Trade finance

It is hard to overestimate the importance of international trade in the modern world. International trade is no less important in the global sense of world economic development, as countries, individual regions, transnational companies, small, medium and large businesses, self-employed entrepreneurs and of course banks may be involved in this process.

Trade finance means that a bank finances its customers’ foreign economic activities by attracting short-term, and if possible, long-term loan capital.

Banks generally offer their customers financing for trade transactions through their internal funds and credit lines of foreign banks. For this purpose, banks structure settlements under international contracts using documentary letters of credit and bank guarantees.

The credit line terms of foreign banks generally offer the use of lower cost foreign resources, which makes it possible to offer customer attractive banking products that promote successful development of the customers’ business.

The key advantages of using trade financing are:

• lower cost of resources for the customer compared with ordinary lending;
• possibility of obtaining financing for a longer term compared with ordinary lending;
• minimized risks in foreign trade transactions owing to the use of documentary forms of settlements, i.e., letters of credit and guarantees

Main international trade risks:

Risk of nonpayment

The exporter may make an inaccurate assessment of its partner’s (buyer’s) creditworthiness. It may also be unfamiliar with local regulations in the buyer’s country.

Risk of non-delivery of goods

The buyer may be the victim of an unscrupulous partner (seller).

Country risks (political risks)

Currency regulation, other government restrictions, political instability, national disasters, outbreak of hostilities

Payment methods

I. Advance payment

The Buyer pays the Seller before the goods are shipped. This is normally used for goods in high demand but in short supply.

Advantages for the Seller:

• payment is received before the goods are shipped (does not depend on the Buyer’s creditworthiness)
• no need to finance the sale, since payment is received before shipment
• does not divert working capital
• the Seller is not exposed to the country (political) risk of the Buyer’s country

Disadvantages for the Buyer:

• no control over the goods
• diverts working capital (a loan may be required for the advance payment)
• if the contract terms are breached, legal proceedings are in the seller’s country

II. Current account

Payment for goods is made after their delivery to the Buyer. Shipping documents are sent directly from the Seller to the Buyer.

Advantages for the Buyer:

• credit is received for an agreed period until the payment date
• the goods may be inspected before payment is made
• reduces the need to obtain bank financing, since payment is made after the goods are received and possibly even after they are sold

Disadvantages for the Seller:

• no guarantee of payment
• no control over the goods
• working capital is diverted, since the goods are shipped before payment is received

• the Seller is exposed to the country (political) risk of the Buyer’s country

III. Documentary collection

Payment is received through the bank against transfer of the corresponding documents.

Disadvantages for the Seller:

• the Buyer’s promise to pay for the goods depends on the Buyer’s financial situation
• The Buyer may not pay due to innovations in currency legislation or other restrictions.
• The Seller must arrange for storage and return of the goods if the Buyer refuses to pay.

Disadvantages for the Buyer:

• The Buyer must pay or agree to pay for the goods before being able to inspect them
• The Seller may appeal nonpayment or nonacceptance if the Buyer refuses to pay or accept the bill; the appeal may harm the Buyer’s financial reputation.

These risks and disadvantages may be minimized or eliminated by using documentary forms of settlements, i.e., letters of credit and guarantees.

LETTER OF CREDIT

A letter of credit is the issuing bank’s obligation to pay the Seller (Beneficiary) a specified amount subject to timely submission of documents in accordance with the terms of the letter of credit.

A letter of credit is a transaction separate from the contract on which it may be based. The banks are in no way connected with this contract, even if the letter of credit makes reference to it.

DOCUMENTARY letter of credit: Banks deal with documents, not goods. In practice this means that a payment obligation is based on submitting DOCUMENTS.

In international trade, letters of credit are governed by UCP 600 “Uniform Customs and Practice for Documentary Credits”, version of 2007 (International Chamber of Commerce publication No. 600). These rules took effect on July 1, 2007.

Advantages

• guarantee of payment when the terms of the letter of credit are observed
• guarantee that payment will be made ONLY upon submission of the necessary documents
• flexible payment terms without decreasing reliability
• high degree of international legal reliability (the Uniform Customs and Practice for Documentary Credits were developed by authoritative international organizations and are recognized around the world).

Disadvantages

• fraud risks

PARTIES TO A LETTER OF CREDIT

Applicant – (Ordering customer/Applicant party) – the party ordering the opening of a letter of credit; importer

Issuing bank – the bank that opens the letter of credit and issues the note to pay upon due presentation of documents on time 

Beneficiary – the party in whose favor the letter of credit is opened; exporter

Advising bank – the bank that advises (informs) the beneficiary of the terms and conditions of the letter of credit at the request of the issuing bank

Confirming bank – the bank that adds its confirmation to the letter of credit at the request of the issuing bank 

LETTER OF CREDIT FORMS

Revocable letter of credit

The issuing bank may alter or cancel it without prior notice to the beneficiary. It is not a firm payment obligation of the issuing bank.

Irrevocable letter of credit

• Unconfirmed

The beneficiary has only the issuing bank’s obligation to make a payment under the letter of credit.

• Confirmed

Along with the obligation of the issuing bank, the beneficiary has a firm payment obligation from the confirming bank.

LETTER OF CREDIT TYPES

• Payment at Sight letter of credit

assumes that the amount specified in the documents is received upon presentation of the documents

• Deferred payment letter of credit

the amount specified in the documents is received on the due date for payment agreed between the parties to the letter of credit

• Letter of credit by acceptance

provides for acceptance of the bill (note) by the authorized bank and payment of the bill (note) by the date specified in the note (bill)

• Letter of credit by negotiation

assumes the purchase of the bill (note) and/or documents by the authorized bank and payment of the beneficiary by advance before receiving reimbursement from the issuing bank

• Red Clause letter of credit

provides for payment of part of the amount to the beneficiary by advance before presentation of the prescribed documents, subject to the presence of a special “red clause” in the terms and conditions of the letter of credit 

• Revolving letter of credit

a renewable letter of credit that is used in payments for regular suppliers of goods, who are generally specified according to a schedule in the contract

• Standby letter of credit

used as an instrument similar to a guarantee

• Transferable letter of credit

may be transferred fully or partially to another beneficiary (“second beneficiary”) at the beneficiary’s (“first beneficiary”) request

Basic documents required to issue a letter of credit:

1. Documents for opening the line of credit under which the letter of credit is issued
2. Agreement (contract) for the supply of goods and performance of services and work
3. Letter of credit servicing agreement
4. Application to open a letter of credit

BANK GUARANTEE

A bank guarantee is the Bank’s written obligation to make payments in favor of the Beneficiary upon the latter’s presentation of a written legal demand for payment (in accordance with the payment dates and conditions, and accompanied by the documents stipulated in the guarantee).

Bank guarantees are generally regulated by the Uniform Rules for Demand Guarantees, ICC Publication 458 or are subject to national laws of the Guarantor Bank’s country.

Advantages

• Flexibility and variety of forms 
• Broad scope of application

Disadvantages

• The laws in effect in the guarantor bank’s location are applied
• Risk of unlawful use

Parties to a guarantee

Applicant – the party on whose order and on whose account the guarantee is issued

Guarantor bank – the bank issuing the guarantee

Advising bank – the bank that advises (informs) the beneficiary of the guarantee

Beneficiary – the party in whose favor the guarantee is issued

The following types of guarantees are most frequently used in international practice:

• Payment Guarantee

in general, it secures the seller’s demand to the buyer to pay the contract price by the specified date

• Advance Payment Guarantee

provides for return of the advance payment received by the seller if it breaches the contract terms

• Performance Bond

is intended to ensure that delivery was made or service was provided according to the contract and on time

• Tender guarantee or Bid Bond

used for tendering

Basic documents required to issue a guarantee:

• Documents for opening the line of credit under which the guarantee is issued
• Agreement (contract) for the supply of goods and performance of services and work
• Bank guarantee agreement

We invite you to familiarize yourself with the Rates for documentary letters of credit and bank guarantees.

Rates for corporations (скачать .pdf, 45 Kб)

Rates for corporations, additional services (скачать .pdf, 45 Kб)

Telephone number of the Department of Financial Institutions +7 (727) 244 85 48.