11 Sep Trade Finance Products | What are the Advantages and Disadvantages?
At EIMF we constantly expand our topics for professional training whilst continuing to work closely with industry experts who can offer sound practical workshops. One of our new associates this season is Demetris Zacharoudes who will present for us, both in Nicosia and Limassol, a very exciting workshop on Trade Finance . Demetris also shares with us some of his know-how through this very interesting article:
How do the main Trade Finance products work; their advantages and disadvantages.
Trade Finance products are provided by Banks and their aim is to reduce the payment risk to the Exporter by reducing the Counterparty Risk (i.e. risk of default of the Importer) and the Country Risk (i.e. risk of default of the Importer’s country and/or the imposition of capital controls). The main Trade Finance products are Bills for Collection, Letter of Guarantee and Letters of Credit. But how do these products work and what are their advantages and disadvantages to Importers and Exporters?
Bills for Collection
Under Bills for Collection the Exporter ships goods, collects all shipping documents and presents same to their bank with instructions to remit documents to the Importer’s Bank. According to the Exporters instructions, the Importer’s bank releases the shipping documents to the Importer ONLY against the Importer’s (a) Sight payment, or (b) Acceptance (i.e. promise to pay at a future date). The bank does not check the documents and does not provide its undertaking for payment to the Exporter (unless the Exporter requests for a guarantee/avalization)
Advantages to the Importer: Provides comfort that goods have already been shipped and is less costly than Letters of Credit or Letter of Guarantee in terms of banking fees.
Advantages to the Exporter: Provides comfort that, in case of Sight payment, the Importer will not be able to obtain the documents for customs clearance and take possession of the goods unless payment is affected. In case of Acceptance, the Exporter will have the Importers promise in writing that they will pay for the goods at a future date; hence in case of non payment, the possibility of success in possible court proceedings will be on the Exporter’s side.
Letters of Credit
Letters of Credit are issued by banks under the Importer’s instructions. This is an irrevocable undertaking of the bank to pay the Exporter provided the latter presents the shipping documents as per the terms of the Letter of Credit. After receipt of the Letter of Credit the Exporter ships goods and presents the shipping documents to the Importer’s bank. The Importer’s bank checks the documents and, if they comply, the latter will proceed with the payment to the Exporter or promise to pay at future date (as per the terms of the Letter of Credit) and release documents to the Importer in order clear goods from customs.
Advantages to the Exporter: Maximum protection for the Exporter
Advantages to the Importer: Comfort that the Importer will be able to clear goods from customs as the payment depends on strict compliance of the documents to the LC terms
Disadvantages: Maximum banking fees as the bank guarantees the payment and also checks the documents
Letters of Guarantee
The Importer’s bank first issues a Letter of Guarantee under which the bank guarantees the payment of the goods to the Exporter. The Exporter ships goods and remits the shipping documents directly to the Importer which clears the goods from customs and pays the Exporter directly through a SWIFT or SEPA payment. If the Importer defaults the Exporter will claim payment from the Importer’s bank. A Letter of Guarantee may cover a single or multiple shipments.
Advantages to the Exporter: Maximum protection as the Exporter has the bank’s undertaking for payment of the goods
Advantages to both parties: Less processing time than Bills for Collection or Letters of Credit
Disadvantages to the Importer: More banking fees than Bills for Collection
If you are interested in learning more about Trade Finance view our upcoming courses.