FAQs Trade Finance. ecobank.com

Transcription

1 FAQs Trade Finance ecobank.com

2 TRADE FINANCE FAQS Q. What are the products used by banks in international trade? A. Cheques, transfers, bill of exchange, documentary bill, documentary collection, letter of credit, guarantees, import and export financing. Q. What is the main difference between a Letter of Credit (LC) and Documentary Collection? A. Under a letter of credit, the bank engages itself to pay a beneficiary in accordance with documents presented by the seller. In a documentary collection, banks act like mailboxes ; they transmit documents to their client while following the payment instructions received. Q. What is the difference between an LC and a Standby Letter of Credit (SBLC)? A. An LC is an international means of payment used to settle buying or selling under a contract upon fulfillment of contractual obligations making it a payment instrument. An SBLC is a guarantee (of payment) that is called upon when ordering party is unable to fulfill its contractual obligations making it a default instrument. Q. What is the similarity between SBLC and LC? A. Whether it is on payment date or for defaults, both require payment to be made against documents to be presented within a valid period; documents are valid if they appear to be compliant. Q. What are the different types of letter of credit? A. Irrevocable, irrevocable and confirmed, transferable, back-to-back, revolving (renewable), red clause, green clause.

3 Q. What payment method to choose considering the level of risk? Documentary Collection Irrevocable Letter of Credit Guarantee / SBLC D/P* D/A** Notified Confirmed Notified Confirmed (reissued) Conterparty risk on the buyer Almost nil X X Average X X High X X Risk on country of import Almost nil X X Average X X High X X Risk on bank of import country Unknown Bank X X Tier 1 bank X X X X *Documents against Payment **Documents against Acceptance Q. Depending on their need, what are the options of the buyer/provider? FROM THE EXPORTER POINT OF VUE (VENDOR) WHAT IS THE MAIN CONCERN? Reassure the buyer of its high level of professionalism. Raise funds for its exportation Obtain a loan in case payment of the export proceeds is delayed. Avoid treasury freeze and boost cash inflows. Protect itself from both country and bank risk. Being paid on time WHAT TO CHOOSE? Issue a bid bond or a performance bond. Get a pre-shipment financing loan Get an advance on bills or receivables (postshipment loan) Request the bank to issue an advance payment guarantee. Obtain an irrevocable and confirmed letter of credit or bank guarantee or SBLC confirmed Obtain a letter of credit or a bank guarantee or SBLC

4 Q. Depending on their need, what are the options of the buyer/provider? FROM THE IMPORTER S POINT OF VUE (BUYER) WHAT IS THE MAIN CONCERN? Being sure - of the professionalism of the exporter Receive merchandises on due date and being assured that it is in line with expectations. Obtain longer payment terms Obtain an Import Financing Pay the vendor when his contractual obligations are completed. WHAT TO CHOOSE? Pay the beneficiary by letter of credit or obtain a bid bond or performance bond. Pay through letter of credit Pay through letter of credit or a bank guarantee or SBLC Negotiate an import financing loan against import bills/invoices Pay through letter of credit only. Q. Advantages and drawbacks of a letter of credit? Advantages? A. On imports: Pay the vendor when his contractual obligations are completed. On exports: A secured payment with no consideration of the country or counterparty risk. Q. Drawbacks? A. Payment is due if documents are in line with the contract. There is no commitment on the compliance of goods. Q. Advantages and drawbacks of documentary collections? Advantages? A. - Simpler and faster, therefore easier to sell to customers than LCs. - Buyer can only get documents of title to the merchandise either upon payment to the bank of the amount owned or upon acceptance of a term bill of exchange - the cost is low because it does not require a payment commitment by banks - Suitable where seller is comfortable with the buyer and country risk of buyer but still wants to ensure payment Q. Drawbacks? A. - Political risk for the vendor / provider - Banks are not undertaking any risk. - Default risk from the buyer: buyer may use several arguments not to pay.

5 Q. Advantages and drawbacks of an SBLC? Advantages? A. - Easy to process and simplicity of gathering documents certifying the non-compliance on the part of the exporter s obligations. Drawbacks? A. - Payment under a guarantee usually requires a simple certification to enforce payment and therefore can be subject to misuse Q. What is an irrevocable and confirmed LC? A. An irrevocable and confirmed LC is not only a means of payment but a guarantee protecting the vendor from both solvency risk of the buyer and country and issuing bank risks. An unconfirmed irrevocable documentary credit is limited in the sense that its security does not protect completely the seller from the risk of non-payment / default. In addition to this constraint, payment could take longer if made at the counter of the ordering bank. Q. What is a transferable LC A. A transferable LC allows the first beneficiary of the LC to transfer all or part of its rights to another beneficiary who is supplying the actual goods Q. Advantages and Drawbacks of a transferable LC? Advantages? A. - Subcontractors are secured - No cash outflow for intermediaries - Flexibility and confidentiality Q. Drawbacks? A. - The main one is to structure this type of letter of credit. It is highly recommended that subcontracts should be aligned with the main contract (currency, transportation mode, incoterms, and documents). Else, transaction could malfunction. - Costly, charges are supported by the subcontractor. - Quality control certifications requested by ordering parties and furnished by inspection establishments and third holders are barely used on this type of LC. What is the certified pricing in case subcontractor is the one sending the goods? Is it subcontractor s pricing or the first beneficiary? What about confidentiality clauses in these cases?

6 Q. What is a back-to-back LC? A. A back-to-back LC can be used where the first beneficiary is not the actual supplier. The first beneficiary will request his bank to issue a second LC to the actual supplier. The two LCs are however independent LCs with their own terms and conditions. The first LC is normally offered as security for the second LC. Q. Advantages and drawbacks of a back-to-back LC? Advantages? A. - Subcontractors are secured - Easier to manage treasury for vendors, confidentiality - Internationalization (the beneficiary of a back to back can be located in a country different from that of the seller) Q. Drawbacks? A. - Heavy costs - Highly complex structure and risky - There are several parties involved making it difficult to manage any changes to the LCs - High risk for the issuing bank, if one of the parties goes bankrupt or if the beneficiary of the first LC does not perform, the issuing bank must still honor its obligations to the beneficiary of the second LC yet it cannot obtain payment under the first LC. Q. What is a Revolving LC? A. It is available for an amount and allows that amount to be reinstated automatically under certain circumstances without need for amendments to the LC. Q. Advantages and Drawbacks of a revolving LC? Advantages? A. - Buyer can use one LC to cover multiple shipments over a long period of time instead of opening an LC for each shipment - Simple, quick and less expensive - Automatism

7 Q. Drawbacks? A. - Partial shipments are allowed but the ordering customer must bear in mind that amending this type of credit is complicated. He should therefore be meticulous regarding renewal conditions. Q. What is a «red clause» LC? A. A specific type of letter of credit in which a buyer extends an unsecured loan to a seller. Red Clause Letters of Credit permit documentary credit beneficiaries to receive pre-shipment financing from the bank nominated in the Letter of Credit for any merchandise outlined in the letter of credit. Financing costs are borne by the LC beneficiary but the nominated bank takes the risk of the LC issuing bank. These letters are commonly used by beneficiaries who act as purchasing agents for buyers in another country. It is then an additional risk for the buyer who finds himself depending on the successful implementation of the beneficiary finally placing him in the position of an unsecured creditor. Q. What is a «green clause» LC? A. The green clause LC follows exactly the same principle as the red clause one except that advance payments will be made only against presentation of documents proving the existence of goods (warehouse and freight receipts, inspection certificate). Advance payments are usually made before shipping goods that are also pledged to the issuing bank. This type of LC is also less risky to the buyer than the red clause one to the extent that the goods constitute a guarantee of repayment of advances made, in the case where the beneficiary does not present the required documents in the documentary credit. For more information and enquiries, please [email protected] Ecobank Transnational Incorporated and or its affiliates ( Ecobank ) make no representation or warranty of any kind, express, implied or statutory regarding this document or any information contained or referred to in the document. The information in this document is provided for information purposes only and while reasonable care has been taken in preparing this document, no responsibility or liability is acceptable for errors of fact or any opinion expressed therein.

8 ecobank.com