Financing international transactions. International financial settlements

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1 Financing international transactions 1

2 Lecture outline Overview of the financing methods Exercises 2

3 Mode of payment vs. financing trade The mode of payment refers to terms of technical transferring the amount of money due between the respective transaction parties Financing trade refers to debtor- creditor relations between the respective transaction parties Some modes of payment require specific types of financing e.g. documentary credit requires financing through bank credit 3

4 Financing of international trade (1) There is always a time span between payment and product delivery financing international trade is always related to a sort of credit Depending on the payment conditions either the importer or exporter is granted a sort of credit 4

5 Financing of international trade (2) Short term transactions- usually up to 180 days with some exceptions Long term transactions- up to many years Usually the ways of financing the import and export transactions are complex a single way is insufficient 5

6 Forms of financing foreign trade Several types of credit Accounts receivable financing Banker s acceptances Factoring Forfaiting Leasing Countertrade 6

7 Financing via credits (1) Credit is a mode of payment and a financing method as well Letters of credit are the oldest form of financing trade A designated bank makes payments to the exporter on behalf of the importer under specified conditions 7

8 Financing via credits (2) The letter of credit is an obligation of the bank to make payments to the exporter upon presentation of specified documents The letter of credit constitutes also a guarantee for the importer to receive his goods upon presentation of documents The role of the bank is crucial in credit financing Bank guarantees make the credit financing one of the safest financing methods 8

9 Financing via credits (3) Other possible sorts of credit are: Standby credits Hybrid types of credit Working capital financing Merchant s credit 9

10 Working capital financing (1) The working capital is used up during operational cycle The working capital is deployed very quickly The whole operational cycle is financed by a bank loan 10

11 Working capital financing (2) The credit is granted for the purchase of the goods by the importer and the sale of these goods The company repays the credit after it sells the goods Suitable especially for small caompanies 11

12 When is financing via credits appropriate? (1) We have to afford the respective types of credit Some types of credit are expensive e.g. the documentary credit- we actually have to buy the bank s guarantee Documentary credit is usually used for large transactions of large market players 12

13 When is financing via credits appropriate? (2) Other less expensive types of credit can be used in smaller transactions For small companies- the merchant s credit is appropriate Hybrid types of credit enable adjustment to changing ways of delivery and payment e.g. transactions with middlemen, deliveries in installments 13

14 Accounts receivable financing (1) The exporter is granted a loan by a bank against the assurance of receivables This way the exporter can receive the payment for his delivery earlier than specified in the contract with the importer 14

15 Accounts receivable financing (2) The exporter benefits from this method because he receives payment immediately this improves his cashflow A drawback for the exporter is that banks demand higher interest for financing foreign transactions than the market interest rates The bank has recourse to the exporter 15

16 Banker s acceptances (1) Financing via banker s acceptance can be an element of various payment methods e.g. documentary collection A banker s acceptance is a bill of exchange or a time draft which is drwan by the importer and accepted by a bank This way the bank accepts its obligation the pay the holder of the bill at maturity 16

17 Banker s acceptances (2) A banker s acceptance is beneficial for the exporter because the credit risk is transferred to the bank, moreover the political risk is eliminated The exporter can sell the bankers acceptance on the money market It is also beneficial for the importer because otherwise the exporter would not be willing to grant the credit 17

18 When is financing via banker s acceptances appropriate? (1) Banker s acceptances financing can make many methods of payment safer e.g. it can be used in open accounts or advanced payment It is less safe than documentary credit financing because the bank is not involved in the document checking process and potential claims The most popular use of financing via banker s acceptances is the documentary collection payment method The banker s acceptance becomes an additional document in the transaction 18

19 When is financing via banker s acceptances appropriate? (2) Banker s acceptances financing can be appropriate for companies which can not afford documentary credits It can be appropriate for small and large transactions as well 19

20 Factoring (1) Factoring is a mode of payment and a way of financing trade as well It is a type of the accounts receivable method Since there is time span between delivery and payment the exporter grants a sort of credit to the importer To hedge the risk of non-payment the exporter may sell the accounts receivable to a factor 20

21 Factoring (2) Factors buy the receivable without recourse, this means that the exporter does not have to repay the factor if the importer refuses to pay The factoring financing method relieves the exporter from many administrative duties The credit exposure of the exporter is eliminated The immediate payment to exporter improves his cashflow 21

22 When is financing via factoring appropriate? Factoring is expensive- factors charge larger rates for the taking over the debt than the market inetrest rate It is an appropriate financing method large transactions usualy for large companies Usually factoring is used in short term transactions (up to 180 days) 22

23 Forfaiting (1) Forfaiting is a mode of payment and a way of financing trade as well Usually aimed at medium-term financing fixed assets (e.g. machinery) Fixed assets are usually expensive and therefore the financing period may account for several years 23

24 Forfaiting (2) Exporters are not willing to finance importers over such a long period This is why the debt of the importer is sold to forfaiters (usually banks) Forfaiting financing usually refers to transactions exceeding USD For larger transaction more than one forfaiting institutions can be involved 24

25 When is financing via forfaiting appropriate? Since the transactions concern fixed assets this financing method is often required by production plants It is an expensive financing method so it is suitable for large companies It is used for long-term transactions 25

26 Leasing(1) Leasing is a financing method of fixed assets The company which requires the assets pays a series of contractual intsallments in exchange for the use of the contractual fixed assets The lesee- the company which requires the assets The lesor- the the leasing company which owns the asstes 26

27 Leasing(2) The duration of the lease contract can be fixed, periodic or indefinite Leasing is usually used for larger transactions were the company can not obtain credit The legal rules concerning leasing transactions differ internationally (tax benefits and various accounting standards) The benefits for the lessor and lessee differ internationally Leasing is an off-balance sheet financing method 27

28 Leasing(3) Leasing plays a substantial role in international transactions Machinery for companies which exports goods abroad Investment abroad The use of vehicles for international transports by transportation agents/ freight forwarders 28

29 Countertrade Financing via exporting goods or services Mutual transactions e.g. offset transactions Suitable for importers from countries with limited foreign exchange Suitable for developing countries 29

30 Discussion (1) You run a company planning to buy an energy windmill as an investment. This is a purchase which is beyond your current core business. You are looking for a proper way of financing this transaction. What financing method would you choose? Consider the pro and con side of the respective financing methods. 30

31 Discussion (2) You are an exporter of FMCG products. You plan to extend your market share and your looking for new customers. A new importer is interested in purchasing your goods. He asks for deferred payment. What should you take into account before granting/not granting credit? Can you suggest any alternative ways of financing than a merchants credit? 31

32 Literature E. Bishop, Finance of international trade, Chapter 3. Publication available via Science Direct Database J. Madura, International Financial Management, Chapter 19, South-Western.Cengage Learning, 11th edition,

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