Trade Finance

A large segment of the business and entrepreneurial activity going on in India relates to trading, that is buying and selling of goods and services. Trading can take place between individuals, small firms and large corporations. Trade can be within the country and outside the country too. To help traders manage their payments and associated risks and cover daily working capital requirements, many lending institutions offer trade finance or trade loans. Let us look at what trade finance is and its features. 

Overview: Trade Finance

Trade finance or trade loan is a borrowing facility offered by various lending institutions to firms involved in trading goods and services with parties within the country or outside the country. These loans usually work as a fully revolving credit facility which bridges the monetary gap between the period it has to pay for the purchased goods and the period when it receives funds from the sale of those goods.

Types Of Trade Finance

There are different types of trade loans. Trade finance is provided at several levels since trade finance involves different types of products and services. Trade finance is available under various categories.

• Letter of credit: In this the buyer’s bank gives an undertaking to the seller that once the shipping of the items is concluded and the necessary documents are received by the buyer’s bank, then the latter will pay the seller. In this case, the financing is provided by the buyer’s bank to the seller. In other words, if you are the buyer of a product, then your bank will provide a letter of credit to the seller (from whom you are purchasing goods), that once the goods have been shipped then your bank will release the payment to the seller. Since banks are involved in the transaction, it provides comfort to the seller that the payment will be made

• Bank guarantee: Bank guarantees protect against default. This guarantee is offered by the buyer’s bank that in case the buyer defaults in making payment, the guarantor bank will have to make payment on the money due

Here again, the guarantor bank is providing the loan to the buyer, who is a client of the bank. There are different bank guarantees available such as financial guarantee, performance guarantee, tender bonds, etc. In each case, the seller gets a guarantee from the buyer’s bank that in case of default by the purchaser, the bank will make the applicable payment on the receivables. In most cases of trade transactions, sellers usually insist on a bank guarantee from the buyer before they proceed with the transaction.

• Bill discounting and collection: Bill discounting and collection services are provided by banks so that customers can get instant finance against receivables while they get money for payables

In such types of trade financing, the bank takes over the payables and the receivables of the customer providing instant finance to the latter and then later collects it from the counterparty with whom the customer is transacting. There is a certain cost associated with such services, and this is built into the amount at which the bank takes over the bills. This cost will be borne by the customer and depends to a large extent on the customer’s relationship with the bank, track record in making payments and the kind of clients that the customer has.

Trade Finance Benefits:

• Trade finance is helpful for those who undertake a lot of domestic and international transactions
• Processing of documents becomes easier when banks are involved especially in the case of international trade
• Trade finance ensures that small business owners can make upfront payments to their customers through an arrangement with their banks or other financial institutions
• Since the payments are made through banks, business owners do not have the hassle of currency conversions and they can pay in their home currencies
• The seller is assured of payments by the borrower’s bank, thus leading to harmonious relations between buyer and seller

Trade Finance Eligibility Criteria

The trade finance eligibility criteria vary from one lender to another. However, a few common criteria are:

• Individuals (Resident) and Non-Individuals (Proprietorship/ Partnership/ Private Limited Companies/ LLPs / Registered Co-operative Societies engaged in trade of any commodity/goods in physical form required by the community and trading in them is not prohibited by law or opposed in public interest
• Dealers in Silver and Gold Jewelry (except for traders dealing in bullion/ raw gold)
• The business should be functioning at least for 2 to 4 years

In certain cases, these criteria can be relaxed, provided the loan applicant has a strong credit and business profile.

Also Know: What are the eligibility criteria for Working Capital Loans?

Trade Finance Features

• The loan advanced varies from one lender to another but it can be extended up to Rs. 10 crores, depending on the nature of the business, the personal situation of the borrower, collateral provided, size of the business, etc.

• The tenure of the loan again varies from one lender to another. The tenure also depends on the loan facility you take. In case of term loans, the repayment period may stretch up to 10 years. Trade finance is usually revolving in nature, that is, it is available whenever the customer wants it and thus has a standing credit facility with the bank

• Trade loans are usually backed by some collateral or security and depending upon that the margin money could be around 40% of the security. Higher or lower margins may be applied by the lender on case to case basis

• Immovable properties such as residential property, commercial property, etc, can be pledged as collateral or security by the borrower. The lenders might also accept shares, fixed deposits, government bonds, etc. taken in the name of the borrower as security or collateral

Also Know: What is the process to get a collateral-free loan in India?

Documentation For Trade Finance

Apart from the proof of identity, proof of residence and other KYC documents, there are some specific documents to be provided for availing trade finance.

• The loan applicant has to furnish the balance sheet and profit and loss account statement of the business for the previous 2 years or more depends on the lender

• Annual sales tax returns (now GST) and income tax returns, stock statements, insurance for the premises and the stock are some of the documents that the financial institution will ask for before providing financing

The bank will also ask for the proof of an agreement between the buyer and seller to check the legitimacy of the transaction and ensure that goods are indeed being transferred from the seller to the buyer.