What is trade finance?

Posted by Paras Goyal on July 30th, 2019

What is trade finance?

Trade Finance is the reason why the global trade and export finance markets are still standing high since 1983. Worthwhile, Trade finance incorporates the basic letter-of-credit outcome with highly organized joint bond and debt ECA financing.

There are limitless meanings to what trade finance is and the choice of words used is of great significance. Fundamentally, It consist of both ‘science’ and ‘an imprecise term covering a number of different activities’. As of the nature, both are accurate. From one perspective, it is a precise science managing technique for capital allocation in response to international trade of flow and yet there is a comprehensive range of tools for financiers to apply, which determine how cash, credit investments and other assets can be utilized for trade.

In layman explanation, an exporter needs to pre compensate the importer for goods shipped. In general terms, the importer wants to calculate and reduce risk by demanding all the necessary documents to ensure that the goods have been shipped efficiently. Then, the importer’s bank provides a letter of credit(LOC) to the exporter or the exporter's bank, to pay upon the presentation of certain documents. Like, bill of lading. The exporter's bank may ask for a loan to the exporter for the ease of export contract. The documents for export finance required by both the parties depends on the nature of the transaction and how to display the ‘evidence of performance’ i.e. the bill of lading. Eventually, It is very amusing to see how banks only deal with the documents involved and not with the actual goods, services or performance to which the documents are concerned.

The main function of trade finance is to present a third-party to remove the commerce risk and the supply risk. Trade finance arranges receivables or payments according to the agreement to the exporter while the importer might extend the credit facility to fulfill the trade order. 

The parties involved in trade finance are as follows:

• Banks

• Trade finance companies

• Importers and exporters

• Insurers

• Export credit agencies and service providers

Trade financing is totally a different concept than conventional financing or credit finance. General financing is mainly focused to manage solvency or liquidity, but on the other side, trade financing may not be a buyer's lack of funds or liquidity. In fact, trade finance can be used to defend against international trade's unique integral risks, such as currency fluctuations, political instability or the creditworthiness of any party involved.

Following are some of the financial tool used in trade finance:

• Providing lines of credit which can be issued by banks to help the traders.

• When companies are paid based on the percentage of their accounts receivables.

• Both Export credit facility and working capital can be granted to exporters.

However, International trade between the countries has been in operation for many centuries, but trade finance helps in its advancement. Although, the general use of trade finance has added to international trade growth.

Trade finance is a very vast topic to cover, since Connect2India provides you the best platform to enhance your knowledge about trade and other related topics of import-export business practices, you can easily start your own overseas business.