TRADE FINANCING

Trade finance typically involves short-term financing to facilitate the import and export of goods. These operations can involve payment if documentary requirements are met (e.g., letter of credit), or may instead involve payment if the original obligor defaults on the commercial terms of the transactions (e.g., guarantees or standby letters of credit). In both cases, a bank’s involvement in trade finance minimizes payment risk to importers and exporters. The nature of trade finance activities, however, requires the active involvement of multiple parties on both sides of the transaction. In addition to the basic exporter or importer relationship at the center of any particular trade activity, relationships may exist between the exporter and its suppliers and between the importer and its customers.

Both the exporter and importer may also have other banking relationships. Furthermore, many other intermediary financial and nonfinancial institutions may provide conduits and services to expedite the underlying documents and payment flows associated with trade transactions. Banks can participate in trade financing by, among other things, providing pre-export financing, helping in the collection process, confirming or issuing letters of credit, discounting drafts and acceptances, or offering fee-based services such as providing credit and country information on buyers. Although most trade financing is short-term and self-liquidating in nature, medium-term loans (one to five years) or long-term loans (more than five years) may be used to finance the import and export of capital goods such as machinery and equipment.

In transactions that are covered by letters of credit, participants can take the following roles:

  • Applicant. The buyer or party who requests the issuance of a letter of credit.
  • Issuing Bank. The bank that issues the letter of credit on behalf of the Applicant and advises it to the Beneficiary either directly or through an Advising Bank. The Applicant is the Issuing Bank's customer.
  • Confirming Bank. Typically in the home country of the Beneficiary, at the request of the Issuing Bank, the bank that adds its commitment to honor draws made by the Beneficiary, provided the terms and conditions of the letter of credit are met.
  • Advising Bank. The bank that advises the credit at the request of the Issuing Bank. The Issuing Bank sends the original credit to the Advising Bank for forwarding to the Beneficiary. The Advising Bank authenticates the credit and advises it to the Beneficiary. There may be more than one Advising Bank in a letter of credit transaction. The Advising Bank may also be a Confirming Bank.
  • Beneficiary. The seller or party to whom the letter of credit is addressed.
  • Negotiating Bank. The purchase by the nominated bank of drafts (drawn on a bank other than the nominated bank) or documents under a complying presentation, by advancing or agreeing to advance funds to the beneficiary on or before the banking day on which reimbursement is due to the nominated bank.
  • Nominated Bank. The bank with which the credit is available or any bank in the case of a credit available with any bank.
  • Accepting Bank. The bank that accepts a draft, providing a draft is called for by the credit. Drafts are drawn on the Accepting Bank that dates and signs the instrument.
  • Discounting Bank. The bank that discounts a draft for the Beneficiary after it has been accepted by an Accepting Bank. The Discounting Bank is often the Accepting Bank.
  • Reimbursing Bank. The bank authorized by the Issuing Bank to reimburse the Paying Bank submitting claims under the letter of credit.
  • Paying Bank. The bank that makes payment to the Beneficiary of the letter of credit.

As an example, in a letter of credit arrangement, a bank can serve as the Issuing Bank, allowing its customer (the buyer) to purchase goods locally or internationally, or the bank can act as an Advising Bank, enabling its customer (the exporter) to sell its goods locally or internationally. The relationship between any two banks may vary and could include any of the roles listed above.

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