Trade & Forex

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Introduction to Trade Finance

International Trade
It is the activity by which, buyers and sellers exchange goods and/or services for payment
or for other goods and/or services, across national borders.

Types of Trade
 Visible Trade - These are the export and import of goods.
 Invisible Trade - Services such as logistics, insurance, consultancy etc.

In international trade transactions, buyers and sellers are in different countries. Banks
provide finance, and act as intermediaries between the buyer and seller.

Trade Documents
 Commercial Documents - It contains information about the
 Buyer and Seller,
 Goods description and quantity,
 Commercial terms and Inco terms (International Commercial terms).

Types of commercial documents-

 Sales contract
 Commercial Invoice

 Financial Documents - The purpose of a financial document is to establish a legal

undertaking to make a payment. Financial Documents are of two types-
 Bill of Exchange
 Promissory Note

 Transport Documents – They provide proof that goods have been received by the
carrier, for transport to a named destination and also evidence the contract, for
carriage of goods. Types of transport documents-
 Marine Bill of Lading
 Airway Bill (Air Freight)
 Lorry Receipt (Road transport)
 Railway Receipt (Rail transport)

 Insurance Documents - Goods under transport need to be insured to protect them

from loss or damage. Insurance Documents could be:
 Insurance Policy
 Insurance Certificate

 Inspection Documents - Produced by independent inspection companies who

inspect goods prior to shipment, and certify the quality/specification of the goods.

 Other Documents – Packing List, Weight Certificate, Certificate of Origin, Consular

Invoice.

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Incoterms
The International Chamber of Commerce (ICC) publishes International Commercial Terms
(Incoterms). These help in interpreting the costs, risks and responsibilities of buyers
and sellers, in international trade.

EXW (Ex Works)

This is the one of the simplest commercial terms used, with the seller agreeing to deliver
the goods at his doorstep (factory, warehouse, etc.).

FOB (Free On Board)

The seller is responsible for the goods till the time they clear the rail of the carrier ship at
the port of origin.

CFR (Cost and Freight)

In this form of agreement, the seller bears the main carriage of the goods. The risk of
damage passes to the buyer from the seller, the moment the goods clear the ship’s rail.

CIF (Cost, Insurance and Freight)

The seller takes on one more additional cost and responsibility under this contract, when
compared to CFR.

DDP (Delivered Duty Paid)

DDP is the reverse form of EXW, where the seller undertakes maximum responsibility, and
delivers the goods at the doorstep of the buyer.

Trade Products - Part I

Trade Transactions
Trade transactions can be classified by the way they are settled between the various
parties. Broadly, transactions can be classified into four types:

 Advance Payment- Here, the buyer pays the seller in advance, for the goods.
These transactions typically take place when the seller enjoys a monopoly market.

 Open Account Trading- This is the reverse of advance payment transactions. The
buyer pays the seller after the goods have been delivered, often after a certain
number of days of credit.

 Documentary Collections- The banks act as intermediaries, to present the

documents to the buyer, and collect payment on behalf of the seller. The documents
which prove the ownership of the goods, play an important part in Documentary
Collections. Only by using these documents, a buyer can claim the goods he has
imported.

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Types of Documentary Collections

 Documents against Payment (D/P) - In this case, documents are released

to the importer, after he pays for the shipment.

 Documents against Acceptance (D/A) - Documents are released to the

importer, on obtaining acceptance of the importer on a document termed the
‘Bill of Exchange (BOE)’. The bill of exchange is a legal document, similar to a
demand draft. Here the importer is signing on a document, agreeing to pay a
certain sum of money, on a particular date.

 Clean Collections - Exporter sends the goods and the commercial

documents directly to the importer. Only the ‘Bill of Exchange’ is sent through
the bank for collection.

 Letter of Credit- A Letter of Credit can be defined as a payment undertaking given

to the beneficiary (seller) by the issuing bank, on behalf of the applicant (buyer).

The issuing bank commits to make payment to the seller, provided, the seller
complies with the documentary requirements specified in the letter of credit.

Parties in a LC Transaction
 Applicant- The buyer or Importer who starts the LC process, by asking his bank to
issue an LC in favor of the seller.
 LC Issuing Bank – The bank, which provides the payment undertaking for the
Applicant.
 Beneficiary - The seller or exporter, who will be paid by the Issuing Bank.
 Advising Bank- Once an LC is issued, this is communicated to the seller, by a bank
in the seller’s country. This process is known as LC advising, and the bank which
communicates this, is known as the Advising Bank.

LC Process Flow – Issuance

Step 1: Applicant/Importer and Beneficiary/Exporter enter into a sales contract.
Step 2: Applicant/Importer applies for Letter of Credit (LC) to the Issuing Bank.
Step 3: Issuing Bank Issues the LC to the Advising Bank.
Step 4: Advising Bank authenticates the LC and advises the same to Beneficiary/Exporter.

LC Process Flow – Settlement

Step 1: Beneficiary/Exporter exports the goods to the Applicant/Importer.
Step 2: Beneficiary/Exporter submits the documents to the Advising Bank for verification.
Step 3: Advising Bank sends the documents to the Issuing Bank.
Step 4: Issuing Bank makes the payment to the Advising Bank and the Advising Bank pays
the Beneficiary/Exporter.
Step 5: Applicant/Importer makes the payment to the Issuing Bank and the Issuing Bank
sends the documents to the Applicant/Importer.

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In certain transactions, you may also come across a confirming bank and a negotiating
bank.

Confirming Bank
A bank that confirms that the LC, issued by importer’s bank, is genuine.

Negotiating Bank
The negotiating bank accepts the documents, and makes the payment on behalf of
the issuing bank.

In the LC issuance process , there is no movement of goods or money between any of

the parties. The issuing bank is only providing an undertaking to pay the exporter, in the
event of the exporter submitting documents that comply with the terms and conditions of
the LC.

A Letter of Credit, therefore, creates a contingent liability on the issuing bank at the time of
it being issued.

Contingent Liabilities
Contingent liabilities are off-balance sheet items, but can have a material impact on
the company. The contingent liabilities table shows the possible risk/liabilities.

Trade Products - Part II

Bank Guarantees (BGs)
This is an instrument by which, the issuing bank guarantees the satisfactory performance of
a contract or the non-happening of an event such as default, to the beneficiary.

Types of Guarantees
Bank Guarantees are broadly classified into:

 Financial Guarantees- Financial guarantees are used to secure a financial

commitment such as a loan, a security deposit, etc.

 Performance Guarantees- Here, the issuing bank, guarantees the ability of the
applicant to perform a contract, to the satisfaction of the beneficiary.

Invocation of Bank Guarantee

 A beneficiary can invoke a bank guarantee by submitting a written demand notice
and the original bank guarantee to the guaranteeing bank.
 The guarantor, on receipt of such a notice of invocation needs to make payment of
the amount under the guarantee without demur.
 Bank gets the reimbursement from the applicant

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The role of the Trade Sales Manager (TSM) is to mediate between the central trade
processing unit and the customer.

Parties engaged in international trade deal with a variety of challenges.

Challenges faced by Importer:

 Managing stock till goods are in transit (under transport)
 Paying for Imports
 Manage working capital till payment is realized from manufactured goods

Challenges faced by Exporter:

 Procure raw material, complete the production process and shipment
 Managing working capital between shipping goods and realizing payment
 Pay for freight, insurance etc. for the shipment

Trade Finance: For Exporters

 Pre-Shipment Export Finance- Banks provide funding to exporters against
confirmed orders, or letters of credit received from overseas buyers.
Finance is provided for all activities up to packing and shipping of goods.

 Post-Shipment Export Finance- An exporter who has successfully executed an

export order still needs to wait before receiving his payment. Finance against
export orders that are already executed, is known as Post-Shipment Export Finance.

Post-Shipment Credit may be provided either in conjunction with Pre-Shipment

Credit, or as a stand-alone facility.

Both pre-shipment and post-shipment credits can be disbursed in:

 Foreign Currency (FCY) - exporter is insulated from foreign exchange
fluctuations.
 Indian Rupee (INR)

 LC Bill Discounting - When the post-shipment finance is granted for an order

executed against a Letter of Credit, issued by a bank acceptable to the funding bank,
the same is known as LC Bill Discounting.

Advantages of LC Bill Discounting for Banks:

 Low cost and low risk product for banks.
 Much more secured product than regular post-shipment credit
 Can provide loans by taking minimal or nil collateral

Advantages of LC Bill Discounting for Banks:

 These payments are not considered within its regular working capital loans.

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Trade Finance: For Importers

 Buyers’ Credit- In a Buyers’ Credit transaction, finance is arranged by the
importer from an overseas financial institution, usually a bank, to pay for the
imports on the due date.

Suppliers’ Credit - The LC plays a key part in a Supplier’s credit transaction. On the basis
of LC, the funding bank (located overseas) makes payment to the supplier at sight, on
presentation of credit complying documents.

Branch FX: Introduction and Key Terms

In India, foreign exchange can be bought or sold only through Authorized Dealers (ADs).
These could be banks or money changers.

Forex services are generally required for:

 Corporate Banking
 Retail Banking

Branch Forex (Retail market) would typically involve:

 Travel related Forex
 Remittances

Travel related Forex :

It involves the following:

• Foreign Currencies - Customers purchase and sell Currency Notes of different

countries, in various denominations.

• Travellers’ Cheques (TCs) - They can be used in the following ways:

 Can be used like cash at some retail locations
 Can be exchanged for local currency

• Bank Travel Card- This is a stored value card. The customer pays for the value of
foreign currency he needs, in INR. The bank then loads that amount into the card

Forex Remittances:
• Inward Remittances
• Outward Remittances

Money can be transferred (received or sent) between bank accounts in different

countries with the help of these services.

Transacting in Foreign exchange:

The rates are decided by the treasury and given to the branches in the form of a ‘Rate Card’
at the beginning of the day. All FX transactions at the branch, take place at the daily rates
on the rate card.

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Sections of the rate card:

 Telegraphic Transfer (T.T.) Buying: Rate at which a Foreign Inward remittance

received by Telegraphic (Wire) Transfer is converted into rupees.

 Telegraphic Transfer (T.T.) Selling: Rate applicable when a customer sends an

Outward remittance through Telegraphic Transfer.

 Bills Buying: Rate applicable on export bill payment

 Bills Selling: Rate applicable on import bill payment

 Travellers’ Cheque (T.C.) Buying: Rate at which the unused Foreign Currency TCs
deposited by the customer, is converted into rupees.

 Travellers’ Cheque (T.C.) Selling: Rate applicable when a customer buys Foreign
Currency TCs from the bank.

 Cash Buying: Rate at which excess Foreign Currency notes, returned by the
customer, are converted into rupees.

 Cash Selling: Rate applicable when a customer purchases Foreign Currency Cash
from the bank.

 Demand Draft (D.D.) Issuance: Rate applicable for the Demand Drafts issued by
the Bank, in favor of an overseas counterparty.

 Cash Offload to FES: Rate at which Branch offloads (sells) foreign currency to
Foreign Exchange Services.

 Cash Purchase from FES: Rate at which Branch purchases foreign currency from
Foreign Exchange Services.

 Forex Card Buying: Rate at which the excess Foreign Currency in the Forex Card
returned by the customer is converted into rupees.

 Forex Card Selling: Rate applicable when a customer loads/ reloads Foreign
Currency Cash from the bank.

Banks must have ‘Nostro accounts’ for foreign exchange transactions.

The Indian foreign exchange market is growing, with increase in outbound and inbound
travel.

These mainly consist of:

 Corporate Travel - Tends to be scattered evenly during the year.
 Student travel – It is concentrated during foreign university admission season
 Leisure travel - Leisure travel takes place most of the year.

Branch Forex makes money on:

 Commissions
 Buy/Sell spreads

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 Margins

The bank makes money both on the spread between buy/sell rates, and on the rates at
which it deals with Treasury

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