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June 2012
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What is Tradefinance

Trade Finance Overview

Trade is a basic necessity of any commercial environment. On account of inherent competencies a country or an organization (defined collectively as party or parties) rarely, if ever, produces everything it needs. This means that such parties are dependent upon one another for those products that they need but they themselves do not produce.

When goods need to be moved from one party to another across national boundaries, the following considerations apply:

q  The physical movement of goods from one party to another

q  Adherence to trade terms decided between parties participating in trade

q  Documents covering the transport of such goods.

q  Insurance of goods against damage during transit.

q  Payment details

q  Regulations within countries e.g. Licensing, Exchange Control.

q  Legal requirements within countries.

The main objective of trade finance is to facilitate a transaction or series of transactions. Banks and other intermediaries can offer services in many forms to participants in trade transactions. Actual financing of the trade as per the requirement of the buyer or supplier is a common function of banks. Banks may also offer their services by providing different kinds of payment mechanisms and may in cases act as guarantors for payment of goods. Compared with other forms of bank lending, financing trade transactions is popular with commercial banks also because these deals are:

q  Short term (in most cases)

q  Self liquidating (e.g., banks finance the import of goods which are then resold to repay the bank)

q  Secured (by the underlying goods)

q  Speedily completed (e.g., within the short life of a documentary credit, there may be several transactions which are completed quickly, at “high velocity”).

The following are the critical aspects in any trade transaction:

q  Payment

q  Movement of Physical Goods.

q  Cross Border and Exchange Risk

q  Documents in Trade Finance

q  Regulations and Procedures


Various methods of payments are used as part of the Financial Supply Chain in Trade Finance. The table below highlights the various methods of payments in use and the comparison between them:

Method Goods Available To Buyer Usual Time Of Payment Risk To Exporter Risk To Importer
Cash In Advance After Payment Before Shipment Very Low Maximum-Relies on exporter to ship goods as ordered
Letter of Credit
Unconfirmed (Advised)
After Payment When documents are available at shipment Very Low Assured of quantity and also quality at shipment if inspection report is required
Documentary Collection Sight Draft Documents against Payment After Payment On presentation of draft to importer If draft unpaid, goods must be returned or disposed of, usually at loss Assured of quantity, also quality, if goods are inspected before shipment
Documentary Collection Time Draft Documents against Acceptance Before payment On maturity of draft Relies on importer to pay draft Minimal—Can check shipment for quantity and quality before payment
Consignment Before payment, exporter retains title until goods are sold or used After use; inventory and warehousing cost to exporter Substantial risk unless through foreign branch or subsidiary Very Low
Open Account Before payment As agreed Relies on importer to pay account as agreed—complete risk Very Low

Table: Method of Payments

Each method of payment carries its own risk profile pertaining to the Exporter and Importer. The degree of risk varies with regards to the payment mechanism used. The diagram below highlights this fact:

Movement of Physical Goods

Apart from financing, logistics plays a very important role in successful trade transactions. Trade Logistics ensures the physical movement of goods from the buyer to the seller. The various participants involved in the logistics value chain are:

q  Freight Forwarders/ Multimodal Operators

q  Cargo Consolidators

q  Insurance Agents

q  Shipping Agents

q  Custom Authorities

Cross Border and Exchange Risks

In trade transactions, apart from standard credit risks where the buyer is unwilling or unable to pay, exporters and their banks also face foreign exchange risk and country risk that causes losses due to political and economic events beyond the control of the exporter.

Foreign currency risk arises from the exposure to fluctuations in exchange rates whenever payments involve foreign currencies. The level of risk depends on the currency involved in the transaction, whether the bank creates an open position, the size of any maturity gap, and settlement uncertainties.

Exporters and their banks usually employ various hedging strategies like forward contracts and currency options to protect themselves against foreign exchange risk.

Documents in Trade Finance

Trade finance is a documentation intensive business, and a single transaction can require many different kinds of documents.

Documents in Trade Finance can be classified into the following five categories:

q  Financial Documents

q  Transport Documents

q  Commercial Documents

q  Regulatory Documents

q  Insurance and others

A brief description of the various categories of documents is given below:

Financial Documents

These are documents used to obtain payment for goods and services. There are mainly 2 types of financial documents

q  Bill of Exchange

q  Promissory Note

Transport Documents

These are documents issued by the freight company to the seller/shipper when moving the merchandise from the seller to the buyer. They provide title to the goods or merchandise. Transport documents are usually in the form of a document known by the generic name of “Bill of Lading” but depending on the mode of transport, it is named accordingly.

Commercial Documents

These are documents issued by the seller and give the details of the merchandise. They contain a clear description of the quality and quantity of the goods and their value. A commercial invoice is an example of a commercial document.

Regulatory Documents

Regulatory documents provide authorization for trading with the other party in the specified goods. These are usually country specific requirements as the importer might require conforming to certain guidelines while taking part in international trades. A certification regarding Country of Origin of the goods can be taken as a typical example of a regulatory document.

Insurance Documents

Insurance documents are required for coverage of loss and/or damage to goods or against any other risk during the transit.

Standard Regulations & Procedures

International trade needs to follow various regulations and procedural guidelines. Trade finance providers, therefore, need to make sure that the any trade transaction that they may take part in, complies with the regulations that may be applicable. The following types of regulations usually govern trade transactions:

Trade Control Requirements

Trade Control lays down the policy and regulations relating to physical movement of goods in and out of a particular country. The banker needs to ensure whether the goods that are involved in trade can be lawfully brought in and out of the country as per its Export-Import policy.

Exchange Control Requirements

In International trade transactions, settlement of payment must be within the scope of exchange control guidelines of participating countries. This is ensured through Exchange control guidelines issued by central banks of the respective countries.

International guidelines

In Trade transactions, international bodies like the International chamber of Commerce (ICC) have published UCP 500 and URC 522 for smooth facilitation of International trade. These regulations are followed for Documentary Credits and Documentary Collections respectively.

UCPDC Guidelines (UCP 500)

In order to standardize the rules governing operations of documentary letters of credit, ICC has codified standard set of rules for operations of Letter of Credit which are known as Uniform Customs and Practices for Documentary Credits (UCPDC). These are guidelines accepted by over 200 countries to facilitate trade and payment through the LC route.

URC Guidelines (URC 522)

These guidelines cover rules and regulations pertaining to trade taking place through the collection mechanism.

Bank to Bank Reimbursements Rules (URR 525)

Bank-to-bank reimbursement is a letter of credit payment settlement service whereby the Letter of Credit issuing bank authorises claims against letter of credit drawings to be paid from its accounts held with the reimbursing bank. All aspects of the bank-to-bank reimbursement process are clearly explained in the ICC Guide to Bank-to-Bank Reimbursements under Documentary Credit.

Trade terms and Incoterms

Trade terms set out the rights and obligations of the parties to a sales contract with respect to the delivery of goods. They define whether the importer (buyer) or the exporter (seller) will be responsible for arranging the transport and insurance necessary for the delivery of goods, and up to what point, and other related matters

International Standard Banking Practices (ISBP)

In October 2002, the ICC Banking Commission approved a document entitled “International Standard Banking Practice for the Examination of Documents under Documentary Credits (ISBP)”. This document represents the content and provisions of the UCP 500. It interprets the clauses in UCP 500 and explains how the practices articulated in the UCP 500 are to be applied by documentary credit practitioners.


eUCP is a supplement to UCP 500 for electronic presentations. With the global trading community using documentary credits were being presented with an increasing range of potential electronic solutions for the preparation and transmission of the of documentation there aroused a need to expand the reach of the UCP 500 to provide it with the flexibility not only to cater for the traditional paper documentation transactions but also for the dematerialized documentation transactions transmitted electronically


In International Trade, Exporter is the seller of goods and services. The seller enters into a contract with the buyer. He ships the goods to the buyer and submits documents to his bank with instructions on how and when the buyer should pay. The seller is also known as the DRAWER of the bill of exchange. The exporter plays different roles depending on the Trade Finance product the exporter enjoys.

q  Beneficiary: Beneficiary is normally a seller of the goods, who has to receive payment from the Applicant. A Credit is issued in his favour to enable him or his agent to obtain payment on surrender of stipulated documents and comply with the terms and conditions of the LC. If LC is a transferable one and he transfers the credit to another party, then he is referred to as the First or Original Beneficiary.


In International Trade an Importer is the buyer of goods and services. Importer will typically buy goods and services from overseas sellers. He pays the bill against receipt of documents. He is also known as the DRAWEE. The importer plays different roles depending on the Trade Finance product the importer enjoys.

q  Applicant (Opener): Applicant is normally a buyer of the goods, who has to make payment to beneficiary. LC is initiated and issued at his request and on the basis of his instructions. Issuing Bank (Opening Bank): Issuing Bank is one which issues the Credit i.e. it is the bank, which creates a letter of credit and undertakes to make payment.


Banks play a very vital role in business of International Trade. They form an important link in the trade finance value chain for the following reasons:

q  Acceptable as an intermediary – various roles.

q  Expertise in handling international trade transactions.

q  Ability to supply trade and credit information.

q  Guaranteed payments.

q  Financial assistance.

q  Provides products and services to mitigate risk.

Different Roles that Banks play

In Trade Finance transactions banks usually act either on behalf of the importer or on behalf of the exporter. Banks acting on behalf of importers usually undertake payment obligations or guarantees on behalf of their importer clients. Banks acting on behalf of exporters usually provide credit facilities for manufacturing and selling of goods and for meeting the liquidity needs of exporters in cases where the terms of trade provide for a credit period. Banks also allow use of their networks for the flow of payment.

The various functions undertaken by banks are detailed blow. It may be noted that the same bank may undertake some of the functions.

q  Issuing Bank: A bank that issues a Letter of Credit (Documentary Credit or Credit) on behalf of an importer is called the Issuing Bank.

q  Advising Bank: When a Letter of Credit is issued, the beneficiary might want a bank to check the genuineness of the Credit. This bank is called the Advising Bank. A bank in its role as the Advising bank advises the Credit to the Beneficiary, thereby assuring the genuineness of the Credit. It is normally situated in the country/ place of Beneficiary. The Advising Bank may be correspondent bank of the Issuing Bank or could be specifically notified by the Beneficiary. The Advising Bank primarily performs the function of an informer communicating to the beneficiary that a LC has been opened in his favour. The only assurance implied is that the LC is genuine.

q  Confirming Bank: In some cases, the exporter might require that a Bank selected by him confirm the Credit. The Confirming Bank adds its guarantee to the Credit opened by another bank, thereby undertaking the responsibility of payment/ negotiation/ acceptance under the credit, in addition to that of the Issuing Bank. Usually a Confirming Bank is required where the exporter is not satisfied with the undertaking of only the Issuing Bank. A confirmation constitutes a definite undertaking by the Confirming Bank that the provision for payments or acceptance will be dully fulfilled. The Confirming Bank takes a credit view on the Issuing Bank.

q  Negotiating Bank: Negotiation is the process of giving value to the documents. The negotiating bank is one with whom the documents may be negotiated. The LC may either specify the Negotiating bank (restricted negotiation) or the exporter may be free to negotiate through any Bank (unrestricted negotiation).

q  Reimbursing Bank: Reimbursing Bank is the bank authorized to honour the reimbursement claim in settlement of negotiation/acceptance/payment lodged with it by the negotiating bank. It is normally the bank with which Issuing Bank has an account, from which payment is to be made.

q  Remitting Bank: Frequently banks offer a service called Documentary Collections wherein they collect export payments on behalf of their exporter clients. When payment is due for a trade transaction, the exporter hands over the accepted documents to its bank. This bank, called the Remitting Bank, scrutinises the documents and sends them to the buyer. The Remitting Bank pays the exporter on receipt of funds from the importer’s bank.

q  Collecting/ Presenting Bank: The Collecting/ Presenting Bank, as an agent of the Remitting Bank, presents the bill to the buyer for payment/ acceptance, release the documents to the buyer when the exporter’s instructions have been followed and remit the proceeds of the bill to the Remitting Bank. There is a slight difference between the Collecting and presenting bank. Collecting Bank is any bank other than the remitting bank involved in the process of collection, whereas the presenting bank is the collecting bank making presentation to the drawee.

q  Correspondent Bank: A Correspondent Bank provides different kinds of services like credit, deposit, collection, clearing and payment services to other banks and financial institutions who do not have networks or branches in the area where the stated service may be required. Correspondent banks may be asked to provide LC advising services or Document collecting and presenting services.

q  Factoring Bank: A Factoring Bank finances receivables of sellers, usually on a “with recourse” basis. They buy off the receivables at a discount and receive the payment from the buyer at the end of the credit period. As these are “with recourse“transactions, the seller has an obligation to pay if the bank is not able to recover the payment from the buyer.

q  Forfaiting Bank: A Forfaiting Bank finances receivables of sellers on a “without recourse” basis. As these are “without recourse“transactions, the buyer is usually required to provide a bank guarantee against the receivables. The table below summarizes the different business segments the various banks in the trade value chain address:

Role Business Segment
Advising Bank Banks provide this service for their exporter clients who are beneficiaries in an LC based trade transaction and require that the LC be authenticated by a bank known to them. Some banks may provide this service on behalf of their correspondent banks that do not have a wide network.The Advising Bank provides LC advising/ LC authentication services on behalf the exporter.
Negotiating Bank Negotiating banks provide their services to Exporter clients who use the services of the bank to negotiate their export bills and obtain funds without waiting for export realization.Negotiating Banks provide negotiating services, wherein they give value to trade documents.
Confirming Bank Banks provide this service for their exporter clients who are beneficiaries in an LC based trade transaction and require a confirmation of the LC from a bank known to them. Some banks may provide this service on behalf of their correspondent banks that do not have a wide network.Confirming Banks provide LC Confirmation services on behalf of the exporter, thereby shifting the risk from the issuing bank to them from the exporter’s point of view.
Reimbursing Bank The business segment for Reimbursing Banks are Local and national banks in other countries / territories that do not have the branch network/reach to provide payment services in a particular currency to and hence depend on correspondent banks to provide these services to them for a fee.Reimbursing Banks provides clearing and settlement services for payments under the Letter of Credit
Issuing Bank Banks issues Letters of Credit for their importer clients who might need them as part of a trade transaction. The Issuing Bank earns commission for this service.The Issuing Bank provides a credit line to the Applicant under which it opens Letters of Credit on the Applicant’s request. Often the issuing bank might also provide finance to the importer to pay for the goods received.
Collecting / Presenting Bank The business segments for banks providing these services are small, medium and large Corporate clients who use the services of the bank to route their import transactions.Collecting/ Presenting Banks provide Documentary collection services for exporters
Correspondent Bank Provide end-to-end trade services for a fee to other banks who does not have network or reach in other countries/territoriesCorrespondent Banking provides credit, deposit, collection, clearing and payment services to banks and financial institutions. These services are only for banks/ financial institutions.
Forfaiting /Factor Bank The business segments for banks providing these services are medium and large exporters who use the services of the bank for early realization of their export proceeds.Banks provide receivable financing in the form of Factoring/ Forfaiting services to exporters

Table: Business Segments and Bank Roles

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