Trade Finance has undergone paradigm shift over a period of last 35 years when it started with Letter of Credit (LC), as an instrument/tool to import as well as export, to highly structured products like combined bond and debt Export Credit Agency (ECA) financing, and simple products like Letter of Undertaking (LoU) utilized for buyer's credit.
In a layman language, there are buyer and seller in any trade transaction residing in different countries. There is an intermediary required as a trustee for the trade transaction between importer and exporter. Importer has its Banker and Exporter also has its Banker. When goods or services to be imported, Importer's Bank issue a Letter of Credit in favour of Exporter as beneficiary. which may be advised/confirmed by the Exporter's Banker. Exporter may avail Export Finance from its Bank against LC. Upon shipment of goods/services, Exporter tenders Bill of Exchange, Invoice and Bill of Lading (shipping document) to its Bank along with LC. Exporter's Bank checks documents as per terms of LC and releases payment to Exporter or liquidate Export Finance, if any, and sends the documents to the Importer's Bank. Importer's Bank releases payment to the Exporter's Bank on receipt of documents in compliance with LC terms and recovers import bill amount from the Importer. This completes an International Trade transaction.
In a trade transaction, Finance may be needed by buyer and seller/supplier that can be arranged through Banks, FIs, Syndication or Trade Finance Agencies. Financier would always look for the control over use of goods as well as control of goods, source of payment, monitoring the trade cycle and collateral security for financing goods and receivables. Trade Finance assists in mitigating conflicting needs of the importer who carries supply risk and exporter who carries payment risk. The function of trade finance is to act as an intermediary in order to mitigate supply risk and payment risk, whilst providing importer with extended credit and exporter with speedier receivables.
Trade Finance facility is, normally, used by Importer, Exporter, Manufacturers, Producers and traders across various sectors. The conventional financing methods are Packing Credit in Foreign Currency (PCFC), Post-Shipment Credit denominated in Foreign Currency (PSCFC), Export Bill Purchasing (EBP), which are availed by Exporters whereas Importer gets non-fund based finance in the form of Letter of Credit, which has potential to become a fund based credit on default. Buyer's credit and Supplier's credit are other traditional sources of finances.
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