summer project on 039 international trade finance 039

Appendix: 1

INTERNATIONAL TRADE FINANCE

Project submitted to

H & G H Mansukhani Institute of Management

in partial fulfillment of the requirements for

Master in Management Studies

By

KAPIL P. ISRANI Roll No: 16

Specialization MMS (FINANCE) Batch: 2010 - 2012

Under the guidance of

(Prof. ANJALI SAWLANI)

Appendix 2:

INTERNATIONAL TRADE FINANCE

Project submitted to

H & G H Mansukhani Institute of Management

in partial fulfillment of the requirements for

Master in Management Studies

By

KAPIL P. ISRANI Roll No: 16

Specialization MMS (FINANCE) Batch: 2010 - 2012

Under the guidance of

(Prof. ANJALI SAWLANI)

Appendix: 3

H & G H Mansukhani Institute of Management Ulhasnagar

Students Declaration

I hereby declare that this report submitted in partial fulfillment of the requirement of MMS Degree

of University of Mumbai to H & G H Mansukhani Institute of Management. This is my original

work and is not submitted for award of any degree or diploma or for similar titles or prizes.

Name : KAPIL P. ISRANI Class : MMS FINANCE Roll No. : 16 Place : Ulhasnagar Date : Students Signature :

Appendix: 4

Certificate This is to certify that the dissertation submitted in partial fulfillment for the award of MMS degree

of University of Mumbai to H & G H Mansukhani Institute of Management is a result of the

bonafide research work carried out by Mr. KAPIL P. ISRANI under my supervision and guidance, no part of this report has been submitted for award of any other degree, diploma or other

similar titles or prizes. The work has also not been published in any journals/Magazines.

Date

Place: Ulhasnagar

Internal Guide External Guide (Miss Anjali Sawlani) (Mr. K.V. Bandekar) Director Dr. Henry Babu

TABLE OF CONTENT

TOPIC PAGE NO.

1. EXECUTIVE SUMMARY 01

2. OVERVIEW . 02

2.1 SETTLEMENT OF ACCOUNTS . 05

3. METHODS OF PAYMENT OF INTERNATIONAL TRADE 06 3.1 DETERMINNANTS / FACTORS .. 07 3.2 CASH IN ADVANCE .. 08 3.3 WIRE TRANSFER 10

4. LETTER OF CREDIT .. 12

4.1 LC TRANSACTIONS . 13 4.2 DOCUMENTARY COLLECTIONS .. 15 4.2 A) D/P COLLECTION . 17 4.2 B) D/A COLLECTION 18 4.2 C) OPEN ACCOUNT .. 18

5. EXPORT CREDIT INSURANCE . 20 5.1 COVERAGE . 21 5.2 PRICING 22 5.3 EXIM BANKS EXPORT CREDIT INSURANCE . 22 5.4 GOVERNMENT ASSISTED FOREIGN BUYERS FINANCING 23

6. FOREFEITING .. 25

6.1 ROLE IN INTERNATIONAL TRADE . 25 6.2 COST ELEMENTS .. 26 6.3 BENEFITS TO THE EXPORTS . 26 6.4 PITFALLS OF FOREFEITING .. 28

7. FACTORING .. 28

7.1 TYPESS OF FACTORING .. 29 7.2 FACTORING V//S FOREFEITING 30

8. BUYERS CREDIT . 32 8.1 PROCESS OF B.C. . 35 8.2 PROCESS OF B.C. FOR CAPITAL GOODS .. 35 8.3 CONCEPT OF WHT 39 8.4 BUYERS CREDIT INTEREST RATES (LIBOR & MARGINS) . 40 8.5 BUYERS CREDTI ROLLOVER .. 45

9. EXPORT FINANCING .. 47

9.1 PRE SHIPMENT FINANCING .. 47 9.2 PRE SHIPMENT CREDIT IN FOREIGN CURRENCY (PCFC).. 51 9.3 POST SHIPMENT FINANCING .. 52

10. ROLE OF ECGC .. 58

11. CONCLUSION 60

12. BIBLIOGRAPHY . 62

INTERNATIONAL TRADE FINANCE |

1

EXECUTIVE SUMMARY

The project INTERNATIONAL TRADE FINANCE is a detailed study of the Import,

Export, & Foreign Exchange Market of India with the main objective of making a

successful career in the sector by getting placed with one of the Foreign Exchange

companies.

The project has explored the need for trade finance and introduced some of the most

common trade finance tools and practices. A proactive role of governments in trade

finance may alleviate the lack of trade finance in emerging economies and contribute to

trade expansion and facilitation.

Recent times have witnessed remarkable growth in international transactions. With the

fast growing international oriented transactions in business enterprise. The different areas

which play vital role in growth of Global Trade Finance market such as Methods of

Payments of International Trade, Letter of credit, and concept of Forfeiting, Factoring,

and Buyers Credit, Pre shipment & Post Shipment Financing and Role of ECGC in

foreign exchange market.

While doing this project, different aspect of ECB, Buyers Credit, concept of LIBOR &

Margins in Interest Rate were studied. Trade financing in India is in nascent stage in

order to explore foreign exchange market & smooth functioning of transactions the

government should undertake some initiative to with-stand among the developed

countries.

Needless to say, no text paper or text book by itself can convey the full richness of either

the theoretical development or subtleness if practice in its chosen fields. This Project is a

sincere attempt to provide a basic understanding of the complexities of international trade

of world finance in simple manner.


2

INTRODUCTION

The absence of an adequate trade finance infrastructure is, in effect, equivalent to a

barrier to trade. Limited access to financing, high costs, and lack of insurance or

guarantees are likely to hinder the trade and export potential of an economy, and

particularly that of small and medium sized enterprises. As explained earlier, trade

facilitation aims at reducing transaction cost and time by streamlining trade procedures

and processes. One of the most important challenges for traders involved in a transaction

is to secure financing so that the transaction may actually take place. The faster and easier

the process of financing an international transaction, the more trade will be facilitated.

Traders require working capital (i.e., short-term financing) to support their trading

activities. Exporters will usually require financing to process or manufacture products for

the export market before receiving payment. Such financing is known as pre-shipping

finance. Conversely, importers will need a line of credit to buy goods overseas and sell

them in the domestic market before paying for imports. In most cases, foreign buyers

expect to pay only when goods arrive, or later still if possible, but certainly not in

advance. They prefer an open account, or at least a delayed payment arrangement. Being

able to offer attractive payments term to buyers is often crucial in getting a contract and

requires access to financing for exporters. Therefore, governments whose economic

growth strategy involves trade development should provide assistance and support in

terms of export financing and development of an efficient financial infrastructure. There

are many types of financial tools and packages designed to facilitate the financing of

trade transactions. This introduces three types, namely:

o Trade Financing Instruments; o Export Credit Insurances; and o Export Credit Guarantees

The primary purpose of the foreign exchange is to assist international trade and

investment, by allowing businesses to convert one currency to another currency. For

example, it permits a US business to import British goods and pay Pound Sterling, even


3

though the business' income is in US dollars. It also supports direct speculation in the

value of currencies, and the carry trade, speculation on the change in interest rates in two

currencies.

In a typical foreign exchange transaction, a party purchases a quantity of one currency by

paying a quantity of another currency. The modern foreign exchange market began

forming during the 1970s after three decades of government restrictions on foreign

exchange transactions (the Bretton Woods system of monetary management established

the rules for commercial and financial relations among the world's major industrial states

after World War II), when countries gradually switched to floating exchange rates from

the previous exchange rate regime, which remained fixed as per the Bretton Woods

system.

FEMA ACT 1999 Defines Foreign Exchange as Foreign Exchange means & includes:

a) All deposits, credits and balances payable in foreign currency, and any drafts,

travelers Cheques, letters of credit and bills of exchange, expressed or drawn in Indian

currency and payable in any foreign currency.

b) Any instrument payable at the option of the drawee or holder, thereof or any other

party thereto, either in Indian currency or in foreign currency, or partly in one and partly

in the other.

DEALING IN FOREIGN EXCHANGE

In India dealing in foreign exchange is permitted only with the approval of RBI. RBI is

the authority to administer exchange control in India. It also has the responsibility to

maintain the external value of rupee. AD is person authorised by RBI in the form of a

license to deal in foreign exchange. In addition to above category to buy & sell foreign

currency / coins and FTC called money changers like hotels and business establishments.


4

Sr. No. SOURCES / INFLOW

USES / OUTFLOW

1 INWARD

REMITTANCE

DD/MT/TT/CREDIT

CARD

OUTWARD

REMITTANCE

DD/MT/TT/CREDIT

CARD

2 REMITTANCE TO

NRE/FCNR(B)/NRO

ACCOUNTS

OUTWARD

REMITTANCE

3 EXPORT

RECEIVABLES

IMPORT PAYMENTS

4 BORROWINGS BY

COMPANIES, AID &

LOANS

LOAN REPAYMENT,

LOAN SERVICING

5 TOURIST INCOME

TOUR, TRAVEL

RELATED PAYMENTS,

EXPORT RELATED

PAYMENTS LIKE

COMMISSION, LEGAL

EXPENSES ETC.


5

SETTLEMENTS OF ACCOUNTS Whenever, there is an international trade and inflow and outflow of foreign exchange,

there must be some mechanism for settlement of these transactions. The need for

settlement leads to opening of accounts by banks in other countries.

1. NOSTRO ACCOUNT

Banks in India are permitted to open foreign currency accounts with bank abroad.

IOB having an account with American Express Bank New York is a Nostro

Account. It is OUR ACCOUNT WITH YOU. When an Indian bank issue a

foreign currency draft, payable abroad on a correspondent bank, the Nostro

Account of the Indian bank is debited and the amount paid to the beneficiary. In

the same way when the bill or Cheques is received for collection the proceeds will

be credit to the Nostro Account Only.

Nostro accounts are usually in the currency of the foreign country. This allows for

easy cash management because currency doesn't need to be converted.

Nostro is derived from the latin term "ours."

2. VOSTRO ACCOUNT

It is the account in India in Indian rupees maintained by overseas bank. It Citi Bank,

New York opens an account with IOB in India it is a Vostro Account. It is YOUR

ACCOUNT WITH US. Any draft, TC, issued by overseas correspondent in Indian

rupees is paid in India, to the debt of vostro account.

The account a correspondent bank, usually U.S. or UK, holds on behalf of a foreign bank. Also known

as a loro account.


6

3. LORO ACCOUNT

This terminology is used when one bank refeers to the NOSTRO account of another

bank. If IOB and SBI maintain nostro account with ABN AMRO Frankfurt, IOB, will

refer to SBI account as LORO account IT IS THEIR ACCOUNT WITH YOU

4. MIRROR ACCOUNT

As the very name suggests it is the reflection of NOSTRO ACCOUNT. The banks

maintain the REPLICA of the NOSTRO account they have with the foreign banks.

There mirror accounts mainly helps in reconciliation of the account and is maintained

in both foreign currency and in Indian rupees.

METHODS OF PAYMENT IN INTERNATIONAL TRADE

To succeed in todays global marketplace, exporters must offer their customers attractive

sales terms supported by the appropriate payment method to win sales against foreign

competitors. As getting paid in full and on time is the primary goal for each export sale,

an appropriate payment method must be chosen carefully to minimize the payment risk

while also accommodating the needs of the buyer. As shown below, there are four

primary methods of payment for international transactions. During or before contract

negotiations, it is advisable to consider which method in the diagram below is mutually

desirable for you and your customer.

Ninety-five percent of the worlds consumers live outside of the United States, so if you

are only selling domestically, you are reaching just a small share of potential customers.

Exporting enables small and medium-sized exporters (SMEs) to diversify their portfolios

and insulates them against periods of slower growth. Free trade agreements have opened

in markets such as Australia, Canada, Central America, Chile, Israel, Jordan, Mexico, and

Singapore, creating more opportunities for U.S. businesses.


7

DETERMINANTS OF INTERNATIONAL PAYMENT

o TRADE FINANCE

Offers a means to convert export opportunities into sales by managing the risks

associated with doing business internationally, particularly the challenges of getting

paid on a timely basis.

O OPPORTUNITIES

a) Helps companies reach the 95 percent of non-U.S. customers worldwide

b) Diversifies SME customer portfolios

O RISKS

a) Nonpayment or delayed payment by foreign buyers

b) Political and commercial risks; cultural influences


8

KEY POINTS

o International trade presents a spectrum of risk, causing uncertainty over the timing of payments between the exporter (seller) and importer (foreign buyer)

o To exporters, any sale is a gift until payment is received

o Therefore, the exporter wants payment as soon as possible, preferably as soon as an order is placed or before the goods are sent to the importer

o To importers, any payment is a donation until the goods are received

o Therefore, the importer wants to receive the goods as soon as possible, but to delay payment as long as possible, preferably until after the goods are resold to generate

enough income to make payment to the exporter.

CASH-IN-ADVANCE

With this payment method, the exporter can avoid credit risk, since payment is received

prior to the transfer of ownership of the goods. Wire transfers and credit cards are the

most commonly used cash-in-advance options available to exporters. However, requiring

Payment in advance is the least attractive option for the buyer, as this method creates

cash flow problems. Foreign buyers are also concerned that the goods may not be sent if

payment is made in advance. Thus, exporters that insist on this method of payment as

their sole method of doing business may find themselves losing out to competitors who

may be willing to offer more attractive payment terms.


9

CHARACTERISTICS OF A CASH -IN -ADVANCE PAYMENT

METHOD

1. APPLICABILITY Recommended for use in high-risk trade relationships or export markets, and ideal

for Internet-based businesses.

2. RISK Exporter is exposed to virtually no risk as the burden of risk is placed nearly

completely on the importer.

3. PROS a) Payment before shipment

b) Eliminates risk of nonpayment

4. CONS a) May lose customers to competitors over payment terms

b) No additional earnings through financing operations

KEY POINTS

o Full or significant partial payment is required, usually via credit card or bank/wire

transfer, prior to the transfer of ownership of the goods.

o Cash-in-advance, especially a wire transfer, is the most secure and favorable method of international trading for exporters and consequently, the least secure

and attractive option for importers. However, both the credit risk and the

competitive landscape must be considered.


10

o Insisting on these terms ultimately could cause exporters to lose customers to competitors who are willing offer more favorable payment terms to foreign

buyers in the global market.

o Creditworthy foreign buyers, who prefer greater security and better cash utilization, may find cash-in-advance terms unacceptable and may simply walk

away from the deal.

WIRE TRANSFER - CASH-IN-ADVANCE METHOD

An international wire transfer is commonly used and has the advantage of being almost

immediate. Exporters should provide clear routing instructions to the importer when

using this method, including the name and address of Silicon Valley Bank (SVB), the

banks SWIFT address, and ABA numbers, and the sellers name and address, bank

account title, and account number. This option is more costly to the importer than other

options of cash-in-advance method, as the fee for an international wire transfer is usually

paid by the sender.

CREDIT CARDA VIABLE CASH-IN-ADVANCE METHOD

Exporters who sell directly to the importer may select credit cards as a viable method of

cash-in-advance payment, especially for consumer goods or small transactions. Exporters

should check with their credit card company(s) for specific rules on international use of

credit cards as the rules governing international credit card transactions differs from those

for domestic use. As international credit card transactions are typically placed via online,

telephone, or fax methods that facilitate fraudulent transactions, proper precautions

should be taken to determine the validity of transactions before the goods are shipped.

Although exporters must endure the fees charged by credit card companies, this option

may help the business grow because of its convenience.


11

PAYMENT BY CHECKA LESS-ATTRACTIVE CASH-IN-

ADVANCE METHOD

Advance payment using an international check may result in a lengthy collection delay of

several weeks to months. Therefore, this method may defeat the original intention of

receiving payment before shipment. If the check is in U.S. dollars or drawn on a U.S.

bank, the collection process is the same as any U.S. check. However, funds deposited by

non-local check may not become available for withdrawal for up to 11 business days due

to Regulation CC of the Federal Reserve. In addition, if the check is in a foreign currency

or drawn on a foreign bank, the collection process is likely to become more complicated

and can significantly delay the availability of funds. Moreover, there is always a risk that

a check may be returned due to insufficient funds in the buyers account.

WHEN TO USE CASH-IN-ADVANCE TERMS

o The importer is a new customer and/or has a less-established operating history

o The importers creditworthiness is doubtful, unsatisfactory, or unverifiable

o The political and commercial risks of the importers home country are very high

o The exporters product is unique, not available elsewhere, or in heavy demand

o The exporter operates an Internet-based business where the use of convenient payment methods is a must to remain competitive


12

LETTERS OF CREDIT

Letters of credit (LCs) are among the most secure instruments available to international

traders. An LC is a commitment by a bank on behalf of the buyer that payment will be

made to the exporter provided that the terms and conditions have been met, as verified

through the presentation of all required documents. The buyer pays its bank to render this

service. An LC is useful when reliable credit information about a foreign buyer is

difficult to obtain, but you are satisfied with the creditworthiness of your buyers foreign

bank. An LC also protects the buyer since no payment obligation arises until the goods

have been shipped or delivered as promised.

CHARACTERISTICS OF A LETTER OF CREDIT

1. APPLICABILITY Recommended for use in new or less-established trade relationships when you are

satisfied with the creditworthiness of the buyers bank.

2. RISK Risk is evenly spread between seller and buyer provided all terms and conditions

are adhered to.

3. PROS a) Payment after shipment

b) A variety of payment, financing and risk mitigation options

4. CONS

a) Requires detailed, precise documentation

b) Relatively expensive in terms of transaction costs


13

KEY POINTS

o An LC, also referred to as a documentary credit, is a contractual agreement

whereby a bank in the buyers country, known as the issuing bank, acting on

behalf of its customer (the buyer or importer), authorizes a bank in the sellers

country, known as the advising bank, to make payment to the beneficiary (the

seller or exporter) against the receipt of stipulated documents.

o The LC is a separate contract from the sales contract on which it is based and, therefore, the bank is not concerned whether each party fulfills the terms of the

sales contract.

o The banks obligation to pay is solely conditional upon the sellers compliance

with the terms and conditions of the LC. In LC transactions, banks deal in

documents only, not goods.

ILLUSTRATIVE LETTER OF CREDIT TRANSACTION

1. The importer arranges for the issuing bank to open an LC in favor of the exporter

2. The issuing bank transmits the LC to the advising bank, which forwards it to the

exporter.

3. The exporter forwards the goods and documents to a freight forwarder.

4. The freight forwarder dispatches the goods and submits documents to the advising

bank.

5. The advising bank checks documents for compliance with the LC and pays the

exporter.


14

6. The importers account at the issuing bank is debited.

7. The issuing bank releases documents to the importer to claim the goods from the

carrier.

IRREVOCABLE LETTER OF CREDIT

LCs can be issued as revocable or irrevocable. Most LCs is irrevocable, which means

they may not be changed or cancelled unless both the buyer and seller agree. If the LC

does not mention whether it is revocable or irrevocable, it automatically defaults to

irrevocable. Revocable LCs is occasionally used between parent companies and their

subsidiaries conducting business across borders.

CONFIRMED LETTER OF CREDIT

A greater degree of protection is afforded to the exporter when a LC issued by a foreign

bank (the importers issuing bank) and is confirmed by Silicon Valley Bank (the

exporters advising bank). This confirmation means that Silicon Valley Bank adds its

guarantee to pay the exporter to that of the foreign bank. If an LC is not confirmed, the

exporter is subject to the payment risk of the foreign bank and the political risk of the

importing country. Exporters should consider confirming LCs if they are concerned about

the credit standing of the foreign bank or when they are operating in a high-risk market,

where political upheaval, economic collapse, devaluation or exchange controls could put

the payment at risk.


15

SPECIAL LETTERS OF CREDIT

LCs can take many forms. When an LC is issued as transferable, the payment obligation

under the original LC can be transferred to one or more second beneficiaries. With a

revolving LC, the issuing bank restores the credit to its original amount once it has been

drawn down. Standby LCs can be used in lieu of security or cash deposits as a secondary

payment mechanism.

DOCUMENTARY COLLECTIONS

A documentary collection is a transaction whereby the exporter entrusts the collection of

a payment to the remitting bank (exporters bank), which sends documents to a collecting

Bank (importers bank), along with instructions for payment. Funds are received from the

importer and remitted to the exporter through the banks involved in the collection in

exchange for those documents. Documentary collections involve the use of a draft that

requires the importer to pay the face amount either on sight (document against

paymentD/P) or on a specified date in the future (document against acceptanceD/A).

The draft lists instructions that specify the documents required for the transfer of title to

the goods. Although banks do act as facilitators for their clients under collections,

documentary collections offer no verification process and limited recourse in the event of

nonpayment. Drafts are generally less expensive than letters of credit. Open Account an

open account transaction means that the goods are shipped and delivered before payment

is due, usually in 30 to 90 days. Obviously, this is the most advantageous option to the

importer in cash flow and cost terms, but it is consequently the highest risk option for an

exporter. Due to the intense competition for export markets, foreign buyers often press

exporters for open account terms since the extension of credit by the seller to the buyer is

more common abroad. Therefore, exporters who are reluctant to extend credit may face

the possibility of the loss of the sale to their competitors. However, with the use of one or

more of the appropriate trade finance techniques, such as export credit insurance, the

exporter can offer open competitive account terms in the global market while

substantially mitigating the risk of nonpayment by the foreign buyer.


16

CHARACTERISTICS OF A DOCUMENTARY COLLECTION

1. APPLICABILITY Recommended for use in established trade relationships and in stable export

markets.

2. RISK Exporter is exposed to more risk as D/C terms are more convenient and cheaper

than an LC to the importer.

3. PROS a) Bank assistance in obtaining payment

b) The process is simple, fast, and less costly than LCs

c) DSO improved if using a draft with payment at a future date

4. CONS a) Banks role is limited and they do not guarantee payment

b) Banks do not verify the accuracy of the documents

KEY POINTS

o D/Cs is less complicated and more economical than LCs.

o Under a D/C transaction, the importer is not obligated to pay for goods prior to shipment.

o The exporter retains title to the goods until the importer either pays the face amount on sight or accepts the draft to incur a legal obligation to pay at a

specified later date.


17

o SVB plays an essential role in transactions utilizing D/Cs as the remitting bank (exporters bank) and in working with the collecting bank (importers bank).

o While the banks control the flow of documents, they do not verify the documents nor take any risks, but can influence the mutually satisfactory settlement of a D/C

transaction.

DOCUMENTS AGAINST PAYMENT (D/P) COLLECTION

A greater degree of protection is afforded to the exporter when an LC is issued by a

foreign bank (the importers issuing bank) and is confirmed by Silicon Valley Bank (the

exporters advising bank). This confirmation means that Silicon Valley Bank adds its

guarantee to pay the exporter to that of the foreign bank. If an LC is not confirmed, the

exporter is subject to the payment risk of the foreign bank and the political risk of the

importing country. Exporters should consider confirming LCs if they are concerned about

the credit standing of the foreign bank or when they are operating in a high-risk market,

where political upheaval, economic collapse, devaluation or exchange controls could put

the payment at risk.

1. Time of Payment : After shipment, but before documents are released

2. Transfer of Goods : After payment is made on sight

3. Exporter Risk : If draft is unpaid, goods may need to be disposed


18

DOCUMENTS AGAINST ACCEPTANCE (D/A) COLLECTION

Under a D/A collection, the exporter extends credit to the importer by using a time draft.

In this case, the documents are released to the importer to receive the goods upon

acceptance of the time draft. By accepting the draft, the importer becomes legally

obligated to pay at a future date. At maturity, the collecting bank contacts the importer

for payment. Upon receipt of payment, the collecting bank transmits the funds to SVB for

payment to the exporter.

1. Time of Payment : On maturity of draft at a specified future date

2. Transfer of Goods : Before payment, but upon acceptance of draft

3. Exporter Risk : Has no control of goods and may not get paid at due date

OPEN ACCOUNT

An open account transaction means that the goods are shipped and delivered before

payment is due, usually in 30 to 90 days. Obviously this is the most advantageous option

to the importer in cash flow and cost terms, but it is consequently the highest risk option

for an exporter. Due to the intense competition for export markets, foreign buyers often

press exporters for open account terms since the extension of credit by the seller to the

buyer is more common abroad. Therefore, exporters who are reluctant to extend credit

may face the possibility of the loss of the sale to their competitors. However, with the use

of one or more of the appropriate trade finance techniques, such as export credit

insurance, the exporter can offer open competitive account terms in the global market

while substantially mitigating the risk of nonpayment by the foreign buyer.


19

CHARACTERISTICS OF AN OPEN ACCOUNT

1. APPLICABILITY Recommended for use

(1) In secure trading relationships or markets or

(2) In competitive markets to win customers with the use of one or more appropriate

trade finance techniques.

2. RISK Exporter faces significant risk as the buyer could default on payment obligation after

shipment of the goods.

3. PROS o Boost competitiveness in the global market o Establish and maintain a successful trade relationship

4. CONS o Exposed significantly to the risk of nonpayment o Additional costs associated with risk mitigation measures

KEY POINTS o The goods, along with all the necessary documents, are shipped directly to the

importer who agrees to pay the exporters invoice at a future date, usually in 30 to

90 days.

o Exporter should be absolutely confident that the importer will accept shipment and pay at agreed time and that the importing country is commercially and

politically secure.


20

o Open account terms may help win customers in competitive markets, if used with one or more of the appropriate trade finance techniques that mitigate the risk of

nonpayment.

EXPORT CREDIT INSURANCE

Export credit insurance provides protection against commercial lossesdefault,

insolvency, bankruptcy, and political losseswar, nationalization, currency

inconvertibility, etc. It allows exporters to increase sales by offering liberal open account

terms to new and existing customers. Insurance also provides security to SVB in the

event it considers providing working capital to finance exports. Forfeiting (Medium-term

Receivables Discounting) Forfeiting is a method of trade financing that allows the

exporter to sell its medium-term receivables (180 days to 7 years) to SVB at a discount,

in exchange for cash. With this method, the forfeiter assumes the risk of non-payment,

enabling the exporter to extend open account terms and incorporate the discount into the

selling price.

CHARACTERISTICS OF EXPORT CREDIT INSURANCE 1. APPLICABILITY

Recommended for use in conjunction with open account terms and export working

capital financing.

2. RISK Exporters share the risk of the uncovered portion of the loss and their claims may be

denied in case of non-compliance with requirements specified in the policy.

3. PROS o Reduce the risk of nonpayment by foreign buyers o Offer open account terms safely in the global market


21

4. CONS o Cost of obtaining and maintaining an insurance policy o Deductiblecoverage is usually below 100 percent incurring additional costs

KEY POINTS

o ECI allows you to offer competitive open account terms to foreign buyers while

minimizing the risk of nonpayment.

o Creditworthy buyers could default on payment due to circumstances beyond their control.

o With reduced nonpayment risk, you can increase your export sales, establish market share in emerging and developing countries, and compete more vigorously

in the global market.

o With insured foreign account receivables, banks are more willing to increase your borrowing capacity and offer attractive financing terms.

COVERAGE

Short-term ECI, which provides 90 to 95 percent coverage against buyer payment

defaults, typically covers

(1) Consumer goods, materials, and services up to 180 days, and

(2) Small capital goods, consumer durables and bulk commodities up to 360 days.

Medium-term ECI, which provides 85 percent coverage of the net contract value, usually

covers large capital equipment up to five years.


22

PRICING

Premiums are individually determined on the basis of risk factors such as country,

buyers creditworthiness, sales volume, sellers previous export experience, etc. Most

multi-buyer policies cost less than 1 percent of insured sales while the prices of single-

buyer policies vary widely due to presumed higher risk. However, the cost in most cases

is significantly less than the fees charged for letters of credit. ECI, which is often

incorporated into the selling price, should be a proactive purchase, in that you have

coverage in place before a customer becomes a problem.

FEATURES OF EX-IM BANKS EXPORT CREDIT INSURANCE

o Offers coverage in emerging foreign markets where private insurers may not operate.

o Exporters electing an Ex-Im Bank Working Capital Guarantee may receive a 25 percent premium discount on Multi-buyer Insurance Policies.

o Offers enhanced support for environmentally beneficial exports. o The products must be shipped from the United States and have at least 50 percent

U.S. content.

o Unable to support military products or purchases made by foreign military entities.

o Support for exports may be closed or restricted in certain countries per U.S. foreign policy.


23

GOVERNMENT ASSISTED FOREIGN BUYER FINANCING

The role of government in trade financing is crucial in emerging economies. In the

presence of underdeveloped financial and money markets, traders have restricted access

to financing. Governments can either play a direct role like direct provision of trade

finance or credit guarantees; or indirectly by facilitating the formation of trade financing

enterprises. Governments could also extend assistance in seeking cheaper credit by

offering or supporting the following:

o Central Bank refinancing schemes; o Specialized financing institutes like o Export-Import Banks or Factoring Houses; o Export credit insurance agencies; o Assistance from the Trade Promotion Organisation; and o Collaboration with Enterprise Development o Corporations (EDC) or State Trading o Enterprises (STE).

CHARACTERISTICS OF GOVERNMENT ASSISTED FOREIGN

BUYER FINANCING

1. APPLICABILITY

Suitable for the export of high-value capital goods that require extended-term

financing.

2. RISK Ex-Im Bank assumes all risks.


24

3. PROS o Buyer financing as part of an attractive sales package o Cash payment upon shipment of the goods or services

4. CONS o Subject to certain restrictions per U.S. foreign policy o Possible lengthy process of approving financing

KEY POINTS

o Helps turn business opportunities, especially in emerging markets, into real

transactions for large U.S. exporters and their small business suppliers.

o Enables creditworthy foreign buyers to obtain loans needed for purchases of U.S. goods and services, especially high-value capital goods or services.

o Provides fixed-rate direct loans or guarantees for term financing

o Available for medium-term (up to five years) and for certain environmental exports up to 15 years.

KEY FEATURES OF EX-IM BANK LOAN GUARANTEES I. Loans are made by SVB and guaranteed by Ex-Im Bank.

II. 100 percent principal and interest cover for 85 percent of U.S. contract price.


25

INTRODUCTION OF FORFEITING Forfeiting and Factoring are services in international market given to an exporter or

seller. Its main objective is to provide smooth cash flow to the sellers. The basic

difference between the forfeiting and factoring is that forfeiting is a long term receivables

(over 90 days up to 5 years) while factoring is short termed receivables (within 90 days)

and is more related to receivables against commodity sales.

DEFINITION OF FORFEITING The terms forfeiting is originated from a old french word forfait, which means to

surrender ones right on something to someone else. In international trade, forfeiting may

be defined as the purchasing of an exporters receivables at a discount price by paying

cash. By buying these receivables, the forfeiter frees the exporter from credit and the risk

of not receiving the payment from the Importer.

HOW FORFEITING WORKS IN INTERNATIONAL TRADE The exporter and importer negotiate according to the proposed export sales contract.

Then the exporter approaches the forfeiter to ascertain the terms of forfeiting. After

collecting the details about the importer, and other necessary documents, forfeiter

estimates risk involved in it and then quotes the discount rate.

The exporter then quotes a contract price to the overseas buyer by loading the discount

rate and commitment fee on the sales price of the goods to be exported and sign a

contract with the forfeiter. Export takes place against documents guaranteed by the

importers bank and discounts the bill with the forfeiter and presents the same to the

importer for payment on due date.


26

COST ELEMENT The forfeiting typically involves the following cost elements:

1. Commitment fee, payable by the exporter to the forfeiter for latters commitment to

execute a specific forfeiting transaction at a firm discount rate within a specified time.

2. Discount fee, interest payable by the exporter for the entire period of credit involved

and deducted by the forfeiter from the amount paid to the exporter against the availed

promissory notes or bills of exchange.

SIX PARTIES IN FORFEITING

1. Exporter (India)

2. Importer (Abroad)

3. Exports Bank (India)

4. Imports Bank / Avalising Banks (Abroad)

5. EXIM Bank (India)

6. Forfaiter (Abroad)


27

BENEFITS TO EXPORTER

i. 100 per cent financing

Without recourse and not occupying exporter's credit line that is to say once the

exporter obtains the financed fund, he will be exempted from the responsibility to

repay the debt.

ii. Improved cash flow Receivables become current cash inflow and its is beneficial to the exporters to

improve financial status and liquidation ability so as to heighten further the funds

raising capability.

iii. Reduced administration cost By using forfeiting, the exporter will spare from the management of the receivables.

The relative costs, as a result, are reduced greatly.

iv. Advance tax refund Through forfeiting the exporter can make the verification of export and get tax

refund in advance just after financing.

v. Risk reduction Forfeiting business enables the exporter to transfer various risk resulted from

deferred payments, such as interest rate risk, currency risk, credit risk, and political

risk to the forfeiting bank.

vi. Increased trade opportunity With forfeiting, the export is able to grant credit to his buyers freely, and thus, be

more competitive in the market.


28

BENEFITS TO BANKS Banks can offer a novel product range to clients, which enable the client to gain 100%

finance, as against 8085% in case of other discounting products. Bank gain fee based

income. Lower credit administration and credit follow up.

DRAWBACKS OF FORFEITING i. Non Availability of short periods

ii. Non availability for financially weak countries

iii. Dominance of western countries

iv. Difficulty in procuring international banks guarantee

DEFINITION OF FACTORING

This involves the sale at a discount of accounts receivable or other debt assets on a daily,

weekly or monthly basis in exchange for immediate cash. The debt assets are sold by the

exporter at a discount to a factoring house, which will assume all commercial and

political risks of the account receivable. In the absence of private sector players,

governments can facilitate the establishment of a state-owned factor; or a joint venture

set-up with several banks and trading enterprises.

Definition of factoring is very simple and can be defined as the conversion of credit sales

into cash. Here, a financial institution which is usually a bank buys the accounts

receivable of a company usually a client and then pays up to 80% of the amount

immediately on agreement. The remaining amount is paid to the client when the customer

pays the debt. Examples includes factoring against goods purchased, factoring against

medical insurance, factoring for construction services etc.


29

CHARACTERISTICS OF FACTORING

1. The normal period of factoring is 90 to 150 days and rarely exceeds more than 150

days.

2. It is costly.

3. Factoring is not possible in case of bad debts.

4. Credit rating is not mandatory.

5. It is a method of off balance sheet financing.

6. Cost of factoring is always equal to finance cost plus operating cost.

DIFFERENT TYPES OF FACTORING

1. Disclosed factoring In disclosed factoring, clients customers are aware of the factoring agreement.

Disclosed factoring is of two types:

Recourse factoring The client collects the money from the customer but in case customer dont pay the

amount on maturity then the client is responsible to pay the amount to the factor. It is

offered at a low rate of interest and is in very common use.

Nonrecourse factoring In nonrecourse factoring, factor undertakes to collect the debts from the customer.

Balance amount is paid to client at the end of the credit period or when the customer pays

the factor whichever comes first. The advantage of nonrecourse factoring is that

continuous factoring will eliminate the need for credit and collection departments in the

organization.


30

2. Undisclosed In undisclosed factoring, client's customers are not notified of the factoring arrangement.

In this case, client has to pay the amount to the factor irrespective of whether customer

has paid or not.

FACTORING V/S FORFEITING Heading

Factoring Forfeiting

Point A Suitable for ongoing open

account sales, not backed by LC

or accepted bills or exchange.

Oriented towards single transactions

backed by LC or bank guarantee.

Point B Usually provides financing for

short-term credit period of up to

180 days.

Financing is usually for medium to

long-term credit periods from 180

days up to 7 years though shorterm

credit of 30180 days is also

available for large transactions.

Point C Requires continuous

arrangements between factor and

client, whereby all sales are

routed through the factor.

Seller need not route or commit

other business to the forfeiter. Deals

are concluded transaction-wise.

Point D Factor assumes responsibility for

collection, helps client to reduce

his own overheads.

Forfeiters responsibility extends to

collection of forfeited debt only.

Existing financing lines remains

unaffected.


31

Point E Separate charges are applied for

financing

collection

administration

credit protection and

provision of information.

Single discount charges is applied

which depend on

guaranteeing bank and country

risk,

credit period involved and

Currency of debt.

Only additional charges are

commitment fee, if firm

commitment is required prior to

draw down during delivery period.

Point F Service is available for domestic

and export receivables.

Usually available for export

receivables only denominated in any

freely convertible currency.

Point G Financing can be with or without

recourse; the credit protection

collection and administration

services may also be provided

without financing.

It is always without recourse and

essentially a financing product.


32

BUYERS CREDIT

A financial arrangement whereby a financial institution in the exporting country extends

a loan directly or indirectly to a foreign buyer to finance the purchase of goods and

services from the exporting country. This arrangement enables the buyer to make

payments due to the supplier under the contract.

A loan or credit line that a bank or other institution provides a company to buy goods

needed to conduct its business operations. For example, a bank may extend buyer credit

for a company to buy inventory, which it then sells to customers. The term is sometimes

used with regard to international commerce.

Buyer's credit is the credit availed by an Importer (Buyer) from overseas Lenders i.e.

Banks and Financial Institutions for payment of his Imports on due date. The overseas

Banks usually lend the Importer (Buyer) based on the Letter of comfort (a Bank

Guarantee) issued by the Importers (Buyer's) Bank. Importers Bank / Buyers Credit

Consultant / Importer arrange buyers credit from international branches of Indian Bank

or other international bank. For this services Importers Bank / Buyers credit consultant

charges a fee call arrangement fee. Buyers credit helps local importers access to cheaper

foreign funds close to LIBOR rates as against local sources of funding which are costly

compared to LIBOR rates. Buyers credit can be availed for 1 year in case the Import is

for trade-able goods and for 3 years if the Import is for Capital Goods. Every six months

the interest on Buyers credit may get reset.


33

BENEFITS OF BUYERS CREDIT TO IMPORTER

a) The exporter gets paid on due date; whereas importer gets extended date for making

an import payment as per the cash flows

b) The importer can deal with exporter on sight basis, negotiate a better discount and use

the buyers credit route to avail financing.

c) The funding currency can be in any FCY (USD, GBP, EURO, JPY etc.) depending on

the choice of the customer.

d) The importer can use this financing for any form of trade viz. open account,

collections, or LCs.

e) The currency of imports can be different from the funding currency, which enables

importers to take a favorable view of a particular currency.

STEP INVOLVED IN BUYERS CREDIT

1. The Indian customer will import the goods either under DC, Collections or open

account

2. The Indian customer request the Buyer's Credit Arranger before the due date of the

bill to avail buyers credit financing

3. Arranger to request overseas bank branches to provide a buyers credit offer letter in

the name of the importer. Best rate is quoted to importer

4. Overseas Bank to fund your existing bank Nostro account for the required amount

5. Existing bank to make import bill payment by utilizing the amount credited (if the

borrowing currency is different from the currency of Imports then a cross currency

contract is utilized to effect the import payment)

6. On due date existing bank to recover the principal and amount from the importer and

remit the same to Overseas Bank on due date.


34

INDIAN REGULATORY FRAMEWORK o Banks can provide buyers credit upto USD 20M per import transactions for a

maximum maturity period of 1 year from date of shipment. In case of import of

capital goods banks can approve buyers credits upto USD 20M per transaction

with a maturity period of upto 3 years. No roll over beyond this period is

permitted.

o RBI has issued directions under Sec 10(4) and Sec 11(1) of the Foreign Exchange Management Act, 1999, stating that authorised dealers may approve proposals

received (in Form ECB) for short term credit for financing by way of either

suppliers credit or buyers credit of import of goods into India, based on

uniform criteria. Credit is to be extended for a period of less than three years;

amount of credit should not exceed $20 million, per import transaction; the `all-in-

cost per annum, payable for the credit is not to exceed LIBOR + 50 basis points

for credit up to one year, and LIBOR + 125 basis points for credits for periods

beyond one year but less than three years, for the currency of credit.

o All applications for short-term credit exceeding $20 million for any import transaction are to be forwarded to the Chief General Manager, Exchange Control

Department, Reserve Bank of India, Central Office, External commercial

Borrowing (ECB) Division, Mumbai. Each credit has to be given `a unique

identification number by authorised dealers and the number so allotted should be

quoted in all references. The International Banking Division of the authorised

dealer is required to furnish the details of approvals granted by all its branches,

during the month, in Form ECB-ST to the RBI, so as to reach not later than 5th of

the following month. (Circular AP (DIR Series) No 24 dated September 27, 2002.

o As per RBI Master Circular on ECB and trade finance 2010, interest cost of overseas lender has been capped at 6 month libor + 200bps for tenure upto


35

BUYERS CREDIT ON CAPITAL GOODS o Buyers Credit can be used both for Raw Material and Capital Goods. Below gives

complete detailed information along with process and sample sanction letters.

PROCESS FLOW OF BUYERS CREDIT FOR CAPITAL GOODS

o Term Loan Sanction o LC Issuance for import of Machinery o On due date of payment of LC convert it to Buyers Credit and rollover for 3 year o At end of 3 year convert to term loan


36

Stage 1

Banks Term Loan Sanction

Facility: Buyers Credit (capex) in lieu of Foreign L/C Capex (to be converted to

Term loan after 3 years)

Purpose for Purchase of Machinery only


37

Tenure of 36 months with rollover every 6 / 12 months till Month / Year

Repayment schedule as the buyers credit is under roll over every 6 / 12 months

subject to availability of funds (to be converted to Term loan after 3 years)

The buyers credit is proposed to be retired through term loan and the same will be

repaid in say 24 equal monthly installments (example of 5 year term loan), starting

from Month / Year. In-case buyer credit is not available for further rollover at any

point of time, the buyer credit will be converted to term loan and the repayment will

start immediately from the next month of conversion, repayable in monthly

installments (starting from the next month of conversion) equal divided into the

balance tenor.

Charges: Issuance of LOU / LOC Charges to overseas bank

Stage 2

Based on the agreement with the supplier either a sight LC or USANCE LC get

opened from bank. Based on this supplier will ship machinery.

Stage 3

The Indian customer will import the goods either under DC, Collections or open

account

The Indian customer request the Buyers Credit Arranger before the due date of the

bill to avail buyers credit financing

Arranger to request overseas bank branches to provide a buyers credit offer letter in

the name of the importer. Best rate is quoted to importer


38

Overseas Bank to fund your existing bank nostro account for the required amount

Existing bank to make import bill payment by utilizing the amount credited (if the

borrowing currency is different from the currency of Imports then a cross currency

contract is utilized to effect the import payment)

On due date (6 / 12 Month) it will again get rollover (Principal + interest) with the

same foreign bank or another bank based on the pricing and availability on that day.

This will keep on happening till 3 years

Stage 4

Based on the sanction convert the buyers credit to term loan at the end of 3rd year.

COST INVOLVED

1. Interest cost: This is charged by overseas bank as a financing cost

2. Letter of Comfort / Undertaking: Your existing bank would charges this cost for

issuing letter of comfort / Undertaking

3. Forward Booking Cost / Hedging Cost

4. Arrangement fee: Charged by person who is arranging buyer's credit for you.

5. Other charges: A2 payment on maturity, For 15CA and 15CB on maturity,

Intermediary bank charges.

6. WHT (Withholding Tax): The customer has to pay WHT on the interest amount

remitted overseas to the Indian tax authorities. (The WHT is not applicable where

Indian banks arrange for buyers credit through their offshore offices)


39

CONCEPT OF WHT (WITHHOLDING TAX)

Tax levied on the interest paid by the Indian corporates to overseas lenders on the loans

taken from them. Rates charged by overseas lenders are net of taxes; tax paid is the

additional cost that needs is borne by the borrower.

IMPACT OF WHT

o Tax is paid @ 20% (As per Income Tax Act, 1961) or as per DTA (Double Taxation Agreement) agreement between India and the lenders country

o No Withholding tax on loans raised from overseas branch of Indian bank:

Withholding tax is 10% of the gross amount of the interest on loans made or

guaranteed by a bank or other financial institution carrying on bona fide banking or

financing business or by an enterprise which holds directly or indirectly at least 10

per cent of the capital of the company paying the interest.

WHT CALCULATION METHOD

o Foreign Bank BC with Withholding tax = (L + 1.00) + ((L+ 1.00) *10%)

= (0.25 + 1) + ((0.25+1) *10%)

= 1.25 + 0.125

= 1.375

o Indian bank overseas branches = L + 1.50

= 0.25 + 1.50

= 1.75

o Assumption - 90 days Transaction USD Libor =0.25


40

BUYERS CREDIT INTEREST RATE (LIBOR+MARGINS)

Earlier on Buyers Credit have provided details on total cost involved like, Interest cost,

libor, Lou charges, forwarding booking cost, arrangement fee, and others.

This provides details on how interest cost (margin) is arrived at by Indian Bank Overseas

Branches or Foreign Bank.

Interest Rate = L + Margin Rates

FACTORS RELATED TO MARGIN

1. Availability of Funds Whether sufficient funds are available (will be able to borrow) for the required

amount of transaction.

2. Cost of Funds

The rate at which these banks gets to borrow funds from their local market (L + X).

3. Banks Lines

For Example: When lines of particular banks are running in scarcity, bank would ask

for higher margin in comparison to other banks lines.

4. Internal Minimum Margin

Over and above cost of funds (L+X) bank adds their margin. There is minimum cut

off margin decided by bank treasury or committee below which they are not able to

offer pricing.


41

5. External Factors

Some recent examples are Market Volatility, US downgrade, Greece

and Portugal debt crisis, etc.

MEANING OF LIBOR

LIBOR stands for London Interbank Offered Rate. LIBOR is an indicative average

interest rate at which a selection of banks (the panel banks) are prepared to lend one

another unsecured funds on the London money market. Although reference is often made

to the LIBOR interest rate, there are actually 150 different LIBOR interest rates. LIBOR

is calculated for 15 different maturities and for 10 different currencies. The official

LIBOR interest rates (bba libor) are announced once a day at around 11:45 a.m. London

time by Thomson Reuters on behalf of the British Bankers Association (BBA).

THE CREATION OF LIBOR

At the start of the nineteen eighties there was a growing need amongst the financial

institutions in London for a benchmark for lending rates. This benchmark was

particularly needed in order to calculate prices for financial products such as interest

swaps and options. Under the leadership of the BBA a number of steps were taken from

1984 onwards which led in 1986 to the publication of the first LIBOR interest rates (bba

libor).

LIBOR PANEL BANKS

As has already been indicated, LIBOR is an average interest rate at which a selection of

banks will lend one another funds. These banks are called panel banks. The selection is

made every year by the British Bankers Association (BBA) with assistance from the

Foreign Exchange and Money Markets Committee (FX&MMC). A panel is made up for

each currency consisting of at least 8 and a maximum of 16 banks which are deemed to


42

be representative for the London money market. Banks are assessed on market volume,

reputation and assumed knowledge of the currency concerned. Because the criteria

applied are strict, the rates can generally be considered to be the lowest interbank lending

rates on the London money market.

LIBOR CALCULATION METHOD

The LIBOR interest rates are not based on actual transactions. On every working day at

around 11 a.m. (London time) the panel banks inform Thomson Reuters for each maturity

at what interest rate they would expect to be able to raise a substantial loan in the

interbank money market at that moment. The reason that the measurement is not based on

actual transactions is because not every bank borrows substantial amounts for each

maturity every day. Once Thomson Reuters has collected the rates from all panel banks,

the highest and lowest 25% of value are eliminated. An average is calculated of the 50%

remaining mid values in order to produce the official LIBOR (bba libor) rate.

SIGNIFICANCE OF LIBOR INTEREST

LIBOR is viewed as the most important benchmark in the world for short-term interest

rates. On the professional financial markets LIBOR is used as the base rate for a large

number of financial products such as futures, options and swaps. Banks also use the

LIBOR interest rates as the base rate when setting the interest rates for loans, savings and

mortgages. The fact that LIBOR is often treated as the base rate for other products is the

reason why LIBOR interest rates are monitored with great interest by a large number of

professionals and private individuals worldwide.


43

LIBOR CURRENCIES

Originally (in 1986) LIBOR was published for 3 currencies: the US dollar, the pound

sterling and the Japanese yen. Over the years that followed the number of LIBOR

currencies grew to a maximum of 16. A number of these currencies merged into the euro

in 2000. At the moment we have LIBOR rates in the following 10 currencies (click on the

currency for the current interest rate for each maturity):

o American dollar USD LIBOR o Australian dollar- AUD LIBOR o British pound sterling GBP LIBOR o Canadian dollar- CAD LIBOR o Danish krone DKK LIBOR o European euro EUR LIBOR o Japanese yen JPY LIBOR o New Zealand dollar NZD LIBOR o Swedish krona SEK LIBOR o Swiss franc CHF LIBOR

LIBOR MATURITIES

Because there are 15 different maturities there are 15 different LIBOR rates in total.

There have not always been 15 maturities. Up until 1998 the shortest maturity was 1

month. In 1998 the 1 week rate was added, and only in 2001 were the overnight and 2

week LIBOR rates introduced.


44

RESTRICTIONS IN BUYERS CREDIT

Type of transaction where buyers credit can be done for limited amount case

where import bill are directly received by importer from his overseas supplier, buyers

credit amount is restricted upto $ 3, 00,000. Except for the followings

o Import bill received by wholly owned Indian subsidiary of foreign companies from their principal

o Import bill received by Status Holder Exporters as defined in the Foreign Trade Policy, 100% Export Oriented Units, Units in Special Economic Zones, Public

Sector Undertakings and Limited Companies

o Import bills received by all limited companies viz. public limited companies, deemed public limited and private limited companies.

TYPE OF TRANSACTION WITH LIMITED TENURE IN B.Cr.

When below given goods / commodity are involved, buyers credit and suppliers credit

cannot exceed 90 days from the date of shipment as per Reserve Bank of India (RBI)

guidelines

o Rough, Cut and Polishes Diamonds o Gold o Silver, Platinum, Palladium, Rodhium


45

GUIDELINES FOR TRANSACTIONS WITH LIMITED TENURE

Reserve Bank of India (RBI) in its circular dated 06-05-2011 has revised guidelines for

import of Rough, Cut and Polished Diamonds. Extracts are given below.

Buyers Credit (Trade Credit) including the Usance period of Letter of Credit (LC)

opened for import of rough, cut and polished diamonds has been restricted to 90 days

from the date of shipment from immediate effect.

Banks have been also advised to ensure that due diligence is undertaken and Know-Your-

Customer (KYC) norms and Anti-Money Laundering (AML) standards, issued by RBI

are adhered to while undertaking the import transactions. Further, any large or abnormal

increase in the volume of business should be closely examined to ensure that the

transactions are bona fide and not intended for interest / currency arbitrage. All other

instructions relating to import of rough, cut and polished diamonds shall continue.

The earlier instruction issued for import of gold, import of platinum / palladium /

rhodium / silver and advance remittance for import of rough diamonds shall remain

unchanged.

BUYERS CREDIT ROLLOVER

One of the important factors in Buyers Credit is the tenure for which you get the

Buyers Credit. From RBI Regulation perspective, RBI allows buyers credit on import

of raw material (noncapital goods) upto 360 days from Shipped On Board on Bill of

Lading (BL) and on Capital Goods upto 3 years.

From the point of view of Importers Working Capital Bank, Non-Fund Based

Limit is sanctioned based on your working capital cycle and your requirement. At the

same time they decide a cap upto to which tenure they would issue Letter of Credit (LC) /

Bank Guarantee (BG) / Letter of Comfort (LOC). This is where the problem starts, when


46

you decide on taking a buyers credit for 180 days but you sanction is say for 90 days.

Solution is

o Get your limits revised for 180 days which might take around 15 days to a month.

o Or you initially take it for 90 days and then again roll it over to another 90 days to meet you requirement. And when you take it for second time, your buyers credit get

rolled over

To explain rollover with an example. Say, you have taken $1, 00,000 buyers credit for

tenure of 90 days and now you want to extend it for another 90 days. There are two

things:-

o Go to your existing buyers credit provider Bank (Foreign Bank or Indian Bank Overseas Branch) and get the extended tenure offer and ask your bank to send the

swift for the same.

o Get fresh quote issued from a bank which is giving further competitive pricing than existing bank. Ask your bank to send new LOU to new bank. When funds are

received from the new bank in the Nostro of your bank, your bank will pay your

existing buyers credit bank and your buyers credit will get rolled over

OTHER FACTORS

o If you have time, prefer to get your tenure change in your sanction instead of taking buyers credit and then rollover

o Cost factor. Every time you roll over LIBOR will Change, Margin might change, LOU charges (like nationalized bank charges some fixed amount for issuance of

LOU plus Usance charges. Because of this overall cost would go up)


47

o In case of non-capital goods transaction, bank would provide LC/BG/LOU limits for not more than 180 days. Thus for using Buyers credit for more than 180 days, you

will have to rollover in such cases.

EXPORT FINANCING

Export or perish Our imports are more than exports. Hence there is a necessity to

encourage exports. Govt. and RBI extend various concessions to boost exports.

Conventional Banks play two very important roles in Exports.

o They act as a negotiating bank and charge a fee for this purpose which is allowed in Shariah.

o Secondly they provide export-financing facility to the exporters and charge Interest on this service.

These services are of two types

o Pre Shipment Financing o Post Shipment Financing

As interest cannot be charged in any case, Shariah experts have proposed certain

methods for financing exports.


48

PRE-SHIPPING FINANCING

This is financing for the period prior to the shipment of goods, to support pre-export

activities like wages and overhead costs. It is especially needed when inputs for

production must be imported. It also provides additional working capital for the exporter.

Pre-shipment financing is especially important to smaller enterprises because the

international sales cycle is usually longer than the domestic sales cycle. Pre-shipment

financing can take in the form of short term loans, overdrafts and cash credits.

Pre shipment financing needs can be fulfilled by two methods,

o Musharakah o Morabaha

The most appropriate method for financing exports is Musharkah or Mudarbah. Bank and

exporter can make an agreement of Mudarbah if exporter is not investing; otherwise

Musharakah agreement can be made.

Pre Shipment Finance is issued by a financial institution when the seller wants the

payment of the goods before shipment. The main objective behind pre shipment finance

or pre export finance is to enable exporter to:

o Procure raw materials o Carry out manufacturing process o Provide a secure warehouse for goods and raw materials o Process and pack the goods o Ship the goods to the buyers o Meet other financial cost of the business


49

TYPES OF PRE-SHIPMENT FINANCE

o Packing Credit o Advance against Cheques/Draft etc. representing Advance Payments.

Pre shipment finance is extended in the following forms :

o Packing Credit in Indian Rupee o Packing Credit in Foreign Currency (PCFC)

ELIGIBILITY & REQUIRMENT FOR PRESHIPMENT FINANCE

o Requirements for Getting Packing Credit

This facility is provided to an exporter who satisfies the following criteria

o A ten digit importer exporter code number allotted by DGFT [ Directorate General of Foreign Trade (India) ]

o Exporter should not be in the caution list of RBI. o If the goods to be exported are not under OGL (Open General Licence), the

exporter should have the required license /quota permit to export the goods.

Packing credit facility can be provided to an exporter on production of the following

evidences to the bank:

1. Formal application for release the packing credit with undertaking to the effect

that the exporter would be ship the goods within stipulated due date and submit

the relevant shipping documents to the banks within prescribed time limit.

2. Firm order or irrevocable L/C or original cable / fax / telex message exchange

between the exporter and the buyer.

3. Licence issued by DGFT if the goods to be exported fall under the restricted or

canalized category. If the item falls under quota system, proper quota allotment

proof needs to be submitted.


50

The confirmed order received from the overseas buyer should reveal the information

about the full name and address of the overseas buyer, description quantity and value of

goods (FOB or CIF), destination port and the last date of payment.

o Eligibility

Pre shipment credit is only issued to that exporter who has the export order in his own

name. However, as an exception, financial institution can also grant credit to a third party

manufacturer or supplier of goods who does not have export orders in their own name.

In this case some of the responsibilities of meeting the export requirements have been out

sourced to them by the main exporter. In other cases where the export order is divided

between two more than two exporters, pre shipment credit can be shared between them

DISBURSEMENT OF PACKING CREDIT ADVANCE

Once the proper sanctioning of the documents is done, bank ensures whether exporter has

executed the list of documents mentioned earlier or not. Disbursement is normally

allowed when all the documents are properly executed.

Sometimes an exporter is not able to produce the export order at time of availing packing

credit. So, in these cases, the bank provides a special packing credit facility and is known

as Running Account Packing.

Before disbursing the bank specifically check for the following particulars in the

submitted documents"

a. Name of buyer

b. Commodity to be exported

c. Quantity

d. Value (either CIF or FOB)

e. Last date of shipment / negotiation.

f. Any other terms to be complied with


51

The quantum of finance is fixed depending on the FOB value of contract /LC or the

domestic values of goods, whichever is found to be lower. Normally insurance and

freight charged are considered at a later stage, when the goods are ready to be shipped.

In this case disbursals are made only in stages and if possible not in cash. The payments

are made directly to the supplier by Drafts/Bankers/Cheques. The bank decides the

duration of packing credit depending upon the time required by the exporter for

processing of goods. The maximum duration of packing credit period is 180 days,

however bank may provide a further 90 days extension on its own discretion, without

referring to RBI.

PRE-SHIPMENT CREDIT IN FOREIGN CURRENCY (PCFC)

Authorised dealers are permitted to extend Pre shipment Credit in Foreign Currency

(PCFC) with an objective of making the credit available to the exporters at internationally

competitive price. This is considered as an added advantage under which credit is

provided in foreign currency in order to facilitate the purchase of raw material after

fulfilling the basic export orders.

The rate of interest on PCFC is linked to London Interbank Offered Rate (LIBOR).

According to guidelines, the final cost of exporter must not exceed 0.75% over 6 month

LIBOR, excluding the tax. The exporter has freedom to avail PCFC in convertible

currencies like USD, Pound, Sterling, Euro, Yen etc. However, the risk associated with

the cross currency truncation is that of the exporter. The sources of funds for the banks

for extending PCFC facility include the Foreign Currency balances available with the

Bank in Exchange, Earner Foreign Currency Account (EEFC), Resident Foreign

Currency Accounts RFC(D) and Foreign Currency(Non Resident) Accounts.

Banks are also permitted to utilize the foreign currency balances available under Escrow

account and Exporters Foreign Currency accounts. It ensures that the requirement of

funds by the account holders for permissible transactions is met. But the limit prescribed

for maintaining maximum balance in the account is not exceeded. In addition, Banks may


52

arrange for borrowings from abroad. Banks may negotiate terms of credit with overseas

bank for the purpose of grant of PCFC to exporters, without the prior approval of RBI,

provided the rate of interest on borrowing does not exceed 0.75% over 6 month LIBOR.

PACKING CREDIT FACILITIES IN DEEMED EXPORTS

Deemed exports made to multilateral funds aided projects and programs, under orders

secured through global tenders for which payments will be made in free foreign

exchange, are eligible for concessional rate of interest facility both at pre and post supply

stages.

PACKING CREDIT FACILITIES FOR CONSULTING SERVICES

In case of consultancy services, exports do not involve physical movement of goods out

of Indian Customs Territory. In such cases, Pre shipment finance can be provided by the

bank to allow the exporter to mobilize resources like technical personnel and training

them.

ADVANCE AGAINST CHEQUE / DRAFTS RECEIVED AS

ADVANCE PAYMENT

Where exporters receive direct payments from abroad by means of Cheques/drafts etc.

the bank may grant export credit at concessional rate to the exporters of goods track

record, till the time of realization of the proceeds of the Cheques or draft etc.


53

POST-SHIPPING FINANCING

Post Shipment Finance is a kind of loan provided by a financial institution to an

exporter or seller against a shipment that has already been made. This type of export

finance is granted from the date of extending the credit after shipment of the goods to

the realization date of the exporter proceeds. Exporters dont wait for the importer to

deposit the funds.

The ability to be competitive often depends on the traders credit term offered to

buyers. Post-shipment financing ensures adequate liquidity until the purchaser

receives the products and the exporter receives payment. Post-shipment financing is

usually short-term.

FEATURES OF POST SHIPMENT FINANCING

The features of post shipment finance are:

1. Purpose of Finance

Post shipment finance is meant to finance export sales receivable after the date of

shipment of goods to the date of realization of exports proceeds. In cases of

deemed exports, it is extended to finance receivable against supplies made to

designated agencies.

2. Basis of Finance

Post shipment finances are provided against evidence of shipment of goods or

supplies made to the importer or seller or any other designated agency.

3. Types of Finance

Post shipment finance can be secured or unsecured. Since the finance is extended

against evidence of export shipment and bank obtains the documents of title of


54

goods, the finance is normally self-liquidating. In that case it involves advance

against undrawn balance, and is usually unsecured in nature.

Further, the finance is mostly a funded advance. In few cases, such as financing of

project exports, the issue of guarantee (retention money guarantees) is involved

and the financing is not funded in nature.

4. Quantum of Finance

As a quantum of finance, post shipment finance can be extended up to 100% of

the invoice value of goods. In special cases, where the domestic value of the

goods increases the value of the exporter order, finance for a price difference can

also be extended and the price difference is covered by the government. This type

of finance is not extended in case of pre shipment stage.

Banks can also finance undrawn balance. In such cases banks are free to stipulate

margin requirements as per their usual lending norm.

5. Period of Finance

Post shipment finance can be off short terms or long term, depending on the

payment terms offered by the exporter to the overseas importer. In case of cash

exports, the maximum period allowed for realization of exports proceeds is six

months from the date of shipment. Concessive rate of interest is available for a

highest period of 180 days, opening from the date of surrender of documents.

Usually, the documents need to be submitted within 21days from the date of

shipment.

FINANCING FOR VARIOUS TYPES OF EXPORT BUYERS

CREDIT

Post shipment finance can be provided for three types of export:


55

o Physical exports

Finance is provided to the actual exporter or to the exporter in whose name the

trade documents are transferred.

o Deemed export

Finance is provided to the supplier of the goods which are supplied to the

designated agencies.

o Capital goods and project exports

Finance is sometimes extended in the name of overseas buyer. The disbursal of

money is directly made to the domestic exporter.

POST SHIPMENT CREDIT

Sr. No. Particular Condition

1 SIGHT BILLS NOT MORE THAN 10%

2 UPTO 90 DAYS NOT MORE THAN 10%

3 91 DAYS TO 6 MONTHS 12%

4 OVERDUE

(Applicable only on the overdue portion)

Left to the discretion of the bank,

through it is most likely to be the

unarranged overdraft rate

5 Post shipment foreign currency loan Maximum of Libor + 1.5 pct


56

TYPES OF POST SHIPMENT FINANCE

The post shipment finance can be classified as:

1. Export Bills purchased/discounted.

2. Export Bills negotiated

3. Advance against export bills sent on collection basis.

4. Advance against export on consignment basis

5. Advance against undrawn balance on exports

6. Advance against claims of Duty Drawback

1. Export Bills Purchased/ Discounted (DP & DA Bills)

Export bills (Non L/C Bills) is used in terms of sale contract/ order may be discounted or

purchased by the banks. It is used in indisputable international trade transactions and the

proper limit has to be sanctioned to the exporter for purchase of export bill facility.

2. Export Bills Negotiated (Bill under L/C)

The risk of payment is less under the LC, as the issuing bank makes sure the payment.

The risk is further reduced, if a bank guarantees the payments by confirming the LC.

Because of the inborn security available in this method, banks often become ready to

extend the finance against bills under LC.

However, this arises two major risk factors for the banks:

1. The risk of nonperformance by the exporter, when he is unable to meet his terms

and conditions. In this case, the issuing banks do not honor the letter of credit.

2. The bank also faces the documentary risk where the issuing bank refuses to honor

its commitment. So, it is important for the for the negotiating bank, and the

lending bank to properly check all the necessary documents before submission.


57

3. Advance against Export Bills Sent on Collection Basis

Bills can only be sent on collection basis, if the bills drawn under LC have some

discrepancies. Sometimes exporter requests the bill to be sent on the collection basis,

anticipating the strengthening of foreign currency. Banks may allow advance against

these collection bills to an exporter with a concessional rates of interest depending upon

the transit period in case of DP Bills and transit period plus Usance period in case of

Usance bill. The transit period is from the date of acceptance of the export documents at

the banks branch for collection and not from the date of advance.

4. Advance against Export on Consignments Basis

Bank may choose to finance when the goods are exported on consignment basis at the

risk of the exporter for sale and eventual payment of sale proceeds to him by the

consignee. However, in this case bank instructs the overseas bank to deliver the

document only against trust receipt /undertaking to deliver the sale proceeds by specified

date, which should be within the prescribed date even if according to the practice in

certain trades a bill for part of the estimated value is drawn in advance against the

exports. In case of export through approved Indian owned warehouses abroad the times

limit for realization is 15 months.

5. Advance against Undrawn Balance

It is a very common practice in export to leave small part undrawn for payment after

adjustment due to difference in rates, weight, quality etc. Banks do finance against the

undrawn balance, if undrawn balance is in conformity with the normal level of balance

left undrawn in the particular line of export, subject to a maximum of 10 percent of the

export value. An undertaking is also obtained from the exporter that he will, within 6

months from due date of payment or the date of shipment of the goods, whichever is

earlier surrender balance proceeds of the shipment.


58

6. Advance against Claims of Duty Drawback

Duty Drawback is a type of discount given to the exporter in his own country. This

discount is given only, if the in-house cost of production is higher in relation to

international price. This type of financial support helps the exporter to fight successfully

in the international markets. In such a situation, banks grants advances to exporters at

lower rate of interest for a maximum period of 90 days. These are granted only if other

types of export finance are also extended to the exporter by the same bank.

After the shipment, the exporters lodge their claims, supported by the relevant documents

to the relevant government authorities. These claims are processed and eligible amount is

disbursed after making sure that the bank is authorized to receive the claim amount

directly from the concerned government authorities.

CRYSTALLIZATION OF OVERDUE EXPORT BILLS

Exporter foreign exchange is converted into Rupee liability, if the export bill purchase /

negotiated /discounted is not realize on due date. This conversion occurs on the 30th day

after expiry of the NTP in case of unpaid DP bills and on 30th day after national due date

in case of DA bills, at prevailing TT selling rate ruling on the day of crystallization, or

the original bill buying rate, whichever is higher.

ROLE OF ECGC

The Export Credit Guarantee Corporation of India Limited (ECGC) is a company wholly

owned by the Government of India based in Mumbai, Maharashtra. It provides export

credit insurance support to Indian exporters and is controlled by the Ministry of

Commerce. Government of India had initially set up Export Risks Insurance Corporation

(ERIC) in July 1957. It was transformed into Export Credi

summer project on 039 international trade finance 039

Documents

mms finance roll

buyers credit

management studies

partial fulfillment

foreign buyers financing

export financing

pre shipment credit

israni roll