Trade Finance instruments
Trade finance (TF) is an important part of the transaction services offered by most international banks. It is a payment instrument and at the same time effectively manages the risks associated with doing business internationally.
To succeed in today's global marketplace and win sales against foreign competitors, exporters must offer their customers attractive sales terms supported by appropriate payment methods. Getting paid in full and on time is the ultimate goal for each export sale, so an appropriate payment method must be chosen carefully to minimize the payment risk while also accommodating the buyer's needs. For exporters, any sale is a gift until payment is received. Therefore, the exporter wants to receive payment as soon as possible, preferably as soon as an order is placed or before the goods are sent. For importers, any payment is a donation until the goods are received. Therefore, importers want to receive the goods as soon as possible but to delay payment as long as possible, preferably until after the goods are resold to generate enough income to pay the exporter.
Payments entail a significant portion of risk especially when executed cross-border and between relatively new trading partners. The need for exporters to formalize a commercial contract to allow maximum coverage of the risks to their exports is as important as knowing the different forms of trade finance available to conclude the transaction. These are classified into two main categories:
- Bank-guaranteed trade finance (i.e., documentary trade)
- Letters of credit
- Not-bank-guaranteed trade finance
- Open Account
Trade finance requires consistent and standard terminology and nomenclature. A full picture of where the trade finance market is heading is given in existing publications from international associations (e.g., BAFT-IFSA, ICC-SWIFT ) that describe reference models and glossaries for trade finance. These documents provide definitions that can serve as a common reference point for banks, their customers, and service providers in order to provide a base clarity as the supply chain finance marketplace continues to grow and evolve.
Useful reading includes the Trade Finance Guide of the US Department of Commerce