International Trade Finance Ch.20 - Tatit Kurniasih - 03

7/28/2019 International Trade Finance Ch.20 - Tatit Kurniasih - 03

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Based on International Trade Administration (ITA) : TradeFinance Guide, April 2008



International Trade Finance

1. International Trade

2. Method of Paymentsa. Cash in Advance

b. Letter of Credits

c. Documentary Collection

d. Open Account :

① Export Working Capital Financing

② Government-guaranteed EWC Programs

③ Export Credit Insurance

④ Export Financing

3. Countertrade

4. Forfaiting

5. Government Assistance in Exporting



Important Terms

• Beneficiary : the recipients of funds or other benefits(exporter)

• Irrevocable : Incapable of being retracted or revoked

• Time Draft : a written order instructing the importer or theimporter bank to pay the amount specified on its face ona certain date.

• A bill of lading : a document issued by the commoncarrier specifying that it has received the goods for shipment, it can serve as title to the goods.

• Banker Acceptance (B/A) : a negotiable money marketinstrument for which a secondary market exists.



1. International Trade

The trade/exchange of capital, goods, and servicesacross international borders or territories.*

International trade is typically more costly thandomestic trade. Why?

Because : the border typically imposes additionalcosts such as tariffs, time costs due to border delays and costs associated with country differences

such as language, the legal system or culture.

*Sources : http://en.wikipedia.org/wiki/International_trade



2. Methods of Payment

Exporter

Importer

MostSecure

LeastSecure

Cash-in- Advance

Cash-in- Advance

Letters of Credit

Letters of Credit

DocumentaryCollection

DocumentaryCollection

Open Account

Open Account



Payment Method should be chosen carefully to minimize thepayment risk, while also accomodating the buyer’s need.

For exporter, any sales is a GIFT until payment is

received (they want to receive payment as soon

as possible, as an order is places before the goodsare sent to the importer)

For importer any payment is DONATION until the

goods are received (they want to received thegoods as soon as possible and delay payment as

long as possible, preferably until the goods are

the resold and generate enough income to pay

the exporter)



2a. Cash-in-Advance

Payment in advance trough credit card / bank’s check / wire-transfer before the ownership of the goods is transferred.

Advantages :1. Payment before

shipment

2. Eliminates risk of non-payment

3. No risk for exporter

Disadvantages :1. May lose customer to

competitors over payments

terms2. No additional earnings trough

financing operation3. High risk for importer

Applicable for high-risk trade relationships and ideal for internet-based businesses.



2b. Letters of Credit (LC) A commitment by a bank on behalf of the buyer that payment

will be made to the beneficiary (exporter) provided that theterms and conditions stated in the LC have been met.

Applicable for use in new or less-established

trade relationships when the exporter issatisfied with the creditworthiness of the buyer bank.

Risk evenly

spread betweenseller andbuyer,

provided thatall terms andconditionsare adhered

to.

Disadvantages :1. Complex and labor-

intensive process2. Relatively expensive

method in terms of

transaction costs

Advantages :

1. Payment madeafter shipment

2. A variety of payment, financing,and risk mitigation

options available.



Fact about LC

• LC is a separate contract from the sales contract.(the bank is not concerned whether each partyfulfill the terms in sales contract or not).

• The bank obligation to pay is solely conditioned

upon the seller’s compliance with the terms andconditions of the LC (bank only deal in document,not goods).

• LC can be arranged easily for one-time deals

• LC is always irrevocable (may not be changed or cancelled unless the seller agrees)



Process of a TypicalForeign Trade Transaction

Importer’s Bank Exporter’s

Bank

Importer Exporter

MoneyMarket

Investor

Purchase order 1

2Letter of Credit3

4 6 9

5 Shipment of goods

1410 11

Shipping Documents and

time draft accepted7

Payment-discounted value of B/A8

B/A

12

13 16B/A presented at maturity

15



Importer (USA)

Exporter (China)

Importer’s Banks Exporter’s Banks

Money MarketSector

1

5

2

11

1014

16

15

12

3

7

8

4

6

9

13

Prior to B/A Creation

At and just after B/A creation

At maturity date of B/A



Explanation of Importing sewing machine from China:

1. USA importer want to buy 1000 sewing machine from

china. They are looking for any sewing machine producer thatwant to ship it under an LC to USA. After they find an exporter that agree with it, they will placing an order to them andChinese exporter will inform the price and other terms of sale.

Suppose the price of 1 sewing machine is 1000 RMB or equalto US$ 158, so the total face value of LC is 1000 x RMB 1000= RMB 1,000,000 or US$ 158,000 (US$ 158 x 1000).

2. USA importer will apply to their bank for a letter of credit for the

merchandise and providing the terms of sale.3. LC sent via the USA bank to the China bank.

4. LC arrived in the China bank and the bank will notify theexporter.



5. The chinese exporter will ship the machine to USA.

6. After shipping the sewing machine, Chinese exporter willpresent to their bank a (60-day) time draft, a bill of lading,invoice and packing list.

7. The China bank presents the shipping documents and the timedrafts to the USA bank. The USA bank accept the time draftand make a banker ’s acceptance and charges an acceptancecommission which is deducted at the time of final settlement.

This commission is based on the term-to-maturity of the timedraft and creditworthiness of the importer.

8. Chinese exporter has a choice to hold the B/A until the maturitydate or sell it at a discount price. Since the risk is similar and

B/A trade rate is similar to the deposit rate of other bank.Suppose Chinese exporter instruct their bank to have the B/Adiscounted by the USA bank.



9. USA bank pay that amount of discounted B/A.

10.USA importer signs a (60-day) promissory note with USA bankfor the face value of the B/A, due on the maturity date.

11.China Bank provides the auto-dealer with the shippingdocuments needed to take possesion of the sewing machines.

12.If B/A is no t held by Chinese exporter or China Bank, USAbank may hold it until maturity date and collect face value fromthe USA importer via promissory note. So USA bank may sellthe B/A in the money market to investor.

13.An investor will buy it at a discount price from face value.

14.USA bank will collect the face value of the B/A via thepromissory note

15.The money market investor will present the B/A for payment toUSA bank

16.USA bank will pay the face value of B/A to the investor.



Formula

Maturity Value :

= Face Value x [1-(commission x days/360)

Discounted Value :

= Face Value x [1-{(B/A rate + Commission Rate) xdays/360}]

Commission Accepted :

= Face Value – Maturity Value

Bond equivalent yield :

= {(maturity value/discounted value)-1} x(365/days)



How to calculate the Banker Acceptance?

1. Suppose the face amount of a promissory notes is

$1,000,000 and the importer bank charges an acceptancecommission of 1.5 percent. The note is for 60 days, so,

a. How much the exporter would get if he decide to hold B/Auntil maturity and if they discounted the B/A?

b. How much the bank commission ? Answer :

a. If Chinese exporter wants to hold B/A until maturity, we canuse this formula :

Maturity Value = Face Value x [1-(commision x days/360)= $ 1,000,000 x [1-(0.15x60/360)

= $ 997,500



But if chinese exporter wants to discount the B/A withUSA bank, they will receive :

= $ 1,000,000 x [1-{(0.525 + 0.0150) x (60/360)}]

= $ 988,750

Regardless the chinese exporter want to hold the B/A tomaturity or not, they have to pay the bank commission.

The importer bank commission is : Face Value – Maturity Value := $1,000,000 - $997,500 = $ 2,500



The bond equivalent yield at maturity date is :

= {($ 1,000,000/$ 988,750-1) x 365/60}

= 0,0692 = 6,92%( note : 365 is the actual number of days in the year,instead of banker’s day)

The bond equivalent rate the exporter received fromdiscounting B/A is

= {(($997,500/$998,750)-1)x365/60}

= 0,0538 = 5,38%If the opportunity cost of capital is greater than 5,38%,discounting makes sense, if not, Chinese exporter should hold it until maturity.



Uniform Customs and Practice for Documentary

Credits (UCP)

• The Uniform Customs and Practice for Documentary

Credits (UCP) is a set of rules on the issuance and use of letter of credits.

• The UCP is utilized by bankers and commercial parties in morethan 175 countries in trade finance. Some 11-15% of

international trade utilizes letters of credit, totaling over a trilliondollars (US) each year.

UCP has been standardized by the ICC (International Chamber of Commerce) by publishing the UCP in 1933 and subsequently

updating it throughout the years. The ICC has developed the UCPby regular revisions, the current version being the UCP600.



Fact about ICC• A significant function of the ICC is the preparation and promotion of

its uniform rules of practice.• The ICC’s aim is to provide a codification of international practiceoccasionally selecting the best practice after ample debate andconsideration.

• The ICC rules of practice are designed by bankers and merchants andnot by legislatures with political and local considerations.

• The rules accordingly demonstrate the needs, customs and practicesof business. Because the rules are incorporated voluntarily intocontracts, the rules are flexible while providing a stable base for international review, including judicial scrutiny.

• The Certified Documentary Credit Specialist is a qualification awardedby IFSA US and IFS UK and endorsed by ICC Paris as the onlyInternational qualification for Trade Finance Professionals, recognizingthe competence, and ensuring best practice.



2c. Documentary Collections

A transaction whereby the exporter entrust the collection of

payment to the remitting bank (exporter bank), which sendsdocuments to a collecting bank (importer bank), along withinstruction for payment.

Applicable for established trade relationships and in stableexport markets.

Advantages :•There is a bank assistance

in obtaining payments•The process is simple, fastand lest costly than LC’s

Disadvantages :•Banks’s role is limited and the

do not guarantee payment•Banks do not verify theaccuracy of the document



Documentary Collection Scheme

Exporter (China)

Importer (USA)

Remitting(Exporter)

Bank

Collecting(Importer)

Bank

Custom/Legal

Institution

9

3

1

12

6

5

74

8



Explanation :① Exporter sends goods to custom and presents the document

with instruction for obtaining payment to the exporter bank.② Importer give the document of purchasing

③ Exporter tell the remitting bank to send the document to thecollecting bank.

④ The remitting bank sends the document to the collecting bank⑤ Collecting bank releases the document to the importer, receipt

of payment or a acceptance of the drafts.

⑥ This documents uses to obtain the goods & to clear them at the

customs.⑦ Importer pay the money to the collecting bank (debited

account)

⑧ After receives the payment, collecting bank forward theproceeds to the remitting bank

⑨ The remitting bank then credits the exporter ’s account.



2d. Open Account

A sale where a goods are shipped and delivered before

payment is due, which is usually in 30 to 90 days.

Applicable for a low-risk trading relationships/markets and incompetitive markets to win customers with the use of one or

more appropriate trade finance techniques.

Advantages :• Boost competitiveness

in the global market• Helps establish and

maintain a succesfultrade relationships

Disadvantages :• Significant exposure to

the risk of non-payment• Additional costs

associated with riskmitigation measures.

H ff O A T i C i i



How to offer Open Account Terms in CompetitiveMarkets?

By using several techniques :a. Export working capital financing

b. Government-guaranteed export

working capital programsc. Export credit insurance

d. Export factoring



a. Export Working Capital Financing

EWC financing allows exporter to purchase the goods and

services they need to support their export sales. EWCfacilitates the Small-Medium Enterprises (SME) who lacksufficient internal liquidity to process and acquire goodsand services to fulfill export orders and to extend open

account terms to their foreign buyer.

Advantages :• Allows fulfillment of

export sales orders• Allows exporter to

offer open accountterms to remaincompetitive

Disadvantages :• Generally available only to

SMEs with access to strongpersonal guarantees, assets or high value receivables

• Additional costs associatedwith risk mitigation measures.



b. Government-Guaranteed Export Working CapitalLoan Programs

Early stage of SME are usually not eligible for commercialfinancing without government guarantee and it alsogenerally reluctant to extend credit due to the repayment riskassociated with export sales. So, government shouldprovide EWC loans to help the exporter ’s liquidity.

Advantages :• Encourages lenders to

offer financing toexporters

• Enables lenders to offer generous advance rates

Disadvantages :• Cost of obtaining and

maintaining a guaranteedfacility

• Additional costsassociated with risk

mitigation measures



c. Export Credit Insurance

Export Credit Insurance (ECI) protects an exporter of products

and services against the risk of non-payment by a foreignbuyer. It reduces the payment risk associated by giving aconditional assurance that payment will be made if the foreignbuyer is unable to pay.

ECI generally covers commercial risks (insolvency of the buyer,bankruptcy, protracted defaults, slow payment, political risk,currency inconvertibility expropriation and regulation changes.

Advantages :• Reduce the risk of non-

payment by foreign buyers• Offer open account terms

safely in the global market

Disadvantages :• Cost of obtaining and

maintaining an insurance policy• Risk sharing in the form of

deductible



d. Export Factoring

Complete financial package that combines EWC financing,

credit protection, foreign accounts receivable bookkeepingand collection services.

This bank or special financial firm offered under an

agreement between the factor and exporter in which thefactor purchases the exporter ’s short term foreign accountsreceivable for cash at a discount from the face value, withoutrecourse.

Advantages :• Eliminating risk of non-paymentby foreign buyers

• Handles collections on thereceivables, Improves liquidityposition and cash flow.

Disadvantages :• More costly than exportcredit insurance

• Generally not availablein developing countries



China Balance of Trade













Why RMB had no exposure in those graphs?

Chinese RenMinBi (RMB) had little to no exposure in the

international markets because of :1. Strict government controls by the central Chinese

government prohibited almost all export of the currency,or use of it in international transactions.

2. Chinese companies unable to hold US dollars andforeign companies unable to hold Chinese yuan.

3. Transactions between Chinese companies and a foreignentity were generally denominated in US dollars.

4. All transactions would go through the People's Bank of China.

5. The central bank would pass the settlement in renminbito the Chinese company at the state-controlled

exchange rate.



Fact about RMB in International Trade Financing

• The World Bank estimated that, by purchasing power

parity, one International Dollar was equivalent toapproximately RMB1.9 in 2004.

• Yuan is undervalued by 37,5% on the basis of purchasing power parity analysis.

• The International Monetary Fund estimated that, bypurchasing power parity, one United States dollar wasequivalent to approximately

RMB 3.462 in 2006,

RMB 3.621 in 2007,

RMB 3.798 in 2008,

RMB 3.872 in 2009,

and RMB3.922 in 2010.



RMB vs US$ (2007-2011)

• d



Countertrade

•Countertrade consists of transactions which haveas a basic characteristic a linkage, legal or otherwise, between exports and imports of goods or services in addition to, or in place of, financial

settlements.•Countertrade can be used as an effectiveinternational business tool.

•Countertrade plays a part in 20-25 percent of world

trade that carried out wholly or partially in goodsrather than money.

Sources : http://www.witiger.com/internationalbusiness/countertrade.htm



Why Countertrade ?1. The world debt crisis has made ordinary trade financing very

risky. (Large banks and financial institutions are "risk adverse" inmany of the hostile regions of the world opening to trade).

2. Many countries cannot obtain the trade credit or financial assistanceto pay for desired imports. (The IMF and World Bank are increasinglyrestrictive in the way they allow governments to operate).

3. Countries are increasingly returning to the notion of bilateralism as away to reduce trade imbalances.

4. Countertrade is often viewed as an excellent mechanism to gain entryinto new markets. The party receiving the goods may become a newdistributor, opening up new international marketing channels andultimately expanding the market.

5. Providing countertrade services helps sellers differentiate its productsfrom those of competitors. (Flexibility is key to winning business in aglobal market that is more and more competitive to vendors)

Sources : Fisher College of Business, Ohio State University



Forms of Countertrade

① Barter- direct exchange of goods or services having

equivalent values without a cash transaction② Counterpurchase: involves 2 simultaneous separate

transactions between 2 parties with or without cash

③ Buyback or compensation: involves repayment in the form

of goods derived from directly from, or produced by, thetechnology, plant, or equipment provided by the seller

④ Offsets: involves an arrangement whereby the seller isrequired to assist in or to arrange for the marketing of

products produced by the buying country or to allow someportion of the exported product to be assembled or manufactured by producers located in the buying country.

⑤ Switch-trading: refers to a switch in the country of

destination goods



Adv & Disadv of CountertradeAdvantages :

• Countertrade conserves cash and

hard currency.

• The improvement of trade

imbalances, the maintenance of

export prices, enhanced economic

development, increased

employment, technology transfer,

market expansion, increased

profitability, less costly sourcing of supply reduction of surplus goods

from inventory, and the

development of marketing

expertise.

Disadvantages :

• It is inefficient.

• Some claim that such

transactions tamper with the

fundamental operation of freemarkets, and therefore

resources will be used

inefficiently.

•Transactions that do not makeuse of money represent a huge

step backwards in economic

development.



Forfaiting

A method of trade financing that allows exporter to obtain

cash by selling their medium-term foreign accountsreceivable at a discount on a ‘without recourse’ basis.

A forfaiter is a specialized finance firm or a department in abank that performs non-recourse export financing trough thepurchase of medium –term trade receivables.

It eliminates the risk of non-payment once the goods havebeen delivered to the foreign buyer in accordance with theterms of sale.

Applicable for exports of capital goods commodities and



Applicable for exports of capital goods, commodities, andlarge projects on medium term credit (180 days to 7 years)

Risk inherent in an export sale is virtually eliminated.

Receivables are normally guaranteed by the importer’s bank which allows the exporter to take the transaction off the balance sheet to enhance financial ratios.

Advantages :• Eliminates the risk of non-

payment by foreign buyers.• Offers strong capabilities in

emerging and developingmarkets.

Disadvantages :• Cost is often higher than

commercial lender financing

• Limited to medium-termtransactions and thoseexceeding $100.000

The current minimum transaction size for forfaiting is $100,000

Cost of Forfaiting : the cost is determined by the rate of



Cost of Forfaiting : the cost is determined by the rate of discount based on the aggregate of the LIBOR(London Inter Bank Offered Rate) for the tenor of thereceivables and a margin reflecting the risk being

sold. The degree of risk varies based on theimporting country, the length of loan, the currency of transaction and the repayment structure.(the higher the risk, the higher the margin and thehigher the discount rate)

Three additional major advantages of forfaiting :a. Volume : forfaiting can work on a one-shot deal, without

requiring an ongoing volume of businessb. Speed : commitments can be issued within hours or days

depending on details and countryc. Simplicity : documentation is usually simpel, concise and

straightforward.

B fi f F f i i



Benefits of Forfaiting

• Eliminates Risk

* Removes political, transfer and commercial risk* Provides financing for 100% of contract value* Protects against risks of interest rate increase andexchange rate fluctuation

• Enhances Competitive Advantage* Enables sellers of goods to offer credit to their customers, making their products more attractive* Helps sellers to do business in countries where the

risk of non-payment would otherwise be too high

B fit f F f iti ( t)



• Improves Cash Flow

* Forfaiting enables sellers to receive cash payment whileoffering credit terms to their customers* Removes accounts receivable, bank loans or contingentliabilities from the balance sheet

• Increases Speed and Simplicity of Transactions * Fast, tailor-made financing solutions* Financing commitments can be issued quickly* Documentation is typically concise and straightforward

* No restrictions on origin of export* Relieves seller of administration and collection burden

Benefits of Forfaiting… (cont)

G A i i E i



Government Assistance in Exporting

Government-assisted by export-import bank helps to turn

export opportunities, especially in high-risk emergingmarkets, into real transactions for large corporations andestablished medium-sized companies.

This type of financing provides direct loans to foreign buyersat fixed rate or provides guarantees for term financingoffered by commercial lenders.

Financing is available for medium term (up to 5 years) and

long term (up to 10 years) transaction.

It is applicable for the export of high-value capital goods or services or large-scale projects that require extended-term

financing

Th E t I t B k



The Export-Import Banks

Ex-Im Bank provides direct loan or by guaranteeing commercial

loans to creditworthy foreign buyers for purchases domesticgoods and services.

Key features of Ex-Im Banks :1. Loans are made by commercial banks and guaranteed by

Ex-Im Bank.2. Loans cover 100 percent principal and interest for 85% of the

contract price.3. Interest rate are negotiable, floating and lower than fixed

rates.4. Loans are fully transferable, securitized and available in

certain foreign currencies.5. Loans have a faster documentation process with the

assistance of commercial banks.



To improve our knowledge of International Trade Financing, let’s answer these :

P bl 1



Problem 1 :

1. Assume the time from acceptance to maturity on a $

2,000,000 banker ’s acceptance is 90 days. Further assume that the importing bank’s acceptancecommission is 1.25 percent and that the market ratefor 90-day B/A is 7 percent.

Determine the amount the exporter will receive if heholds the B/A until maturity and also the amount theexporter will receive if he discounts the B/A with theimporter ’s bank.

Problem 2



Problem 2 :

2. The time from acceptance to maturity on a

$1,000,000 banker ’s acceptance is 120 days. Theimporter ’s bank acceptance commission is 1.75percent and the market rate for 120-days B/A is 5.75percent.

What amount will the exporter receive if he holds theB/A until maturity? If he discount the B/A with theimporter ’s bank? Also determine the bondequivalent yield the importer bank will earn fromdiscounting the B/A with the exporter. If theexporter ’s opportunity cost of capital is 11 percent,should he discount the B/a or hold it to maturity?

Conclusion



Conclusion• Conducting international trade transactions and trade

financing is difficult in comparison to domestic trades.• Commercial and political risk enter into the equation so it isImportant for a country to be competitively strong ininternational trade.

• A typical foreign trade transaction requires three basic

documents: letter of credit, time draft, and bill of lading.• Forfaiting in which a bank purchase at a discount from animporter a series of promissory notes in favor of an exporter is a medium-term form of trade financing

• The export-import bank provide competitive assistance to

exporters through direct loans to foreign importers, loanguarantees and credit insurance to the exporters.• Countertrade transaction are gaining renewed prominence

as a means of conducting international trade transactions.



IndonesiaImporter

This is the end of Chapter 20,

Any Questions?

Thanks for your Attention!