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Consider this, you own a company, and you are planning to source (import) products from a seller (exporter) who is from a different country. To initiate the export of goods, the seller demands upfront capital; this way he believes that he will not be facing any risk of being cheated. However, the buyer will be facing two dilemmas:
Situations like these can disrupt business workflow and lead to exponential losses.
In such situations, where exporters and importers are exposed to significant risks in international trade, particularly when the trading partner is located far away or in a country where contracts are difficult to enforce, financial intermediaries can help businesses reduce these risks by offering trade finance products.
Simply put, trade finance relates to the process of financing activities related to commerce and international trade. A trading transaction involves both a buyer and a supplier of products and services. By financing the trade, various middlemen such as banks and financial institutions can facilitate these transactions.
While a seller may want the buyer to pay in advance for goods and services, the buyer may simultaneously want to minimize risk by seeking proof for the goods supplied. In this case, a bank or financial institution can help the two parties by providing letters of credit that can be cashed upon presentation of documents such as the bill of lading. The seller's bank can also sanction a business loan based on the trading contract as part of trade finance.
Based on recent market research published by Valuates Reports, the global Trade Finance market size was projected to reach USD 10987510 Million by 2026, from USD 7616520 Million in 2019, at a CAGR of 5.4% during 2021-2027.
Furthermore, according to WTO, Some 80 to 90 percent of world trade relies on trade finance (trade credit and insurance/guarantees), mostly of a short-term nature.
While a seller may want the buyer to pay in advance for goods and services, the buyer may simultaneously want to minimize risk by seeking proof for the goods supplied. In this case, a bank or financial institution can help the two parties by providing letters of credit that can be cashed upon presentation of documents such as the bill of lading. The seller's bank can also sanction a business loan based on the trading contract as part of trade finance.
The role of Trade Finance in trade is very important as the latter rarely takes place safely and securely without the former.
Multiple parties on both sides of the transaction are involved in trade finance, which involves financial institutions providing credit facilities such as short-term finance to guarantee the exchange of goods (domestic and international). Payments are generally made through letters of credit (LC) or guarantees. Medium- and long-term loans could also be used for trade finance.
Here are some of the major trends that are significantly impacting the trade finance market:
Increasing worldwide imports and exports is the main factor that is expected to increase the trade finance market. Based on the WITS report, World had a total export of 20,538,351,810.39 in thousands of US$ and total imports of 18,449,266,346.81 in thousands of US$ leading to a positive trade balance of 2,089,085,463.58 in thousands of US$.
Trade finance procedures require a large volume of physical paper documentation. As a result, document-related expenditures account for the majority of Trade Finance costs. Banks' Trade Finance products must be adaptable, agile, low-cost, and deliver value to their clients to survive in today's competitive and uncertain climate. Digitalization is one of the ways that banks can compete. Thus, the rapid digitization in the financial industry is expected to provide lucrative growth opportunities for the trade finance market.
Furthermore, the adoption of technologies such as Blockchain, artificial intelligence (AI), machine learning (ML), and the Internet of Things (IoT) will increase efficiency and simplify the invoice finance transaction from end to end. The integration of technology to improve the business financing cycle's efficiency will be one of the main industry developments that will boost the trade finance market size.
Improved Cash Flow and Efficiency of Operations offered by trade finance can further increase the trade finance industry growth. Trade finance assists businesses in obtaining funding to help them expand their operations, but it is also a kind of credit in many circumstances. In the instance of factoring, trade financing allows enterprises to obtain a cash payment based on their accounts receivables. A letter of credit can assist both the importer and the exporter in completing a trade transaction while lowering the risk of non-payment or non-receipt of products. As a result, cash flow is enhanced because the buyer's bank guarantees payment, and the importer has the assurance that the items will be transported.
The ability to reduce the risk of financial hardship is expected to further fuel the trade finance market growth. A firm that does not have trade financing may fall behind on payments and lose a major customer or supplier, which could have long-term consequences for the organization. Options such as revolving credit facilities and accounts receivables factoring can assist businesses not just in foreign transactions but also in times of financial difficulty.
Various trade finance products are provided by the banks to cater to the needs of the businesses. Below is the list of the most common products/services that are a part of trade finance.
A guarantee can be defined as An independent document in which a bank makes an irreversible guarantee to pay a sum of money to a third party at the request of a customer provided a complying demand is produced.
A bank guarantee is a written guarantee from a lender or financial institution that a borrower will be able to pay its counterparty regardless of the borrower's financial situation. It assures payment to a third party, even if the borrower is unable to repay the amount.
Letters of credit (LCs) are financial, legally binding instruments issued by banks or specialist trade finance companies. If the requirements provided in the LC are met, an LC guarantees that the seller will be paid on behalf of the buyer.
An LC requires two parties: an importer and an exporter, as well as an issuing bank and sometimes a confirming (or advising) bank. For this sort of trade finance, the financiers and their trustworthiness are critical. The issuing and confirming bank effectively replaces the buyer's payment guarantee, lowering the supplier's risk. This is referred to as credit enhancement.
SCF (Supply Chain Finance) is a cash flow solution that helps firms free up working capital stuck in worldwide supply chains. It's a solution that benefits both suppliers and buyers by allowing buyers to extend their payment terms and providers to get paid sooner. This approach enables businesses that import items to free up working capital while also lowering the risk of purchasing goods in bulk and/or transporting them internationally. SCF is defined as "an agreement between a buyer and his suppliers to authorize their invoices for financing by a bank or other financier."
In Documentary Collections (DC), the seller (exporter) will request payment by producing their shipping and collection documentation to their remitting bank. The remitting bank will subsequently send these documents to the importer's bank. The bank of the importer will then pay the bank of the exporter, who will credit the funds to the exporter.
Factoring is a process in which a company sells the value of accounts receivables for which it has not yet received payment to a financial institution.
Invoice factoring is commonly employed when the funder oversees the business's customer collections and ledgers. This gives them additional power, and most invoices are discounted before being sent out. It's generally employed by small enterprises with limited or no credit control. However, the business's industry, size, and growth trajectory will all be considered.
The trade finance landscape is highly competitive with multiple major multinational organizations. Furthermore, with the digitization trend in play, many new fintech organizations are emerging with new trade finance offerings. This, in turn, is expected to intensify the competition further. It is estimated that the top ten manufacturers account for about 14% of the total market share in 2019.
ICBC trade finance services incorporate the entire trade flow that includes the complete product lines of import, export products, such as L/C, bills collection, and open-account sales, etc. There are tailor-made product combinations to fulfill different import/export trade finance needs, which facilitates customers' business development and trade risk monitoring.
HSBC's solutions pull from a vast portfolio of trade and receivables finance products to release funds from the sales, inventory and supply chain. With this consolidated view, one could be able to unlock and move spare working capital to reduce the cost of funding and minimize reliance on more expensive unstructured lending. We could even help make your business more attractive to investors by analyzing key metrics and increasing efficiency ratios.
BNP Paribas is one of the founding members of Voltron, the open platform for documentary trade. The bank has also entered a partnership with Cashforce, a fintech, to offer digital cash flow forecasting and working capital services to corporate treasurers. Greenwich Associates has named BNP Paribas as a quality leader in trade finance in parts of Europe and Asia.
Through innovation and with a strong foundation in digitally-enabled strategies, Citi can enable access to highly tailored products and sources of funds while focusing on balance sheet efficiency targets. Strategies include offerings such as Electronic Trade Loans, Receivables and Distribution or Sales Finance, and a variety of enhanced data insight analytics to add value throughout the transaction life cycle.
