Methods of Export Finance

Methods of Export Finance
Export Finance
Export financing enables businesses to sell their
foreign invoices all over the world.
Export financing releases working capital that has
been tied up in foreign invoices allowing business to
grow overseas.
Export credi t can be broadl y cl assi f i ed i nto
pre-shi pment f i nance and
post shi pment f i nance.
Pre-shi pment f i nance ref ers to f i nance
extended to purchase, processi ng or packi ng
of goods meant f or exports.
Fi nanci al assi stance extended af ter the
shi pment of exports f al l s wi thi n the scope
of post shi pment f i nance.

EXPORT FINANCE
Concession for exporters
Some of the concessions include:
1. Cheap credit to exporters.
2. Minimum of 12% of net credit should go to
exports.
3. Refinance to Banks on eligible portion of export
credit outstanding.
4. ECGC guarantee for export credits
5. No margin requirements for advance against
export receivables.

The Trade Relationship
Copyright 2004 Pearson Addison-Wesley. All
rights reserved.
23-5
The nature of the relationship between the exporter and the
importer is critical to understanding the methods for
import-export financing utilized in industry.
There are three categories of relationships (see next
exhibit):
Unaffiliated unknown
Unaffiliated known
Affiliated (sometimes referred to as intra-firm trade)
The composition of global trade has changed dramatically
over the past few decades, moving from transactions
between unaffiliated parties to affiliated transactions.
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Exhibit 23.1 Alternative International
Trade Relationships
Unaffiliated
Known Party
A long-term customer
with which there is an
established relationship of
trust and performance
Unaffiliated
Unknown Party
A new customer
which with exporter has
no historical business
relationship
Affiliated
Party
A foreign subsidiary
or affiliate
of exporter
Requires:
1. A contract
2. Protection against
non-payment
Requires:
1. No contract
2. No protection against
non-payment
Requires:
1. A contract
2. Possibly some protection
against non-payment
Exporter
Importer is .
Sources of Exporter Financing
Financing exporter credit to the importer:

Letter of Credit
Bankers acceptance (of the draft)
Factoring
Forfaiting
EXIM loans
Letter of Credit (L/C)
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A letter of credit (L/C) is a banks conditional
promise to pay issued by a bank at the request of
an importer, in which the bank promises to pay an
exporter upon presentation of documents specified
in the L/C.
An L/C reduces the risk of noncompletion because
the bank agrees to pay against documents rather
than actual merchandise.
The following exhibit shows the relationship
between the three parties.
23-9
Exhibit 23.5 Parties to a Letter of Credit (L/C)
I ssuing Bank
Beneficiary
(exporter)
Applicant
(importer)
The relationship between the importer and the
exporter is governed by the sales contract.
The relationship between the
importer and the issuing bank is
governed by the terms of the
application and agreement
for the letter of credit (L/C).
The relationship between the
issuing bank and the exporter
is governed by the terms of the
letter of credit, as issued by
that bank.
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The essence of the L/C is the promise of the issuing bank to pay
against specified documents, which must accompany any draft
drawn against the credit.
To constitute a true L/C transaction, all of the following five
elements must be present with respect to the issuing bank:
Must receive a fee or other valid business consideration for
issuing the L/C
The L/C must contain a specified expiration date or definite
maturity
The banks commitment must have a stated maximum amount of
money
The banks obligation to pay must arise only on the presentation
of specific documents
The banks customer must have an unqualified obligation to
reimburse the bank on the same condition as the bank has paid
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Commercial letters of credit are also classified:
Irrevocable versus revocable
Confirmed versus unconfirmed
The primary advantage of an L/C is that it reduces risk
the exporter can sell against a banks promise to pay rather
than against the promise of a commercial firm.
The major advantage of an L/C to an importer is that the
importer need not pay out funds until the documents have
arrived at the bank that issued the L/C and after all
conditions stated in the credit have been fulfilled.
Draft
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A draft, sometimes called a bill of exchange (B/E), is the
instrument normally used in international commerce to
effect payment.
A draft is simply an order written by an exporter (seller)
instructing and importer (buyer) or its agent to pay a
specified amount of money at a specified time.
The person or business initiating the draft is known as the
maker, drawer, or originator.
Normally this is the exporter who sells and ships the
merchandise.
The party to whom the draft is addressed is the drawee.
Draft
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If properly drawn, drafts can become negotiable instruments.
As such, they provide a convenient instrument for financing the
international movement of merchandise (freely bought and sold).
To become a negotiable instrument, a draft must conform to the
following four requirements:
It must be in writing and signed by the maker or drawer
It must contain an unconditional promise or order to pay a definite
sum of money
It must be payable on demand or at a fixed or determinable future
date
It must be payable to order or to bearer
There are time drafts and sight drafts.
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Essence of a Time Draft
Name of Exporter
Date: October 10, 2003
Draft number 7890
Ninety (90) days after sight of this First of Exchange, pay to the order of Bank
of the West [name of exporters bank] the sum of Five-hundred thousand U.S.
dollars for value received under Bank of the East, Ltd. letter of credit
number 123456.
Signature of Exporter
Bill of Exchange
The most common versions of a bill of
exchange are:

A) Sight Draft
When the drawer (exporter) expects the drawee
(importer) to make payment immediately upon the draft
being presented to him.

Unless and until the Draft is received, the Negotiating/
Collecting Bank does not hand over the Shipping
documents and the buyer cannot take delivery of goods.
Bill of Exchange

B) Usance Draft
When draft is drawn for payment at a date later than the
date of presentation.
It may be a fixed future (specific) date or determinable
date according to the period of credit viz. 30 days, 60
days or 90 days etc.
It is presented to the drawee (importer) who will retire
the documents by accepting the draft by putting his
signature and date.

Advance Payment
Seller may insist for advance payment :
When he is not confident on the buyers financial position
When the buyers Country is not stable.

Under this method seller is able to secure his commercial risk on the
buyer by receiving the advance payment for his supply.

While agreeing for advance payment buyer is exposed to a risk on the
seller and his capacity to supply the materials.

In a competitive buyers market seller may not be able to receive advance
payment.

If it is the sellers market and if the seller has monopoly in certain items,
seller can insist for advance payment.
Open account
It is an arrangement between the buyer and the seller that seller
delivers the goods to the buyer directly or to his order and the
buyer agrees to pay on an agreed date.

Under this method, the goods are with the buyer on trust and the
buyer is expected to pay the seller on the due date.

Seller is exposed to a high degree of risk since the goods are under
the control of the buyer.

This type of trading requires a high degree of trust between buyer
and seller and this method is more advantageous to the buyer.

This method is also known as consignment sale or on account
sales.
Documents against payment
It is an arrangement by which the seller after shipping the goods
submits the documents to his bank with a request for collecting
the payment from the buyer.
Sellers bank forwards the document to the buyers bank with a
request to collect the payment from the buyer against the
documents.
Documents are presented to the buyer and if the buyer makes
payment, buyers bank collects the payment and remits to the
sellers bank, which in turn will transfer the payment to the seller.
Under this method sellers bank does not undertake any
responsibility for payment. It acts as agent for collection.
If the payment is not received the documents are returned to the
seller.
Payment risk is with the seller. If the payment is not forthcoming,
seller has to recall the documents or direct it to a new buyer.
Documents against acceptance
Under this arrangement all the commercial documents are
forwarded by the sellers bank to the buyers bank.
Sellers bank specifically instructs the buyers bank to deliver all
the commercial documents to the buyer only on acceptance of the
payment liability by the buyer on the bill of exchange.
Bill of exchange is drawn on the buyer demanding payment on the
due date.
Buyer accepts his payment liability by signing on the bill of
exchange and collects all the original documents.
With the original shipping document he is able to take delivery of
the consignment.
Buyer goes to the bank on the due date and pays the dues with or
without interest as per the arrangement.
Bill of Lading (B/L)
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Another key document for financing international
trade is the bill of lading or B/L.
The bill of lading is issued to the exporter by a
common carrier transporting the merchandise.
It serves three purposes: a receipt, a contract, and
a document of title.
Bills of lading are either straight or to order.
Documentation in a Typical
Trade Transaction
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A trade transaction could conceivably be handled
in many ways.
The transaction that would best illustrate the
interactions of the various documents would be an
export financed under a documentary commercial
letter of credit, requiring an order bill of lading,
with the exporter collecting via a time draft
accepted by the importers bank.
The following exhibit illustrates such a transaction.
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Exhibit 23.8 Steps in a Typical Trade Transaction
Exporter
Bank X Bank I
Importer
Public
Investor
1. Importer orders goods
2. Exporter agrees to fill order
6. Exporter ships goods to Importer
4. Bank I sends
L/C to Bank X
9. Bank I accepts draft, promising to pay in 60
days, and returns accepted draft to Bank X
7. Exporter presents
draft and documents
to its bank, Bank X
12. Bank I obtains
importers note
and releases shipment
3. Importer
arranges L/C
with its bank
13. Importer
pays
its bank
8. Bank X presents draft and
documents to Bank I
5. Bank X
advises
exporter
of L/C 10. Bank X sells
acceptance to investor
14. Investor presents acceptance
and is paid by Bank I
11. Bank X
pays
exporter
Government Programs
to Help Finance Exports
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Governments of most export-oriented industrialized countries have
special financial institutions that provide some form of subsidized
credit to their own national exporters.
These export finance institutions offer terms that are better than those
generally available from the competitive private sector.
Thus domestic taxpayers are subsidizing lower financial costs for
foreign buyers in order to create employment and maintain a
technological edge.
The most important institutions usually offer export credit insurance
and a government-supported bank for export financing.
Trade Financing Alternatives
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In order to finance international trade receivables,
firms use the same financing instruments as they
use for domestic trade receivables, plus a few
specialized instruments that are only available for
financing international trade.
There are short-term financing instruments and
longer-term instruments in addition to the use of
various types of barter to substitute for these
instruments.
Forfaiting
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Forfaiting is a specialized technique to eliminate the risk of
nonpayment by importers in instances where the importing
firm and/or its government is perceived by the exporter to
be too risky for open account credit.
The following exhibit illustrates a typical forfaiting
transaction (involving five parties importer, exporter,
forfaiter, investor and the importers bank).
The essence of forfaiting is the non-recourse sale by an
exporter of bank-guaranteed promissory notes, bills of
exchange, or similar documents received from an importer
in another country.
Forfaiting is a practice that allows exporters to sell
their receivables to a third party known as a forfaiter.
The exporter receives immediate funds to cover
transactions, which limits risk and cleans up its
account books.
The importer can enter a credit agreement with the
forfaiter to get goods on credit and repay it over
terms varying from 180 days to five years or more.
This allows goods and services to move freely
through the international supply chain.
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Exhibit 23.10 Typical Forfaiting Transaction
Exporter
(private industrial firm)

Importer
(private firm or government
purchaser in emerging market)
FORFAITER

Importers Bank
(usually a private bank in
the importers country
Investor
(institutional or individual)

Step 1
Step 3
Step 2
Step 7
Step 5
Step 4
Step 6
Countertrade
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The word countertrade refers to a variety of international
trade arrangements in which goods and services are
exported by a manufacturer with compensation linked to
that manufacturer accepting imports of other goods and
services.
In other words, an export sale is tied by contract to an
import.
The countertrade may take place at the same time as the
original export, in which case credit is not an issue; or the
countertrade may take place later, in which case financing
becomes important.
Countertrade

Structures an international sale
when means of payment are difficult,
costly, or non-existent
No currency convertibility
Weak reserves prohibit access to hard currency
Barter-like agreements
Trade goods and services for other goods and
services
Countertrade
Main attraction:
way to finance an export deal
meet requirement of local
government to support exports
Main drawback:
risk of disposal / sale of goods at
less than full value
disposal of imports may require
resources other than those that
the firm possesses
Types of Countertrade
Barter
Counterpurchase
Offset
Switch Trading
Compensation or Buyback
Barter
It is the exchange of goods and services for
goods and services without any use of money.
Like the trade relationship between China and
Thailand where fruit has been traded by
Thailand for buses made by China.
International Reciprocal Trade Association
(IRTA) the industry trade organization -
almost a half a million small businesses use
commercial barter exchanges every year.
Counter Purchase
In this, a foreign company, or country, trades with a
nation with the promise that in the future they will
make purchase of a specific product from the nation.
Seller agrees to buy products/services unrelated to
its business
Seller then sells products to third parties
A recent example of this is the ongoing trade
between Congo and China where infrastructure is
being traded for a supply of metals.

Offset Purchase
Usually large projects, often involving expenditure of
buying governments money
A % of the selling price is required to be purchased or
sourced from the buying country
Compensation
Barter with a combination of goods and convertible
currency
Less risk than in straight barter

Buyback
In this type of counter trade, a company builds a
plant, supplies technology, training, etc. In exchange
they take a part of output of the plant.
For example, a company based in the USA sets up a
lets say an automobile factory in X country. They
take a part of the total produce as their own but they
have setup the industry, provided the technology and
the training to X country.
Switch Trading

In this method one company trades products and
services or, in some cases, builds infrastructure like
roads, railway lines, hospitals with another nation
and, in turn, are obligated to make a purchase from
that nation.
One such example is a deal proposed by the
Philippine Government where they offer to trade
Philippine coffee for essential products.
Export Factoring
Factoring is a continuous arrangement between a
factoring concern and the seller of goods and services (on
credit) whereby the factor i.e. a commercial bank or a
specialized financial firm purchases the accounts
receivable for immediate cash and also provides other
services such as sales ledger maintenance, collection and
credit protection.
The factor also assumes the risk on the ability of the
foreign buyer to pay, and handles collections on the
receivables. Thus, by virtually eliminating the risk of
non-payment by foreign buyers, factoring allows the
exporter to offer open account terms, improves liquidity
position, and boosts competitiveness in the global
marketplace.

Contd..
Factoring is suited for continuous short-term export
sales of consumer goods on open account terms.
It offers 100 percent protection against the foreign
buyers inability to pay no deductible or risk
sharing.
It is an option for small and medium-sized
exporters, particularly during periods of rapid
growth, because cash flow is preserved and the risk
of non-payment is virtually eliminated.

Export Credit

Export credit:
Loan facility extended to an exporter by a bank in
the exporter's country.

Working capital finance
Export Credit Performance Indicator for Banks
:Banks are required to reach a level of outstanding
export credit equivalent of 12% of each bank's
Adjusted Net Bank Credit.
Project SME Gyanshala Capsule
Training Programme for Officials
handling SME Credit 9.1
EXPORT FINANCE

Pre-Shipment Finance, also referred to as
EPC(EXPORT PACKING CREDIT), is extended as WC
for purchase of RM, processing, packing,
transportation, warehousing, etc., of goods meant for
exports.

Post-Shipment Finance is extended after shipment to
bridge the time lag between the shipment of goods and
the realisation of proceeds.
PRE-SHIPMENT CREDIT

Export Finance is by and large governed by RBI
directives / guidelines.

Pre-Shipment Credit can be classified as:
Packing Credit Advances (PCA) in Rupees
Advance against Duty Drawback entitlements
Pre-Shipment Credit in Foreign Currency (PCFC)
PACKING CREDIT
This advance is granted to the exporter (and in some
cases even to the sub-suppliers who are not exporters)
for procuring the goods from the market may be of a clean
nature at initial stage,
It should be converted into secured advance as soon as
the goods are procured by the exporter and are undergoing
further processing/manufacturing, by hypothecating
the goods in the name of the Bank.
The security offered may further be perfected by
pledging the goods to the Bank when the
physical / constructive custody of the goods
remains with the Bank or Banks approved clearing
agent.
However, this stage will arise when the goods are
ready for shipment and do not require
further processing.

PACKING CREDIT ADVANCE
Packing credit advance - available to the eligible exporter
against lodgement of irrevocable LC
established/transferred in his favour by the foreign buyer
through the medium of a First Class bank
or confirmed order/contract placed by the buyer for
export of goods from India.
However, branches may grant advances without
insisting on lodgement of LC or confirmed
order/contract at initial stage,
In case of exporters with good track record and if the
reasons for delayed submission of LC/orders are genuine

POST-SHIPMENT CREDIT

Post-Shipment Credit means any loan or advance
granted or any other credit provided by the Bank to an
exporter of goods from India from the date of
extending the credit after shipment of the goods to the
date of realisation of the sale proceeds.

Standing of L/C Opening Bank is vital.

The period prescribed for realization of export
proceeds is 12 months from the date of shipment

POST-SHIPMENT CREDIT
Post-Shipment Credit can be classified as follows:

Negotiation / Payment / Acceptance of export documents
under L/C.
Purchase / Discount of export documents under
confirmed orders / export contracts.
Advances against bills sent on collection basis.
Advances against exports on consignment basis.
Advances against Duty Drawback Entitlements.
Advances against undrawn balances / retention money.
Re-discounting of Export Bills abroad (EBR).

Post-shipment advance can mainly take the form of -
(i) Export bills purchased/discounted/negotiated.
(ii) Advances against bills for collection.
(iii) Advances against duty drawback receivable from
Government.

Export of Services
Pre-shipment and post-shipment finance may be provided to
exporters of all the 161 tradable services covered under the
General Agreement on Trade in Services where payment for such
services is received in free foreign exchange as stated at Chapter
3 of the Foreign Trade Policy 2009-14.
A list of services is given in Appendix 36 of Handbook (Vol.1) of
the Foreign Trade Policy 2009-2014..
The financing bank should ensure that there is no double
financing and the export credit is liquidated with remittances
from abroad.
Banks may take into account the track record of the
exporter/overseas counter party while sanctioning the export
credit.
Exporters of services qualify for working capital export credit
(pre and post shipment) for consumables, wages, supplies etc

Export Credit Insurance

Risks such as non-payment, country, geographical,
loss in transit and war are inherent in foreign trade.
Export Credit Guarantee Corporation of India Ltd
(ECGC) offers policies to protect exporters from non-
payment risks of buyer/country and guarantees to
banks against non-payment by the borrower.
Export credit insurance assesses the buyer and the
country risks, enabling it to devise various insurance
schemes.

Methods of Export Finance

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Methods of Export Finance

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