Trade Finance

The Trade Dilemma

A common dilemma faced when engaging in the sale and purchase of goods and services, especially where international trade is concerned, is the seller wanting to get paid before shipping the goods and the buyer wanting to receive the goods before paying the seller. In simple terms, this can be called the trade dilemma, where certainty around the inherent risks associated with trade, and the need to bridge working capital cash flow gaps through access to external sources of funding, become key in the facilitation of trade transactions. In order to provide a solution for buyers and sellers, the financial sector intervenes by providing them with trade finance products and services, increasing certainty for both parties involved in a trade as well as funding where necessary.

Trade Finance is a set of techniques aimed at mitigating and transferring trade risks to the financial sector, and/or using bank funding to enable domestic and cross border/international trade flows. Trade finance focuses on supporting the physical flow of goods (primarily across borders) while primarily using the goods, receivables and cash generated from the trade as primary security.

Trade Finance deals typically involve at least three parties: the exporter (seller), the importer (buyer) and the financier, and differ from other types of credit products as transactions should have the following features:

  • An underlying supply of a product or service
  • A purchase and sales contract
  • Shipping and delivery details
  • Other required documentation (certificates of origin, etc)
  • Insurance cover
  • Terms and instruments of payment, e.g. letter of credit, advance payment, deferred payment, etc.

Trade Finance exists to finance the trade cycle at various points of the transaction, also allowing participants to manage the capital required for trade, while mitigating or reducing the risks involved in an international trade deal.

International and local financial institutions support international trade through a wide range of products that help manage their international payments and associated risks, as well as catering for the need for working capital. For example, trade finance includes instruments, such as LC Refinancing or trade loans, which are used between banks to provide liquidity in the emerging markets.

Examples of Providers of Trade Finance

  • Banks
  • Funds
  • Alternative Financiers such as forfaiting houses
  • Insurance Underwriters
  • Trading Companies

Users of Trade Finance

  • Importers / Buyers
  • Exporters / Sellers
  • Banks
  • Trading Companies 

In August 2022, ITFA in cooperation with Komgo has published the Trade Finance Taxonomy which explains the trade finance universe in an easy-to-understand, comprehensive and diagrammatic model.

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