Financing of International Trade

Financing of International Trade!

When an importer buys goods from a foreign country, or an exporter sells goods, no movement of currencies from one country to another need be generated. Instead, transactions are settled through the banking system, which involves offsetting one debt against another.

An importer of goods can make payments in variety of ways through the banking system. But whatever method is used, the net effect will be to reduce the foreign currency balances of a domestic bank or to increase the rupee balances of an overseas (foreign) bank.

If, for instance, the customer asks his bank for a draft in American bank, so that when the draft is eventually presented for payment at the American bank by the supplier of the goods, the In­dian bank’s account will be debited.

The Indian bank would have charged its customer in rupees for the draft at the appropriate rate of exchange, at the time the draft was issued. A bank can replenish its stocks of foreign currencies by buying from its customers (normally exporters), claims against foreign banks and, if these are insufficient, can buy currencies in the foreign exchange market.

To the exporter of goods, the banking system offers several methods of receiving payment and to the importer, several ways of making payment. Two of these alternatives, bills of exchange and documentary credits, account for the major payment part of all inter­national transactions.

From the exporter’s point of view the most satis­factory arrangement, to ensure that the goods are paid for, would be to receive payment in advance.

Whilst this might be practicable for small consignments sent overseas, such as postal packages sent to a large num­ber of individual customers who have ordered goods in response to a mail order advertisement, it is hardly conceivable that many large orders between firms would be paid for in this way.

The second best thing is the confirmed irrevocable documentary credit, which ensures that the exporter receives payment immediately upon shipment, or within a stipulated time after shipment, provided that he had fulfilled all the requirements of the credit.

After two firms have been trading with each other for some period of time and have built up a relationship of trust, they must decide to change the system of settlement to that of documentary bills of exchange (or clean bills of exchange.) Other possibilities include the carrying out of transactions on open account, the use of telegraphic transfers, mail transfers, and cheques or drafts.

Open Accounts Remittances:

Where the credit status and general reputation of the importer is high, the exporter may agree to supply his goods on an open account basis (i.e., they would carry on their trade in the same way that they would if they were two domestic firms—located in the same country).

The exporter would despatch his goods, debiting his customer’s account with their cost, and send the documents relating to the consignment direct to the importer.

At some agreed period of time, such as every month or three months, the importer would send a remittance to settle the outstanding balance on the open account. The settlement could, alternatively, take place at some agreed time after each shipment has been received.

Telegraphic Transfers:

A periodic settlement on an open account could be in the form of a telegraphic transfer. This is an instruction from the importer’s bank to the exporter’s bank to transfer some of the balance on its account to the exporter. The importer pays the bank the local currency equivalent of the sum in foreign currency. The principal advantage of this type of transfer is that it is a speedy form of payment.

Mail Transfer:

This is similar to telegraphic transfer except that the process takes longer time because the advice to the correspondent bank is sent by mail and not telegraph.

Banker’s Draft:

This is in effect a cheque drawn by one bank on another. An importer, for instance, could pay for a consignment by buying a banker’s draft from his bank in the exporter’s currency.

The exporter, on receiving the draft by post, would either negotiate it or send it for collection through his bank. The importer’s bank is, as with a telegraphic or mail transfer, instructing a correspondent bank to pay over to the exporter some of its balance with that bank.

Cheques:

Alternatively the importer might settle his ac­count by drawing a cheque on his account with his bank and sending the cheque to the exporter. He would have to make sure, however, that in doing so he was not contravening the exchange control regula­tions of his country. The exporter would then have to send the cheque to his bank for negotiation or collec­tion.

Bills of Exchange:

A bill of exchange is defined as “an uncondition­al order in writing, addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand, or at a fixed or determinable future time, a certain sum in money to, or to the order of, a specified person or to bearer.”

There are three parties to a bill, the drawer, the drawee and the payee. The drawer is the person who draws the bill (i.e., the person to whom a debt is due). The drawee is the person to whom the bill is addressed and payee is the person to whom the payment is to be made.

The drawee’s acceptance of a bill is necessary before he is legally liable therefore. Once the drawee has intimated his acceptance of the bill by writing his name across the face of it, the trader who has supplied him with goods has a negotiable instrument which he can turn into cash immediately, if he wishes to do so, by discounting it with his bank.

The exporter, who might otherwise have to wait for settlement some time after the goods have been received by the importer, can thus obtain payment immediately after the goods have been shipped.

The importer, on the other hand (if the bill is a usance bill payable, say, 60 to 90 days after sight) is given time in which he sells the goods and obtains the proceeds with which to meet the bill of exchange when it matures.

However, in drawing a bill the drawer “assures that on due presentation it shall be accepted and paid according to its tenor and that if be dishonoured he will compensate the holder or any endorser who is compelled to pay it, provided that the requisite proceedings on dishonour be duly taken”.

Where the relations between the exporter and importer are long- standing, the exporter may be will­ing to send the documents direct to the importer and draw a clean bill (one with documents attached) which he will pass on to his bank for collection. This implies complete trust in the importer on the part of the exporter.

Clean bills form only a small proportion of the bills used in international trade, but they are “a cheap and convenient means of settlement where trade relations are sufficiently developed for goods to be supplied on open account and are a useful method of payment where goods are sent on consignment account to agents overseas. When a documentary bill is accepted and the documents handed over to the importer, the bill becomes a clean bill”.

Documentary Bills:

When a bill of exchange is accompanied by documents of titles to goods it is called a documentary bill.

The exporter sends his documents through this bank for delivery to the importer upon acceptance of the accompanying bill of exchange (D/A, i.e., docu­ment against acceptance) or upon payment of the bill (D/P, i.e., documents upon payment). If the bill is a sight or demand bill, the documents will only be handed over against payment of the bill.

Short Bills and Long Bills:

A short bill is one which has only a few days to run to maturity, irrespective of the original tenor of the bill. The term “long bill” usually refers to bills having a usance of at least three months.

Bank Bills:

A bank bill is one which bears the acceptance of a bank. Such a bill carries little risk and can therefore be discounted at the finest rate, i.e., at the lowest rate of discount.

Trade Bills:

Bills drawn by and accepted by commercial firms are known as trade bills. Those bearing the sig­natures of firms of first class repute are known as fine trade bills (or fine trade paper) and can be discounted as rates only fractionally higher than those for bank bills.

Accommodation Bills:

These are bills drawn as a means of enabling the drawer to raise funds. A person or company (such as a mercantile bank) lends his or its name as drawee and acceptor of a bill to enable the drawer to raise funds by discounting the bill.

In drawing up their contract an exporter and an importer will agree upon the documents that are to accompany a documentary bill. In some cases, the importer will have no choice but to ask for particular documents to comply with the laws and customs of his country.

Usually these include several copies of the invoice, the bill of lading and the insurance policy, together with such other documents as a certificate of origin, a certificate of quality or a consular invoice. If the goods are despatched by real or by air, a railway receipt or air consignment note will be required.

Negotiation of Bills:

When a bank negotiates a bill of exchange, it hands over the face value of the bill to its customer, less discount. This is exactly the same process as dis­counting a bill, but as far as foreign bills are concerned the practice is called negotiation.

In effect, the banker advances the value of the bill to his customer until the proceeds are received, taking a small discount as com­mission. The banker has full recourse against the drawer and, in addition, usually takes a signed under­taking from his customer that he will reimburse the bank in the event of the bill being dishonoured.

In addition to the undertaking concerning dishonour, the bank may require the customer to sign an assignment giving a charge over any bills, and documents relating thereto, which the bank is collect­ing for the customer, or possibly over his book debts.

Where funds are not required immediately, or where bills are not sufficiently attractive to a banker for negotiation, they may be handed by an exporter to his bank for collection.

The bank will then act merely as an agent for its customers, sending the bills (and documents if there are any) to a corresponding bank overseas, with a request that it presents the bills for acceptance (if necessary) and for payment, and that it remits the proceeds back to the exporter’s bank.

If a bill of exchange carries an exchange clause, it does so in order to establish the method of calculating the rate of exchange at which the bill is to be paid so that dispute and uncertainty about the rate of ex­change can be avoided.

The Documentary Credit:

Next to obtaining a simple transfer of funds from the buyer of his goods at some stage in the preparation and delivery of the shipment, getting the buyer to open a documentary credit is the next best thing. The exporter, in specifying the method of payment in the contract for the goods, may stipulate that payment is to be made in this way.

If the importer agrees with the terms of the contract, he will instruct his bank to open a documentary credit in favour of the exporter. In the process he will request his bank to stipulate in the credit all the documents which he requires the ex­porter to present before he receives payment for the goods.

The importer’s bank will draw up a letter of credit addressed to the seller of the goods and send it to a corresponding bank in the exporter’s country.

The corresponding bank will then, as requested, pass the letter of credit on to the exporter, acting simply as an agent for forwarding the letter and for paying cash or accepting bills as laid down in the credit. This bank will make it clear to the exporter that it is merely passing on the credit and not adding its confirmation, unless it has been authorized to confirm the credit.

Certain documents are necessary in a documentary credit. This is to ensure that the goods have been despatched and that they purport to be of the type and quality ordered. Furthermore, the documents are re­quired to ensure that the goods are being properly transported and in order that the buyer can claim possession of the goods when they arrive.

Invariably the documentary credit will call for an invoice specifying the quality and the quantity of the goods consigned and the price that is being charged.

The bill of lading is the single most important document called for in a documentary credit as it is a document of title to the goods and, to some degree, has the attributes of a negotiable instrument. The goods are handed over only against surrender of the bill of lading and the holder is prima facie the person entitled to received the goods.

Where the exporter has a c.i.f. contract to supply the goods, he must insure them during transit and the importer will specify in the letter of credit that a marine and war risk insure policy (or possibly an in­surance certificate) must be produced.

In addition to the invoice, bill of lading and insurance policy, a documentary credit may require the presentation of other documents such as a railway receipt, air consignment note, certificate of origin, certificate of quality, or consular invoice.

Back-to-Back Credits:

Where customer of a bank has had a documen­tary credit opened in his favour by a foreign importer of his goods, he may be able to persuade his bank to open a credit for the benefit of the original supplier of the goods, on the strength of the existing credit. The two credits are put “back-to-back”, the one being is­sued on the security of the other. This is useful to the middleman with slender capital resources.

Transferable Credits:

Whereas in a back-to-back credit a second credit is opened on the strength of the first, in the case of a transferable credit the benefit of the credit opened in favour of the middleman by the purchaser is trans­ferred to the seller of the goods.

Red Clause Credits:

A packing or anticipatory credit, often referred to as a red clause credit because the credit has a clause in it printed in red, enables the correspondent bank in the exporter’s country to grant advances to the beneficiary.

The issuing bank accepts responsibility for such advances, which are intended to enable the exporter to obtain his raw materials such as iron, or finance the movement of goods such as finished steel, from the interior of the country to the ports.

Export Credit and Guarantee:

The Export Credit and Guarantee Corporation Ltd. (ECGC) is a Government of India concern, estab­lished to provide insurance on a commercial basis for exporters. It is not the function of ECGC to provide finance for exporters; it provides only insurance cover for exports.

However, the fact that exports have been insured in this way gives an inducement to financial institutions, particularly the banks, to provide the necessary finance for exports in cases where they would otherwise not be willing to do so.

The Export Credit & Guarantee Dept. of U.K. also performs a similar function. It not only provides guarantees which help to bring forth finance for the exporter, but such guarantees may take the form of financial guarantees to banks and other financial institutions to cover loans direct to overseas buyers, to enable them to buy goods and services from Britain which they might otherwise be unable to finance.

The ECGD (U.K.) provides two types of in­surance to exporters: comprehensive insurance and specific insurance. C.I is the term given to insurance of trade that is of a more or less repetitive nature, often with the same regular buyers and involving goods which are being sold for each or on a short-term credit basis, and ‘extended’ credit up to five years. S.I. is in respect of isolated capital transactions overseas for expensive installations and construction projects, which are generally paid for on lengthy credit terms.

(a) ECGD provides insurance against the political and economic risks, which include inter­ference with the goods by a foreign government, can­cellation of a valid import licence, inability to transfer exchange, and war.

(b) It also provides insurance against the buyer’s inability to pay.

(c) It performs a complementary role to that of the banks whose aim is necessarily to safeguard from loss, to the greatest possible extent, the finance which it may make available for commercial ventures. This safeguard is provided by the Department’s insurance cover and direct guarantees to the banks and other financial institutions which might not otherwise be provided.

In fact, a bank guarantee is a supplement to the normal cover in which ECGD guarantees the exporter’s bank direct that it will pay the bank uncon­ditionally in the event of non- receipt of money due from the buyer.

(d) The climate of security fostered by ECGD enables exporters to offer better credit terms to buyers and to break into new markets.

Availability of credit, at the right time and in adequate measure, is essential for exporters to develop and expand their overseas trade Banks are best known to extend preferential treatment to the needs of exporters.

But the main consideration of any banker in financing an export transaction will be the security of his funds besides his relations with his constituent. The bank may hesitate to increase the credit limit for the simple reason that it may expose to undue risks.

The ECGC seeks to solve the difficulty in this regard through its guarantees. The corporation issues guarantees in favour of the banks which entitle them to claim from ECGC a major portion of any loss sus­tained by them due to the insolvency or protracted default of exporters. Thus protected against possible losses, the banks are enabled to lend to the export sector with greater confidence and on a liberal basis.

In order to provide for the varying requirements of banks, six types of guarantees have been evolved:

(a) Packing Credit Guarantee,

(b) Post Ship­ment Export Credit Guarantee,

(c) Export Finance Guarantee,

(d) Export Production Finance Guarantee,

(e) Export Performances Guarantee and

(f) Transfer Guarantee.

These guarantees have become increas­ingly popular with the banks.

In fact, the primary goal of the ECGC is to support and strengthen the export promotion drive in India by:

(i) Providing a range of risk insurance covers to ex­porters against loss in export of goods and services and

(ii) Offering guarantees to banks and financial institutions to enable exporters to obtain better facilities from them.

Another goal of ECGC is to give, with the highest possible efficiency, customer-satisfying service at a reasonably low cost to as wide a range of customers as possible.

ECGC furnishes guarantees to the financial bank, so that the exporter gets adequate credit facilities to ex­pand his business. It also insures the exporter’s credit risk, commercial and political, and guarantees pay­ment to the exporter. And the exporter insured with ECGC can go into the world marked with confidence and enlarge his business with a sense of security.

The covers issued by ECGC can be divided broadly into the following categories:

(i) Standard policies issued to exports to protect them against the risk of not receiving pay­ments while trading with overseas buyers on credit terms;

(ii) Policies designed to protect Indian firms against the risk of not receiving payments in respect of

(a) Service rendered to foreign parties and

(b) Construction works undertaken abroad;

(c) Financial guarantees issued to banks against the risks involved in providing credit to exporters; and

(d) Special policies.