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Trading finance is a set of financial instruments that aid in the conduct of inland commerce and international trade. This includes articles like letters of credit, guarantees, insurance, factoring, bill collection and discounting, etc. Trading finance is mainly sought after by importers and exporters of goods, manufacturers and traders. It is offered by suppliers, buyers, banks, financial institutions, trade finance houses and syndicates.
The main function of trading finance is to bridge the gap in financials from the time of purchase to the time of delivery. For suppliers, it is a form of guarantee for the payment they are yet to receive. For buyers, it is a form of risk mitigation until they receive the goods. In international trade, these monetary instruments are necessary to protect the interests of both the buyer and the seller.
In India, trading finance is offered by banks and NBFCs with equal fervour. Some of the leading banks to approach for trading finance are SBI, ICICI Bank, HDFC Bank, Axis Bank and Kotak Mahindra Bank. A few leading NBFCs well known for trading finance are Bajaj Finance Finserv, Indiabulls, L&T Finance Holding, Mahindra & Mahindra Financial Services Ltd.
About Trading Finance
Trade financing reduces payment risk - Trade financing presents a form of payment guarantee to the seller in the form of letters of credit or bank guarantee.
Increases credibility for both the importer and exporter - It helps in assuring the each other of the financial goodwill of the other party, thereby reducing the stress on them.
Provides enhanced credit - Buyer or the seller can access increased amounts of capital while waiting for the transaction to be complete.
Enables increased cash flow - All open invoices and account receivables can be sold to trade financiers for a discount to obtain credit or cash (Factoring & Forfaiting), that can be used for development of the business.
Empowers small business units - Small business units may not get business loans, despite producing pending invoices or bills. Trading finance enables them to avail working capital through forfaiting or discounting of bills.
As mentioned earlier, trade financing is rather a set of monetary instruments that facilitates trade. Trade financing can be obtained in various forms as required by the borrower.
This is a very common method used in international trade. This is an undertaking offered by the buyers/importer’s bank stating that once the exporter presents all the shipping documents as mentioned in the purchase agreement. The common document needed for this is “Bill of Lading”. This assures the exporter of his/her payment as soon as the goods are shipped.
Here, the bank accepts to act as the guarantor on behalf of the applicant and pay an agreed-upon sum of money to the beneficiary if there is a failure in the fulfilment of the purchase agreement. Bank guarantees are of different forms such as Performance guarantees, Bid Bond guarantees, Financial guarantees, Advance guarantees.
A common method used by exporters to enhance their cash flow. The exporter sells all his trade invoices to a financier for a discounted price. The exporter reduces his risk of bad debts by doing so while the financier earns a profit when the importer pays the full amount. Exporters resort to this method to increase their daily working capital.
There are other types of products such as supply chain finance, structured trade and commodity finance, export and agency finance, trade credit and political risk insurance.
Trading Finance should be considered as an enabler in trade, rather than a simple loan product. Some people refer to it as a ‘Process’ more than a financial article. Any trade involves the process of buying and selling. Trading finance acts as an assurance for the monetary value of the sale until the transaction is completed.
Upon the creation of the purchase agreement, the exporter requests the importer for a Letter of Credit from the importer’s bank. The importer’s bank issues a letter of credit stating that once the exporter presents all the necessary shipping documents, as mentioned in the agreement, the bank will immediately make the payment to the seller.
Another finance option is bank guarantee. Upon creation of the purchase agreement, the exporter or the importer can approach the bank to act as a guarantor on their behalf, to the other party, in case of any failure to meet the terms of the agreement.
Other options include, Factoring, Discounting of Bills and Forfaiting. Here, the importer or the exporter, can sell their pending bills or open invoices to a financier, for a discounted rate of the total value in order to obtain cash or credit. This provides them with immediate liquidity that can be used for working capital or to meet daily business needs.
Though trading finance is different from traditional term loan products, it is essentially a loan. It is a credit facility provided to the applicant in a different form. Hence, it applies all major rules and regulations similar to a term loan. This finance facility also considers the applicants age, income, credit history, etc; before extending the facilities to them. Some of the important factors considered are
Banks require the business to be at least 2 years old before considering for Trading Finance. The longer you have been in business, better are the financing terms offered to you
Banks & NBFCs give considerable importance to the stability and the income generation of the business. A business that has shown consistent performance and considerable gains is given preference.
Loyal customers are always the preferred group of customers to offer loans. Your credit standing with the bank/NBFC is a testament to your creditworthiness. Making timely repayments of your existing loans, having a clean credit card history, maintaining a healthy credit cycle with all your accounts, these factors play an important role in determining your credit history, which in turn enlists you for great loan terms and benefits.
Providing substantial collateral and security against your loan is an added advantage. This could help you secure higher loan amounts and other offers and benefits.
Apart from the above factors, there are a few common factors like
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