matter how straightforward it may seem at
the start, is not completed until delivery has taken place, any other obligations
have been fulfilled and the seller has received payment. This may seem obvious;
however, even seemingly simple transactions can, and sometimes do, go wrong.
Each area of international trade requires its own knowledge, from the first contact
between buyer and seller to final payment. One such area of expertise is how to
develop professional and undisputed terms of payment and how to solve currency
and trade finance questions in a competitive way.
INTERNATIONAL FINANCIAL MARKETS
Financial markets, from the name itself are a type of market place that provides an avenue for the sale and purchase of
assets such as bonds, stocks, foreign exchange and derivatives. Often they are called different names including Wall Street
and capital market.
Darškuvienė (2010) defines a financial market as a market where financial instruments are exchanged or traded. They
facilitate the flow of funds in order to finance investments by corporations, governments and individuals.
The capital markets consist of the markets for stocks, bonds, mutual funds, and exchange-traded funds (ETFs).
The global economy is massive and growing. According to the World Bank, global Gross Domestic Product (GDP) had
grown from $71.83 trillion in 2012 to approximately $74.91 trillion in 2013. The United States accounted for over 22% of
global GDP in 2013, but this percentage has been declining over time owing to the emergence of the economies in India,
China, Brazil, and other developing countries.

Financial markets are undergoing major and at times very rapid changes, mostly as a result of the financial crisis that
began in 2007. It is still too early to say for certain which of these changes will endure and which will disappear and to what
degree when a new balance is reached.
 Forces driving these market developments

i. Changes in market participants’ perception and management of

risk
ii. Imbalances accumulated on public and private balance sheets
over many years
iii.Regulatory changes
FUNCTIONS OF A FINANCIAL MARKET
Financial markets provide the following three major economic functions: price discovery, liquidity and
Reduction of transaction costs.
i. Price discovery function
This means that transactions between buyers and sellers of financial instruments in a financial market
determine the price of the traded asset.
ii. Liquidity function
This provides an opportunity for investors to sell a financial instrument, since it is referred to as a measure
of the ability to sell an asset at its fair market value at any time.

iii. Reduction of transaction costs

This is performed when financial market participants are charged and/or bear the costs of trading a financial
instrument.
 Other Functions of a financial market

i) Puts savings into more productive use/Funds mobilization

ii) Risk Sharing
iii) Easy access
iv) Capital formation
 MOTIVES FOR USING INTERNATIONAL
FINANCIAL MARKETS.

The market for real or financial assets are prevented from full integration by barriers
like tax differentials, tariffs, quotas, labor immobility, communication costs, cultural
and financial reporting differences.
Market imperfections further create special opportunities for specific geographic
markets, helping these markets attract foreign creditors and investors. Investors move
funds to foreign markets:(Björkman, 1990)
Investors move funds to foreign markets;

i. to take advantage of favorable economic (e.g. interest rates) conditions;

ii. when they expect foreign currencies to appreciate against their own; and
iii. to reap the benefits of international diversification.
 MOTIVES FOR USING INTERNATIONAL
FINANCIAL MARKETS.

Investors move funds to foreign markets;

i. to take advantage of favorable economic (e.g. interest rates)

conditions;
ii. when they expect foreign currencies to appreciate against their own;
and
iii. to reap the benefits of international diversification.
 MOTIVES FOR USING INTERNATIONAL
FINANCIAL MARKETS.

creditors provide loans in foreign markets:

i. to capitalize on higher foreign interest rates;
ii. when they expect foreign currencies to appreciate against their own;
and
iii. to reap the benefits of diversification.
 MOTIVES FOR USING INTERNATIONAL FINANCIAL
MARKETS.

borrowers seek funds in foreign markets:

i. to capitalize on lower foreign interest rates;
ii. and when they expect foreign currencies to depreciate against their
own.
CLASSIFICATION OF INTERNATIONAL FINANCIAL
MARKETS

International financial markets are classified mainly into international

banking and international money market. The international banks
provide the following services:
i.  Trade financing to importers and exporters.
ii.  Foreign currency exchange services.
iii. Foreign investments.
iv. Hedging instruments such as forwards and options, etc.
 The international money market

i) The international money market includes:

i.  Eurocurrency markets.
ii.  Euro credits.
iii. Euro notes.
iv. Euro commercial paper, etc.
All the above international money markets involve foreign currencies:
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