Varies according to product or instrument
To reduce the risk of trading abroad
Businesses importing or exporting goods and services
Trade finance is an umbrella term that covers many financial products and instruments used by businesses to reduce the risk of trading abroad. It includes importing, exporting and domestic trade. Trade finance is a broad term that encompasses a range of financial products utilised by banks and companies to make trade transactions possible.
If you’re an importer you won’t want your own money tied up in shipments of goods that could take several weeks to arrive – assuming they have actually been shipped.
And if you’re an exporter, you probably don’t want to wait until your goods have arrived at their final destination before you get paid – assuming your importer doesn’t default on payments. You might also want a cash advance based on a purchase order or invoice.
In theory, trade finance mitigates these potential risks (e.g. payment risk, supply risk, bankruptcy risk) to international and domestic trade.
International trade involves various risks, such as currency fluctuations, credit risks, and shipment risks, which can make it difficult for parties to secure financing for their trade deals. Trade finance helps to mitigate these risks by providing financial instruments such as letters of credit, trade guarantees, and documentary collections that ensure payment and delivery of goods.
Moreover, trade finance also offers other services like financing working capital, providing credit insurance, and managing currency exchange risk, which are essential for companies engaged in international trade to grow their business.
Overall, trade finance plays a vital role in facilitating global trade and ensuring that trade transactions are executed efficiently, safely, and securely.
The trade financing process can involve several different parties, including the buyer and seller, the trade finance provider, export credit agencies and insurers.
Trade finance for importers and exporters includes:
Some people have a much narrower definition of trade finance. They use the term to describe loans that help you pay suppliers. Let’s look at these trade finance loans (or trade loans) in more detail.
If you’re a wholesaler, distributor or importer, a loan can give you the cash you need to buy inventory or stock from a supplier, in order to fulfil and order. In this narrower definition, trade finance is a form of working capital finance along the same lines as purchase order finance and supplier finance.
Let’s say you have a confirmed purchase order from a customer and you want to either import stock or inventory, or export products for resale. This is the point at which you’d talk to a trade finance lender. They will look at you favourably if both your customer and supplier are established businesses. Their loan will pay your supplier (in this case the exporter) before you (the importer) receive the goods.
Goods can be shipped to you more quickly so that you can fulfil your order. Your trade finance lender in other words acts as a third party to mitigate payment risk and supply risk.
A trade finance loan (trade loan) works like this:
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