8 years ago

Financing in international trade: An overview

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Unlike domestic trade, international business can not be performed without the involvement of banks of both buyer and seller as a standard foreign currency is involved for payment of the goods. That is why international trade is also called foreign exchange business.
We can also describe foreign exchange business as:
(1) The transfer of credits to a foreign country to settle debts or accounts between residents of the importing as well as the exporting country and
(2) Foreign bills, currencies etc. used to settle such accounts.  
Export is shipment of goods/merchandise in the buyer-nominated vessel via customs authority of the exporting country to the buyer of another country against a firm sales contract or letter of credit under Uniform Customs and Practice for Documentary Credits (UCPDC) with a payment guarantee that full value of the export has been/will be repatriated through exporter bank within the time specified by the central bank of the seller country. The seller must deliver the goods to the carrier nominated by the buyer at the agreed point of a specified place on the agreed date or within agreed period.
In the process of export sellers' obligation is to provide the goods and commercial invoice and other shipping documents in conformity with the L/C/contract and any other evidence of conformity that may be required by the contract/L/C. While buyers' obligation is to pay the price of goods as provided in the contract of sale and take delivery of the goods if seller delivers the goods as per terms of sale contract/letter of credit.
A letter of credit is a payment undertaking given by a bank to the seller and is issued on behalf of the applicant. Letter of credit is also called "documentary credit". The idea in an international trade transaction is to shift the risk from the actual buyer to a bank.
The banks involved in the process of letter of credits are: issuing bank, reimbursing bank, advising bank, confirming bank and negotiating bank.
i) Issuing bank undertakes to reimburse a nominated bank that has honoured or negotiated a complying presentation and forwarded the documents to the issuing bank. Issuing bank is the buyer's bank.
ii) Advising bank advises the credit and any amendment thereof to its  beneficiary. An advising bank advises the credit and any amendment thereto without undertaking to honour or negotiate.
iii) Confirming bank undertakes to reimburse another bank that has honoured or negotiated a complying presentation and forwarded documents to the confirming bank.
iv) Negotiating bank negotiates the documents on complying presentation as per L/C terms and pay L/C value to the beneficiary and send the documents to confirming/issuing bank. Negotiating bank is the beneficiary's bank.
v) Reimbursing bank is the bank through which negotiating bank realises negotiated proceeds from the issuing bank

Authorised dealer bank provides financing to the exporter against lien of export mother L/C or sales contract for procurement of raw materials, production of export goods and wages of the workers and to meet operating costs of the company in the form of:   

1) Pre-shipment credit: to produce or purchase the material and labour necessary to fulfill the sales order; and
2) Post-shipment credit: to generate immediate cash while offering payment terms to buyers.  
Pre-shipment credit is financing made before goods are shipped (usually against a confirmed order) to help an exporter to perform an export order and is extended in the form of:
a) back to back letter of credit
b) packing cash credit/packing credit.
Back to back letter of credit is an arrangement in which an irrevocable Export letter of credit serves as the collateral for another Import L.C; the advising bank of the first letter of credit becomes the issuing bank of the second letter credit (back to back letter of credit). It is non-funded assistance to the exporter.
A bank establishes L/C on back to back basis without prior permission of central bank under following   guidelines:
a) Only the recognised units of readymade garments industries, specialized textile industries under bonded warehouse system will be extended back to back L/C facilities
b) Irrevocable L/C opened by the buyer's bank conforms to the UCPDC.
c) The L/C shall be valid for a reasonable period to cover shipment of the merchandise (lead time) after completion of the manufacturing process.
d) The import L/C will be opened for 75 per cent of the FOB value of the export L/C and the price must be competitive. For computation of FOB value, freight charges, insurance and commission involved in shipment of the merchandise under the L/C must be deduced if the freight element is not shown separately, a certificate from the shipping company or the shipping agent should be asked for.
e) The import L/C will be opened on the usance basis covering usance of not more than 120 days. However, incase of specialised textiles usance may be up to 180 days.
f) Interest for usance period, shall not exceed LIBOR (London Interbank Offered Rate).
g) All amendments of the export L/C should be noted down carefully to route out chances of excess L/C obligation under export L/C.
h) Opening of import L/C against export L/C received under barter Strategic Trade Authorisation (STA) will not be allowed.

i) Export L/C must be retained with the branch duly marked lien on the L/C.
j)    The L/C opening bank will assess the capacity of the factory and will physically verify and confirm about the efficiency of labor.

k)    For estimate of BTB (back-to-back) limit the branch should consider the working capacity of the industries, three months working requirement and past performance, securities available with the branch and present liabilities with the branch and latest inspection report of the goods/stocks imported under BTB credit, if any.
l)    Despite the above AD bank also opens BTB against lien of another import L/C. This facility is extended to the private importer against supply of food item, fertilizer, etc. for the government authority. For example, TCB imports various food items through the local/international suppliers under open tender. In this case TCB opens a local L/C in favor of the supplier. The supplier submit that L/C to their bank and then supplier's bank in turn opens another import L/C in favour of the foreign supplier against lien of the local L/C/master L/C.                                                                                                                                                                                                                                        
On issuance of BTB L/C exporter's bank constitutes a definite undertaking of payment to the beneficiary of the L/C as per article 7 of UCPDC 600. But until the export documents are received from exporter after completion of shipment as per terms of the mother L/C the risk of realization of the value of the BTB from the exporter is involved. To ensure production and shipment in time the BTB L.C issuing bank has the obligation of closely supervising the imported raw materials and production process of the export as under:
i) The master export LC (against which opening of back to back L/C is requested) should have validity period adequate to cover the time needed for importation of inputs, manufacture of merchandise and shipment to consignee.

ii) The back to back L/C value shall not exceed the admissible percentage of net FOB (free-on-board) value of the relative master export L/C (as per prescribed value addition requirement) and the price of goods to be imported must be competitive.

For computation of net FOB value of a master export L/C, the freight charge, insurance cost and commission if payable by the exporter shall be deducted from the L/C value. If the freight element is not shown separately, a certificate from the shipping company or the shipping agent should be asked for.

iii) All amendments of the master export L/C should be noted down carefully to rule out chances of excess obligation under the back to back import L/C.
iv) Bank branch will arrange clearance of the imported consignment by deputing suitable bank officials to escort consignment on arrival in importer's warehouse under bank's lock and key.
v) During the course of manufacture the branch will exercise close supervision and control over the consignment by deputing inspector of advances/godown staff /experienced officers.
vi) The branch manager/senior level officers will supervise the process of export until the consignment is shipped in addition of the above stated control measures.

After shipment of the export the exporter wants to get balance payment as soon as possible from their bank against export documents to generate immediate cash flow. To receive payment an exporter or shipper must have the documents required by the letter of credit.

The documents are classified in to the following category:

a) Financial documents: bill of exchange, co-accepted draft
b) Commercial documents: invoice, packing list
c) Shipping documents: transport documents (bill of lading), insurance certificate, commercial, official or legal documents, inspection certificate, certificate of origin, GSP (Generalised System of Preferences) certificate.

Exporter after completion of the shipment of export goods submits the above documents with EXP certified by the custom authority to their bank to get the export payment as per L/C terms.

After receiving the export documents exporter's bank/negotiating bank must examine all documents stipulated in the credit with reasonable care to ascertain whether or not they appear, on their face, compliant with the terms and conditions of the credit.

If the documents are compliant with the L/C, the negotiating bank will negotiate and purchase the documents and pay the rest of L/C value keeping the value against liability created on pre-shipment credit with tax, duties, exchange, commission, and buying commission if any in the banks' ledger.

After completion of the negotiation and payment the negotiating bank must send the documents to the issuing bank for payment within five working days.

The negotiation is called post-shipment credit as the negotiating bank provides rest of L/C value to the exporter before collection of payment of the export L/C value from the issuing bank.

If the documents are not compliant with the credit the negotiating bank will not negotiate the document rather the documents will be sent for collection.
Financing an international trade-related activity is risk-based one, mainly because of  uncertainty about repatriation of export proceeds.

Bank invests in the export process before collection of the proceeds keeping the risk of non-repatriation of the L/C value from the buyer in mind.

The banker should remember instruction contained in para (c) of chapter 22 of guide lines for foreign exchange transactions as: "For delay in repatriation or non-realisation of export proceeds the exporter as well as the AD and its official certifying the export forms render themselves liable to punitive action under Foreign Exchange Regulation (FER) act".

Therefore, in their own interest all parties involved should be alert and active in ensuring timely repatriation of export proceeds.

The writer is General Manager (ITFD & ITD), Sonali Bank Limited.

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