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Ashutosh Kumar Aug 31, 2020 0

What is Trade Finance?

trade finance, what is trade finance, SimplyFI blogs

Trade Finance in its simplest form can be presented as the financial transactions, involving both domestic and international trade, that takes place between a seller and a buyer which is also facilitated by intermediaries such as banks and financial institutions. These financial transactions generally include lending, issuing letters of credit, factoring, export credit, insurance, etc. Approx 80–90% of ongoing ‘import and export’ or ‘trade transactions’ between various countries of the world depend on trade finance and thus these transactions make up an enormous portion of global trade. Whenever there is an ‘import or export of goods’ or a ‘trade transaction’ among borders there is trade finance involved. The process involves a vast number of activities and also faces many difficulties. One of the major issues that make the trade finance process complex is to deal with a large volume of paper documents. Dealing with these bundles of documents creates an even more complex trade network.


Trade Finance Working Explained

The working of Trade finance is easy to be understood by the following example. Let’s assume that there are two companies in different countries say India and China. Now, The company named MHK in India wants to import a certain number of goods from a supplier company that is located in China. Let’s name this supplier company CSI. Now to import the goods from China the company MHK needs to pay for the goods, but on the same hand, it also wants to make sure that the goods should arrive as ordered and thus hesitates in processing the payment. Now, on the other hand, the exporter company CSI is also hesitant to ship the goods, because they want to be confirmed that the payment will arrive for the goods they supply.


Now at this step, the banks or the financial institutions get involved to solve the issues faced by the importer and exporter company. The importer’s bank is asked to issue a Letter of Credit to the exporter via the exporter’s bank. This Letter of Credit promises to pay the required amount once the exporter bank provides the valid documents proving that the ordered goods have been loaded to the ship or any other means of transport. Thus the involved banks or intermediaries ensure that the trust is being built between the importer and exporter parties of different countries by holding the money transaction for each party.


Providers and Users of Trade Finance

Providers of Trade Finance Operations:

Trade finance providers may be many lenders in different fields who facilitate trade business. They may come in many different forms like buyers, suppliers, banks, syndicates, or trade finance houses.


Trade finance providers attempt to understand the underlying risk of the borrowing company for long-term growth. The providers’ structures and look after the trade cycles, underlying goods, creditor book, debtor ledger, and stock held by understanding the performance of the company and any underlying assets. All of this helps the provider to understand the picture of the company in totality and what is required in the future.

Also, Trade finance providers may be situated all over the world and may specify jurisdictions that they can lend to and work with them. It is important to understand a trade finance provider’s policy and what they specialize in to carry out the process.

Users of Trade Finance Services:

Trade finance is a vast industry and covers many various sectors. Users of Trade Finance:


  • Producers,


  • Manufacturers,


  • Importers,


  • Traders and,


  • Exporters.



Types of Product used in Trade Finance:

Trade finance is a single term that includes various instruments used by the parties involved. They are quite different from the usual financing of products and services.


Some important trade finance products or instruments available in India are listed below:


  • Term Loans,


  • Working Capital Limits like Overdraft and Cash Credit,


  • Letters of Credit,


  • Invoice Discounting or Invoice Factoring,


  • Export Credit (Packing Credit)


  • Insurance



Risk Reduction through Trade Finance

Trade finance helps in reducing the risk associated with global trade by establishing friendly relations between an exporter and an importer. One issue in the process of trade finance is that an exporter may ask the importer to pay the required amount for an export shipment to avoid the risk in case the importer receives the shipment but refuses to pay for the goods. Another issue is that if the importer pays the exporter, then there might be a chance that the exporter received the payment but refuses to ship the goods.


A common solution to the mentioned problem is to issue a Letter of Credit to the exporter’s bank from the importer’s bank that acts as a prove for processing payment once the exporter presents documents to the importer’s bak that prove the shipment occurred, like a bill of lading, etc. The letter of credit guarantees that once the importer’s bank receives proof that the exporter shipped the goods and the terms of the agreement have been met, it will process the payment to the exporter.


With the Letter of Credit (L/C), the buyer’s bank assumes feels secure in paying the seller. The buyer’s bank ensures that the buyer was financially viable enough to proceed with the transaction. Trade finance helps both the parties importers and exporters to build trust in dealing with import and export and thus facilitating trade.


Important Benefits to Trade Finance:

Besides reducing the failure of nonpayment and non-receipt of products, trade finance has become a crucial tool for companies to enhance their efficiency and boost revenue.


Improves income and Efficiency of Operations

Trade finance helps companies obtain financing to facilitate business but also it’s an extension of credit in many cases. Trade finance allows companies to receive a cash payment on the basis of accounts receivables just in case of factoring. A letter of credit might help the importer and exporter to enter a trade transaction and reduce the chance of nonpayment or non-receipt of products. As a result, income is improved since the buyer’s bank guarantees payment, and therefore the importer knows the products are going to be shipped.


Trade finance helps companies obtain financing to facilitate business but also it’s an extension of credit in many cases. Trade finance allows companies to receive a cash payment on the basis of accounts receivables just in case of factoring. A letter of credit might help the importer and exporter to enter a trade transaction and reduce the chance of nonpayment or non-receipt of products. As a result, income is improved since the buyer’s bank guarantees payment, and therefore the importer knows the products are going to be shipped.


Increased Revenue and Earnings

Trade finance allows companies to extend their business and revenue through trade. For instance, a U.S. company that is going to land purchase with a corporation overseas may not have the power to supply the products needed for the order.


Without trade financing, a corporation might fall behind on payments and lose a key customer or supplier that might have long-term ramifications for the corporate. Having options like open-end credit facilities and accounts receivables factoring doesn’t only help companies transact internationally but also help them in times of monetary difficulties.


Reduce the chance of economic Hardship

Without trade financing, a corporation might fall behind on payments and lose a key customer or supplier that might have long-term ramifications for the corporate. Having options like open-end credit facilities and accounts receivables factoring doesn’t only help companies transact internationally but also help them in times of monetary difficulties.


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