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Trade Finance Overview
What is Trade Finance ?
Trade finance is a specialized area of finance that deals with import and export transactions. Traditionally, only major banks, international financial institutions and government agencies have been involved in trade finance. These days, however, as more smaller companies become involved in international trade, often being ‘born global’, and the internet and other technologies help facilitate international trade, the world of trade finance is changing. It remains, however, a specialized area, with its own risks, products and systems over and above what a domestically trading business would encounter.
The Four Pillars of Trade Finance:
According to the
there are four ‘pillars’ of trade finance:
Enabling and facilitating payment across the globe. For example, banks and financial institutions around the world are members of SWIFT (Society for World Interbank Financial Telecommunications). This Brussels based organization facilitates the transfer of funds for international business transactions.
Trade finance instruments also define pre-arranged payment conditions and protect either the exporter, the importer or both against non-performance, fraud and other risks.
Any business which chooses to become involved in international trade will have some appetite for risk. Nevertheless, they will also be keen to minimize and mitigate that risk as far as possible. Trade finance instruments and services help enable these risks to be managed properly.
Broadly speaking, the risks in international trade fall into 3 categories:
• Country Risk – such as civil unrest, revolution, financial crisis in the other party’s country.
• Commercial Risk – insolvency, non-performance, etc, of either the other party or its bank.
• Currency Risk – Fluctuating exchange rates can turn a viable transaction into a loss maker.
The trade finance arena creates a great variety of opportunities for financing across the lifespan of a transaction. Funds can be borrowed from financial institutions or deals can be structured in such a way that one party is in effect financing the other through the terms of their contract.
Trade finance instruments are often very flexible and versatile. Sometimes specific products, services or instruments, or variations of existing ones, are created to meet the needs of a particular industry, region or set of circumstances. Some of these financing methods are standard practice in domestic transactions and some are specific to the international arena
Examples of the instruments used are:
• Direct Loans
• Payment in Advance
• Open Account
• Documentary Credits
• Documentary Collections
• Supplier Credits (Note Purchase Agreements and Forfaiting)
• Export Credit Agency Lending
The final pillar of trade finance is providing access to timely and accurate information. Businesses need accurate information about the physical movement of goods and the flow of money in a transaction, to mitigate risk and to retain their competitive edge.
Trade finance providers have moved towards providing end to end services, creating systems and supports for their clients from deal negotiation to after sales service.
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