Many trade finance instruments have been in use for hundreds or even thousands of years. Of course, modern technologies will change this market, but the potential for financing trade operations using traditional instruments is still very great.
LILIYA FIALKO, MAXIM RIZHSKY
Thousands of years of experience
About 4 thousand years ago, the first prototypes of merchant banks of the Ancient World appeared in Assyria and Babylon. They lent grain to farmers and traders. In the Middle Ages, the Italians continued the work of merchant banks. Jewish settlers were attracted to trade and brought ancient practices from the East. Methods designed to finance long trading journeys were applied to credit for grain production and trade.
A letter of credit, or more precisely, a financial instrument similar to it, was offered by the Templars back in the 11th century. The merchant could deposit funds and receive a receipt at one of the branches of the wide “branch network” of the Templars. The receipt provided food and accommodation during the journey and allowed funds to be received in local currency at the final point of the journey. In the 17th century in France there was a similar product - a letter of credit. The merchant received a letter from his banker to the banker from the city where he was going, asking him to pay a certain amount. The merchant's bank reimbursed the amount to the paying bank in a preliminary or subsequent manner.
Among the prototypes of promissory notes are singraphs and chirographs, which originated in Ancient Greece and were borrowed from the Roman Empire. In V??? century, bill-like Feiqian securities arose in China. Among the Arab prototypes of promissory notes are hawala and suftaj debt instruments. Most likely, it was they who influenced the emergence of the first forms of the bill proper in Italy in the 10th-10th centuries.
Initially, the holder of the bill was prohibited from transferring rights to other persons. However, by the beginning of the 17th century, restrictions had become a limiting factor in trade, and they were gradually abolished. Bill rights began to be transferred by placing a special order of the bill holder - an endorsement (Italian in dosso - back, ridge, reverse side; the inscription was usually made on the reverse side of the bill).
The Russian word "bill" comes from the German Wechsel, which means "exchange", "transition". In Russia, the bill appeared at the beginning of the 18th century due to the development of international trade - at that time mainly with the German principalities.
A trillion-size market
“Global trade volume in 2013 was $18.8 trillion, and the first quarter of 2014 showed growth of about 4% year-on-year. Approximately 15-16% of this volume was settlements using documentary letters of credit and collections, so the potential of the trade finance market is enormous.” , says Tatyana Shalashnikova, head of the documentary operations and trade finance department of Raiffeisenbank.
Natalya Perkhova, head of the trade finance department of Rietumu Bank (Latvia), gives slightly different figures. According to her, in recent years the volume of trade finance in the world has been declining: in 2013 it amounted to $124.1 billion, 32% less than a year earlier. “This year has been very volatile for the markets, and, in all likelihood, at the end of it we will see a continuation of the downward trend,” she predicts.
According to Alexander Biryuchinsky, Deputy Head of the Documentary Operations and Trade Finance Department at Gazprombank, “the main factors influencing the development of the global trade finance market are the level and volume of global trade, changes in regulatory approaches (in particular, the introduction of Basel III standards), and the widespread tightening of client verification procedures , the fight against money laundering, as well as the requirement to comply with sanctions restrictions.”
The predominance of certain instruments in the trade finance market depends on the situation in the world economy in general and on international financial markets in particular. “During periods of economic upswing in conditions of excess liquidity in the markets, instruments that allow one to simultaneously attract significant amounts of financing for long periods (issue of bonds, pre-export financing, etc.) become very popular. In times of crisis, in conditions of tight liquidity and growing distrust in the In the markets, the role of development institutions, export credit agencies, and other government institutions that act as creditors or insure the risks of other creditors is increasing. Transactions with the participation of these institutions make it possible to attract long-term money on attractive terms even during periods of crisis,” explains Biryuchinsky.
"In conditions of global instability, many financial institutions are limiting or even completely curtailing the direction of trade finance. Although, on the contrary, we see certain prospects and opening niches in this direction. Over the past five years, Rietumu has been purposefully developing trade finance, which allows us to work successfully in this segment not even in the simplest periods,” says Perkhova and adds that “at present, Rietumu is practically the only bank in the Baltic region specializing in this area.”
A crisis is a crisis, but in the modern world an industry with a thousand-year history cannot stand still. Perkhova believes that “the world is striving to simplify and speed up payments in international trade,” and lists the main trends.
First of all, “in world practice there is a tendency to reduce settlements through letters of credit; transactions are carried out on a simpler, faster and more confidential basis.” “Speed is important, original documents are being replaced by electronic ones, electronic mail is being used instead of standard mail,” says Perkhova. “In this situation, banks, which are by nature conservative and burdened with many regulatory procedures, must also follow this trend and show flexibility, respond quickly and make decisions ".
In addition, "a variety of private investment funds have emerged willing to finance international trade." “It’s no secret,” explains Perkhova, “that deposit rates are very low and private investors are exploring other opportunities for placing money at a more attractive interest rate. Such funds can afford more flexible approaches (including to various risks), demanded by international trading companies, and become prominent players in the trade finance market."
Compliance has become much more important than before - compliance of the activities of trading companies, as well as the banks and financial institutions that finance them, with legislative acts and international sanctions. “Everyone has heard the very recent story of the leader in trade finance, BNP Paribas Bank, which was fined by the US government with a multibillion-dollar fine for financing trade transactions with countries under sanctions,” recalls Perkhova. “As a result, the bank that occupied a leading position , has significantly reduced its trade finance activities."
Experts agree that the role of factoring operations is growing in global trade. According to Shalashnikova, “international factoring has received a new impetus in development: in 2013, the growth in the turnover of the factoring market in the world was about 8%.”
Over the past five years, according to Shalashnikova, several new trade finance instruments have appeared on the market, “among which we can highlight BPO (bank payment obligations).” However, according to experts, there is no need to expect any drastic changes in the set of trade finance instruments yet.
According to Perkhova, new tools will be of interest primarily to small and medium-sized companies. “Large corporations, of course, have access to financial resources; the situation with the availability of financing for smaller companies is worse. Perhaps new tools should solve this very issue,” she says.
Russian question
In the post-Soviet space, despite the fact that the provision on promissory notes and bills of exchange, known in narrow circles, was approved in the USSR in the 1930s, trade finance has received active development only in the last 20 years. However, even now in Russia it is not much different from the world.
“If we talk about the features of the trade finance market in the post-Soviet space, then it should probably be noted that they primarily depend on the specifics of legislation and, accordingly, on the regulation of foreign economic activity in a particular country. But in general, I would not talk about what “those global differences,” notes Shalashnikova. “In most post-Soviet countries, almost all major trade finance instruments are implemented. However, there are restrictions on products related to the specifics of local legislation (including foreign exchange),” says Biryuchinsky. “The trade finance market in the CIS countries, due to historical reasons, is still relatively young. Domestic banks do not always use all the tools available in the arsenal of traditional trade finance banks with Western roots. Certain restrictions are imposed by the existing currency regulation and imperfection of customs procedures,” Perkhova clarifies .
According to her, “Russia now accounts for about 9% of the global trade finance market; at the end of 2013, the volume of the Russian market is estimated at $11.8 billion.” Shalashnikova notes that the Russian portfolio of trade finance transactions showed steady growth in 2013 and the first half of 2014, even despite the fact that foreign trade turnover in the Russian Federation in January-June of this year decreased by 2% (to $396 billion, exports remained at the same level, imports decreased by 5.4%). Here Perkhova is more pessimistic. “By the end of 2014, we can expect a noticeable decline in market volumes,” she says. And Biryuchinsky adds that the Russian trade finance market is significantly influenced by geopolitical factors, including sanctions imposed on a number of Russian banks, companies and certain types of products.
In general, Russia is an attractive market with growth potential, Perkhova is sure. “Classical trade finance is most often applicable when trading raw materials and commodities, which these territories are rich in. Another thing is that this potential can be realized in the presence of favorable political, economic and legislative prerequisites,” she says. Although in the short term, “the issue of maintaining the achieved level of volumes is more pressing.”
Basic concepts and tools of trade finance
Glossary
Trade finance(trade finance) is an important element of foreign trade activities and trade operations in the country. Includes a number of tools for financing and supporting purchase and sale transactions, import and export.
Trade finance instruments are divided into four areas: financing trade operations in the country, financing imports, financing exports, and conducting settlements for international transactions.
For financing trade operations in the country instruments such as forfaiting, bills of exchange, bank guarantees and letters of credit are intended.
For import financing You can use a loan guaranteed by the buyer's (importer's) bank, a loan from a foreign bank under insurance coverage from an export credit agency, a loan from a supplier (exporter) under insurance coverage from an export credit agency, a loan from a foreign bank to the buyer (importer).
For export financing you can apply forfeiting, international factoring, a loan from a bank under insurance coverage from EXIAR (Russian Agency for Insurance of Export Credits and Investments), a loan from Roseximbank (a subsidiary of VEB), pre-export financing under a supply contract.
For international payments You can use covered and uncovered bank letters of credit, collection. Here, a letter of credit is used to reduce commercial delivery risks (non-delivery of goods, non-return of payment, etc.).
Letter of Credit- an obligation of the bank, accepted at the request of the client (payer/buyer), to pay a third party (beneficiary/seller) a certain amount upon presentation of documents that meet all the requirements of the letter of credit. The tool is convenient when the parties to the transaction are not ready to work on prepayment or pre-delivery. The buyer can be sure that the bank will transfer funds in favor of the seller of the goods only upon receipt of documents indicating that the seller has fulfilled contractual obligations. The seller receives a guarantee that the bank will make payment for the goods delivered.
Bill of exchange- a written obligation of a strictly established form, giving one person (the holder of the bill) the right to receive from the debtor on the bill the amount specified in the document within the specified time frame. With a promissory note, the debtor is the drawer; with a bill of exchange (draft), another person specified in the bill (drawee), who is a debtor in relation to the drawer.
Bank guarantee— a guarantee for the client’s fulfillment of monetary or other obligations, issued by a guarantor bank. In case of failure to fulfill these obligations, the bank that issued the guarantee is liable for the debts of the borrower to the extent specified in the guarantee.
Forfaiting— purchase by a bank or a specialized non-banking forfeit company of rights of claim to the client’s receivables (debts of enterprises to the client, expressed in negotiable securities). The bank/company undertakes to not demand anything from the client in the future if it is impossible to receive payment from his debtor and thereby assumes the risk of the latter’s insolvency.
Factoring- a set of financial services that a bank or factoring company provides to manufacturers and suppliers in exchange for the assignment of rights to the client’s receivables. Allows companies operating on deferred payment terms to receive funds under already concluded contracts before the buyer pays for goods and services. Three parties are usually involved in a factoring operation: the factor (factoring company or bank) - the buyer of the claim, the supplier of the goods (creditor) and the buyer of the goods (debtor).
Pre-export financing— provision of funds by a credit institution to the exporting seller secured in the form of confirmed orders from foreign buyers. Typically, the exporter enters into an agreement with the buyer for the latter to make payments directly to the credit institution.
Collection- a method of settlement between two parties in which the exporter instructs his bank to obtain payment or acceptance (confirmation that the amount will be paid) directly from the buyer (importer) or through another bank.
In modern economic literature there is no unified approach to defining the term “trade finance” (Trade Finance). In international and Russian banking practice, there has been an idea of trade finance as the financing of export-import operations of clients using various instruments and, as a rule, attracting credit resources on international capital markets. The main providers of trade finance are commercial banks, but export credit agencies (ECAs), export-import banks (exim banks), international financial organizations and development banks, such as the International Finance Corporation, also take an active part in organizing international trade finance. Financial Corporation - IFC) and the European Bank for Reconstruction and Development (EBRD).
Until the end of 2008, when Russia fully felt the impact of the global financial crisis, the volume of the country's foreign trade operations grew steadily for ten years (Fig. 1). The growth of the national economy also influenced the improvement of the country risk category for Russia, assigned by the Organization for Economic Co-operation and Development (OECD) 2 . If in 1999 the country risk of Russia was assessed at a level corresponding to the 7th category, then in 2008 Russia already belonged to the group of countries with the 3rd risk category. On the one hand, this was evidence of the increased ability of our country and its residents to timely and fully fulfill their debt obligations to counterparties from other countries. On the other hand, this allowed Russian banks to attract foreign capital on more favorable terms.
Figure 1. Dynamics of foreign trade and country risk category of Russia (according to OECD data)
The positive dynamics of foreign trade turnover stimulated the Russian banking sector to expand its participation in this fast-growing market segment. The number and volume of trade finance transactions grew, the range of banking products for clients participating in foreign economic activity gradually expanded, and an increasing number of banks offered trade finance services.
Trade finance today uses a fairly wide range of instruments (Table 1). Some of these instruments are in demand not only in foreign trade transactions, since they are also of interest to participants in domestic trade. Often, bank divisions responsible for trade finance organize financing of transactions in which the international element is either completely absent or is contained in an implicit form. In particular, such situations quite often arise in the case of trade relations between two residents of the Russian economy, at least one of which is a company with foreign capital. However, trade finance is initially positioned as a banking product aimed at participants in foreign trade activities, so the prospects for the development of trade finance will primarily depend on the situation on international markets.
Table 1. Main trade finance instruments
Restorative growth of international trade after the crisis
International trade is the main form of international economic relations. According to some estimates, its share accounts for up to 80% of the total volume of foreign economic activity of the countries of the world. The latest global crisis has led to a noticeable decline in global economic activity. However, if the fall in the production of goods and services in the world in 2009 amounted to 0.6–1.0%, the reduction in international trade turnover was unprecedented since the Second World War, reaching a record 10.7% (Fig. 2). It is also noteworthy that the negative growth rate of international trade recorded last year was noted for the first time in the last 28 years. The reduction in international trade volumes was the result of a number of factors: a fall in demand and prices for basic commodities on world markets, a crisis of confidence between various economic entities, tightening requirements for counterparties, rising interest rates and, as a result, a shortage of financing for international trade. Thus, statistical data allow us to conclude that the global economic crisis, which initially manifested itself as a financial crisis, was also, to a large extent, a trade crisis.
Figure 2. Dynamics of growth rates of international trade in goods and services, in% compared to the previous year
A recent study (Freund, 2009) 3 showed that the elasticity of international trade to global GDP has increased markedly over the past half century, from 2% in the early 1960s. to levels above 3% currently. This means that a 1% change in global GDP results in a 3% or more change in international trade. At the same time, the elasticity indicator tends to increase during periods of instability and crisis in world markets, which was clearly observed in 2009. In this regard, the decision of the G20 club leaders to allocate $250 billion taken in April 2009 at the London summit seems quite justified over a two-year period to support and finance international trade.
Currently, there are different forecasts regarding the pace of recovery in international trade. Thus, the IMF predicts the growth of international trade in 2010 at 7%. The World Trade Organization (WTO) is much more optimistic in its assessments. In September of this year, WTO experts raised their forecast for world trade growth in 2010 from 10.0 to 13.5% 4 . The improvement in the forecast is due to a faster-than-expected pace of recovery in international trade from the effects of the global crisis. According to WTO estimates, developing countries and CIS countries will demonstrate export growth at the end of 2010 at 16.5% against a reduction of 7.8% a year earlier, developed countries - by 11.5% (-15.3% in 2009 .). At the same time, it is expected that in the second half of 2010, world trade will grow at a more modest pace compared to the first half of 2010. Experts attribute the slowdown in growth rates to the gradual refusal of the authorities to stimulate the economy. Despite such optimistic forecasts, it must be remembered that the basis for determining growth rates is the “disastrous” year of 2009, so the process of restoring international trade turnover to the historical maximum of April 2008 will most likely take several years.
Promotion of international trade
Promotion of international trade at the level of countries and regions, as well as, if possible, the abandonment of protectionist measures contributes to the gradual restoration of the volume of international trade turnover and the emergence of the world economy from recession. A comparative assessment of the effectiveness of individual countries' policies in the field of international trade and economic cooperation is given in the World Economic Forum (WEF) report on promoting international trade (The Global Enabling Trade Report 2010 5). The 2010 WEF report presents a ranking of 125 countries around the world according to a comprehensive index of the openness of national economies to international trade, The Enabling Trade Index, which takes into account four blocks of indicators:
1) access to the domestic market;
2) administrative management at the borders;
3) business climate;
4) transport and communication infrastructure.
The top five most open countries in the world in terms of international trade this year included Singapore, Hong Kong Special Administrative Region of China, Denmark, Sweden and Switzerland (Table 2). These same countries topped the WEF ranking last year. Russia occupies an extremely low position in this ranking both in terms of a comprehensive indicator (114th place) and in its individual components: access to the domestic market - 125th place (last place in the ranking), border administration - 109th place, business climate - 92nd place. In terms of the level of development of transport and communication infrastructure, Russia occupies a higher position relative to other indicators - 48th place.
Table 2. Rating of countries according to the index of openness of national economies to international trade The Enabling Trade Index
| A country | Place in the ranking | |
|---|---|---|
| 2010 | 2009 | |
| Singapore | 1 | 1 |
| Hong Kong | 2 | 2 |
| Denmark | 3 | 4 |
| Sweden | 4 | 5 |
| Switzerland | 5 | 3 |
| Germany | 13 | 12 |
| Great Britain | 17 | 20 |
| USA | 19 | 16 |
| Estonia | 23 | 22 |
| Lithuania | 41 | 40 |
| Latvia | 46 | 44 |
| China | 48 | 49 |
| Azerbaijan | 77 | 70 |
| Ukraine | 81 | 71 |
| Kazakhstan | 88 | 93 |
| Kyrgyzstan | 100 | 101 |
| Tajikistan | 108 | 114 |
| Pakistan | 112 | 100 |
| Bangladesh | 113 | 111 |
| Russia | 114 | 109 |
| Burundi | 125 | 116 |
Noteworthy is the fact that Russia’s position in the overall ranking is significantly worse than that of many former Soviet republics. WEF experts note the extremely limited access of foreign companies to the Russian domestic market and the low efficiency of administrative management at the borders. The domestic economy remains poorly open and difficult for imports and exports, which creates objective limitations for the qualitative growth of the country’s foreign trade.
Risk management in international trade
In addition to the difficulties mentioned above, Russian exporters and importers face risks that are quite traditional for international trade. The classification of the main risks in international trade in accordance with the approach adopted in risk management and documents of the Basel Committee on Banking Supervision is given in Table. 3.
Table 3. Risks in international trade
| Risk groups | Types of risks | Characteristic |
|---|---|---|
| Operational risks | Legal risks |
Risks of losses associated with the fact that legislation was either not taken into account or changed during the transaction; Risk of inconsistency of laws (legal systems) of different countries; The risk of incorrectly drawn up documentation, as a result of which the counterparty may not fulfill the terms of the contract |
| Transport risks |
Risks associated with possible loss or damage to goods during transportation |
|
| Market risks | Exchange and currency risk |
The risk associated with the likelihood of losses due to changes in the exchange rate of the payment currency different from the currency of the country of the exporter and importer |
| Liquidity risk |
Funding liquidity risk associated with a decrease in the ability to finance assumed obligations and meet the monetary requirements of counterparties due to the increase in the duration of the working capital cycle when participating in international trade |
|
| Credit risks | Counterparty risk |
Risk of loss due to failure to fulfill obligations to pay for goods by the importer or refusal of the exporter to return the advance payment |
| Political (political/sovereign risks) |
Risks of losses as a result of events that may prevent the importer from transferring funds or the exporter from sending goods: strikes, uprisings, wars, embargoes; Risks associated with the economic policies of countries: risk of inconvertibility, risk of transfer, risk of a moratorium on payments abroad |
Participation in international trade is a riskier activity compared to domestic trade. Therefore, an effective international trade finance infrastructure must not only provide capital to exporters and importers, it must offer effective risk management mechanisms, for which demand from international trade participants is always present and must be satisfied. The methods, schemes and tools used today in trade finance make it possible to successfully cope with risks such as funding liquidity risk, counterparty credit risk, and political risks (Fig. 3).
Figure 3. Risks in international trade, methods and tools for reducing them
It should be noted that during the acute phase of the global economic crisis, due to a sharp reduction in risk appetite, the need of various economic entities for additional guarantees has noticeably increased. Many foreign banks took a wait-and-see attitude regarding the provision of credit resources to Russian banks (especially medium-sized and small ones) and were ready to finance foreign trade transactions only if there was additional coverage of credit risks. In other words, the general trend of “flight to quality” observed in the world at that time did not bypass such a market segment as trade finance, and was expressed in a noticeable increase in demand from the private sector for the services of export credit agencies, international financial organizations and development banks. If previously, transactions for long-term financing of equipment imports were mainly organized under ECA insurance or guarantees, then during the crisis many participants in international trade were faced with the impossibility of attracting even short-term financing without insurance or guarantee coverage from national export credit agencies. Most export credit agencies have taken anti-crisis measures aimed at liberalizing the conditions for providing coverage. Thus, the traditional role of ECAs as government instruments for supporting national exports has become again in demand.
Trade Finance: Short-Term Perspectives
The trade finance market is recovering, foreign banks are opening (although often not in the same pre-crisis volumes) previously closed credit limits for Russian banks, financing terms are increasing, and there is a gradual decline in interest rates.
In the short term, an increase in demand for trade finance services will occur as the country's foreign trade turnover grows, and data on Russia's export and import indicators for the first half of 2010 inspires some optimism (Fig. 4). Trade finance will remain relatively attractive in terms of the cost of credit resources. Price competitive advantages will be on the side of large Russian banks (primarily banks with state participation) and subsidiaries of credit institutions of large foreign banks. It can also be assumed that the most popular trade finance instruments will be documentary letters of credit and bank guarantees - traditional, time-tested instruments that are understandable to market participants and regulated by international unified rules. At the same time, one should not expect a sharp increase in the risk appetite of both Russian and foreign banks in the short term. Consequently, banks will continue to involve export credit agencies and international financial institutions in transactions whenever possible.
Figure 4. Russia's foreign trade in the first half of 2009 and the first half of 2010
1 - The article expresses solely the opinion of the author and does not represent the position of JSC CB Svenska Handelsbanken.
2 - OECD country risk categories are presented in the Arrangement on Officially Supported Export Credits, which classifies countries into eight country risk categories (0–7) depending on the level of credit risk countries. Countries in category 0 are countries with low country credit risk, countries in category 7 are with high risk. Country risk is determined according to the internal methodology of the OECD and is based on a study of such indicators as the presence in the country of a moratorium on the repayment of external loans and credits, currency restrictions, political events and economic difficulties that prevent the timely repayment of external debt, etc.
3 - Freund C. 2009. The Trade Response to Global Downturns: Historical Evidence // Policy Research Working Paper 5015, World Bank, Washington, DC.
4 - Trade Growth Forecast Revised Upwards for 2010. September 20, 2010. Press/616 (http://www.wto.org/english/news_e/pres10_e/pr616_e.htm).
5 - The Global Enabling Trade Report 2010. World Economic Forum, 2010 (http://www.weforum.org).
6 - Flight to quality is a term used in investment analysis to describe the tendency of investors to move capital into the safest possible investments in order to protect themselves from losses during periods of high economic instability and market volatility.
E.R. Shakirova, JSC CB "Svenska Handelsbanken"
In order to avoid the emergence of internal and external risks associated with foreign economic activity, modern requirements for the organization of this activity of enterprises provide for the mandatory construction of schemes in international payments that would be effective. Among such risks, the main one is the loss of own funds. Therefore, in recent years, in practice, more and more attention has been paid to the following forms of ensuring obligations undertaken in the field of foreign trade transactions:
- international bank guarantee.
International bank guarantee
These financial instruments are becoming increasingly relevant among both suppliers and buyers. This is because both tools are easy to use. In addition, all risks associated with them are borne by the banking institution.
First of all, when starting to consider the roles in international payments that an international bank guarantee and a standby letter of credit perform, it is worth clarifying that there is a significant difference between these documents. In principle, both of these banking instruments are the same. And the goal of each is to ensure that the obligations assumed by one party to the other are in accordance with the terms of the contract. But standby letters of credit originated in the United States, where they became popular for use, although the issuance of bank guarantees in the United States is not a type of banking activity, as established by legal provisions. Following modern trends in the development of banking activities, products of these activities, as well as increasing customer requirements, US banks began developing a new product. Thus, an exceptionally new banking product called the standby letter of credit was created. Its use in international trade contributed to the provision of additional security to bank clients in terms of fulfillment of contractual obligations in relation to counterparties. In addition, banks also took advantage of this product. Since there are no restrictions on transactions using documentary letters of credit in the United States of America, a new source of income has opened up for US banks.
Unlike a letter of credit, bank guarantees are a classic product of banking. Services for issuing guarantees are offered not only by banks in the Russian Federation and Europe, but also by banking institutions in other countries. Thanks to many years of experience in the application of bank guarantees, these banks can establish good relationships with clients, providing advice on the preparation and issuance of bank guarantees, as well as providing assistance in selecting the optimal guarantee option, taking into account the nature of the obligations that the guarantee provides.
Thus, both bank guarantees and standby letters of credit are financial instruments, the use of which can achieve the same goals. Regarding the features that each of them have, they will be discussed below.
Standby letter of credit
This type of banking product is a type of documentary letter of credit and represents obligations assumed by the issuing bank in relation to the beneficiary. These obligations may relate to claims for the need to reimburse the amount of money received by the orderer. Or regarding the return of a pre-paid payment (advance payment) issued to the applicant. In other situations, they may include requirements for payment by the applicant of the obligation in the event of failure to fulfill its terms for any reason. Examples of situations in which a standby letter of credit is used:
- If the seller and the buyer have concluded a contract, according to the terms of which the seller must supply goods/provide services to the buyer, then the seller has the right to demand that the buyer provide additional guarantees regarding the fulfillment of obligations to pay for these goods or services. In such situations, a standby letter of credit provides confidence to the seller that if the buyer does not pay the amount of money, the party who is the guarantor will pay it. In turn, the role of guarantor is performed by the bank that issued this standby letter of credit (issued a bank guarantee).
- If, when the seller sells goods to the buyer, the terms of the contract provide for an advance payment in favor of the seller, then the buyer has the right to demand an additional guarantee that the goods will be delivered (services provided) within the period specified in the contract and in full. Otherwise, the down payment must be returned to the buyer. In this case, the standby letter of credit also acts as additional security for the seller’s obligation.
In both the first and second cases, the beneficiary transfers possible risks of non-payment of the amount or non-compliance with the terms of the main contract to a third party, which acts as a financial intermediary in settlements between the beneficiary and the principal. The third party issues this standby letter of credit, which will subsequently protect the beneficiary from possible risks.
When working in the banking market, it is important to understand the difference between regular documentary letters of credit and standby letters of credit. Their main difference is what is the nature of the obligations that are guaranteed to the beneficiary. In cases of using a regular documentary letter of credit, the beneficiary must present a package of documents that comply with the terms of the letter of credit. They will act as evidence of proper fulfillment of the terms of the contract (shipment was carried out within the period specified in the contract). Under a standby letter of credit, the beneficiary will need to provide documents demonstrating the non-fulfillment of the terms of the contract by the applicant to the beneficiary.
A standby letter of credit also has a number of features that distinguish it from a regular letter of credit:
Payment under a standby letter of credit is subject to the presentation of a specific document, which is a demand for payment due to the fact that the principal has not fulfilled his obligations to the beneficiary according to the terms of the contract. And payment under a regular documentary letter of credit can occur upon presentation of the original documents on shipment and others to the bank.
- Under a standby letter of credit, payments are not made as frequently as compared to a documentary one. This is because the probability of providing shipping documents is much higher than the probability of presenting a demand for payment.
- A standby letter of credit is used for settlements of financial/commodity transactions, while a regular documentary letter of credit is used only for settlements of transactions of a commodity nature.
Over the years of banking practice, situations have arisen when standby letters of credit were issued in favor of other banking institutions. This occurs in cases where it is impossible to use a direct letter of credit. Or when a loan relationship arises between banks.
A standby letter of credit is a fairly flexible banking document. In most cases, it is used in settlements of trade transactions provided that the account is open. In this situation, the seller agrees to open a standby letter of credit in his favor. Subsequently, payment under this letter of credit can be made in the event of failure by the buyer to pay for the goods delivered to him according to the terms of the contract.
In most cases, standby letters of credit are executed upon the first written request from the beneficiary. In order to make a claim for payment, the beneficiary must provide the bank with evidence in writing of the failure to fulfill the obligations undertaken by the applicant to the beneficiary.
Often, a condition is included in the standby letter of credit to ensure that payment is released to the beneficiary immediately. According to it, the bank must make a payment without requiring evidence of the validity of this requirement, as well as its correctness. First, the bank is obliged to make a payment to the beneficiary.
Therefore, the first risk that the bank faces is that there is a high probability of bad faith behavior on the part of the beneficiary in terms of making an unproven claim to receive payment under the letter of credit. Accordingly, when working with these banking instruments, such as a standby letter of credit, special attention should be paid to the possible increase in the amount of the letter of credit itself, as well as the special terminology used in the field of application of letters of credit, in order to prevent various types of misunderstandings.
Bank guarantee
Bank guarantee
Bank guarantees are a financial instrument that is an irrevocable obligation of the bank that issued the guarantee to make a payment in favor of the beneficiary if a situation arises related to the failure of the principal to fulfill any obligations to the beneficiary in accordance with the conditions specified in the main agreement. The application of guarantees is governed by the current domestic legislation of the country in which the guarantor bank is located. Also, relations on the use of bank guarantees are regulated by the provisions of the International Chamber of Commerce, which include regulations:
No. 458 "Uniform Rules for Payment Guarantees"
No. 325 "Uniform Rules for Contract Warranties"
These publications control the manner in which bank guarantees can be used. These acts essentially perform the same role as Regulation No. 500 “Uniform Customs and Practice for Documentary Letters of Credit.” Each bank has its own standard form of bank guarantee with special text. At the same time, it should be noted that Act No. 325 has not received universal recognition and therefore is practically not used in modern banking.
Uniform Rules No. 458 for Payment Guarantees defines that a guarantee may be applied as any guarantee, promissory note, or any other payment obligation that has been issued in writing by a banking institution, insurance organization, or other person that guarantees the payment of a specified amount of money under presentation of documents that comply with the terms of this written obligation. This guarantee may be issued:
- in response to a request from the principal or in accordance with the provisions and at the expense of the principal;
- in response to a request from a bank (insurance organization, other party), acting on behalf of the applicant and in accordance with the instructions of this bank.
Classification of bank guarantees
- A bank payment guarantee can be used in situations where the buyer makes a demand to pay for goods subject to an open account. At the same time, the seller gives consent in response to this requirement, but, in turn, requires the issuance of a guarantee in his favor regarding the payment. In accordance with it, the bank undertakes to make a payment to the seller if the buyer does not make payment upon receipt of a document from the seller confirming this.
- Loan repayment guarantee, which can be used as security for a corporate type loan. For example, subsidiaries located abroad need a loan. The latter can be provided to companies if they issue guarantees to the parent company. In the event of a warranty situation, it will ensure the return of the issued amounts.
- Tender bank guarantee, the issuance of which the buyer may require to ensure the requirements for concluding a contract previously agreed upon by the parties. Typically, a tender guarantee (offer guarantee) covers amounts ranging from 1-5% of the total contract value.
- Guarantee of fulfillment of obligations according to the terms of the contract. Sometimes situations arise when the buyer makes a demand to the supplier's bank to issue him a bank guarantee so that it guarantees that the seller will ship goods in full and within the specified period, according to the terms of the contract. If the terms of the contract are violated by the supplier, the bank will be forced to make a payment to the buyer in the amount of about 10-50% of the total contract value.
- Advance repayment guarantee. Sometimes the buyer may make an advance down payment to the seller. Consequently, he has the right to demand a counter guarantee for the return of the advance amount from the supplier’s bank, so that in the event of failure to fulfill the terms of the contract (non-delivery of goods), the supplier’s bank will ensure the return of the advance amount made in advance.
Bank guarantees and standby letters of credit serve the same purposes. They are used as security for the fulfillment of one of the parties' obligations to the other. Also, bank guarantees can be used in other circumstances, if there is no simple transaction for the supply of goods. Therefore, there is often a need to issue a guarantee when conducting real estate transactions. Such projects in most cases involve the use of tender guarantees (offer guarantees). They are used by contractors starting a new project. This guarantee is used to demonstrate its financial capabilities in relation to the fulfillment of the conditions specified in the contract. This banking document can also be used when organizing project financing. Contractors involved in project financing also resort to bank guarantees. A specific area of use of a bank guarantee includes the implementation of projects in the field of heavy industry. In such projects, suppliers are faced with the requirement to provide a guarantee to ensure the fulfillment of their obligations. In particular, this concerns the fact that the goods supplied according to the terms of the contract will fully comply with them.
Bank guarantees can be:
- Direct, which are issued directly in the name of the party who is the beneficiary and can be advised through his bank (no obligation is required by this bank). If situations arise that for some reason the potential guarantor bank does not meet the requirements of the beneficiary, then in international calculations a scheme using a confirmed international bank guarantee may be relevant.
- Indirect (confirmed), during the implementation of schemes in which the issuing bank asks another bank to issue a guarantee in favor of the beneficiary. As security for its obligations, the issuing bank issues a counter document (counter-guarantee) in favor of this local banking institution. This type of bank guarantee is used in cases where for some reason the issuance of direct guarantees is prohibited. Or in situations where the beneficiary makes a request to issue a guarantee to a specific local bank.
Transcript
1 TRADE FINANCE INSTRUMENTS
2 Towards clients Joint Stock Bank “Pivdenny” is a leader among banks in the South of Ukraine in servicing documentary transactions of guarantees and letters of credit. The bank provides its clients with a full range of services in the field of documentary operations. The Bank's policy is to provide advice to clients when conducting settlements and transactions using documentary transactions. Bank employees will help you prepare and carry out such operations, starting with the development of draft agreements and documentary obligations (letters of credit, guarantees), and ending with the preparation of documents for receiving payment. You can obtain from the Bank comprehensive information about the types of documentary obligations and their applicability in various situations and in connection with various types of transactions. We will tell you about the disadvantages and advantages of each type of documentary obligations in order to help you choose the most convenient settlement scheme with your partners. The Bank has the ability to ensure confirmation of its obligations by first-class European banks, which allows it to issue documentary obligations in a form acceptable to you and your counterparties. Our goal is to protect your interests.
3 We bring to your attention this presentation to demonstrate how the use of guarantees, letters of credit and export insurance will help to conclude profitable transactions with moderate risk for the parties without high costs.
4 International payments Prepayment Payment upon delivery Deferred payment
5 Why are documentary obligations needed? When making payments by bank transfer, depending on the terms of payment under the contract (advance payment, payment upon delivery, receipt or provision of deferred payment), risks arise associated with: Failure to comply with the terms of the contract by the seller. Failure to comply with the terms of the contract by the buyer. Risks associated with force majeure. These risks can be divided into the following categories:
6 Risks associated with a party to the contract Types of risk Risk of non-payment Risk of non-fulfillment of the contract For the seller Insolvency or unwillingness of the debtor to pay. Example: the buyer's unstable financial condition. Cancellation or change of order by the buyer. Example: goods are purchased for further sale, the conditions of which have changed. Causes of damage For the buyer Inability or unwillingness of the seller to return the advance payment. Example: the seller’s unstable financial condition. The inability or unwillingness of the exporter to fulfill the terms of the contract for technical or financial reasons. Example: the seller is not the manufacturer of the product, and he cannot purchase it under pre-existing conditions.
7 Political risks Types of risk Risk of non-payment Risk of non-fulfillment of the contract For the seller Political events (war, revolution, moratorium) prevent the buyer from making payment. Example: funds frozen in the accounts of Vnesheconombank of the USSR. Political events or measures (war, revolution, confiscation of imports, embargo) prevent the buyer from fulfilling the contract. Example: US embargo on supplies from Iran. Causes of damage For the buyer Political events (war, revolution, moratorium) prevent the seller from returning the advance. Example: Political events in Ukraine in 2004 led to an increase in the US dollar and problems with payments. Political events or measures (war, revolution, confiscation of imports, embargo) prevent the seller from fulfilling the contract. Example: UN embargo on supplies from Iraq.
8 Economic risks Types of risk For the seller Causes of damage For the buyer Risk of delay in the transfer of amounts due Risk of non-fulfillment of the contract Currency risk Refusal or inability of states or organizations to make payments in the agreed currency (moratorium). Example: 1998 economic and financial crisis. The introduction of import quotas or taxes (fees) makes it impossible or unprofitable for the buyer to fulfill the contract. Example: the introduction of an excise tax on goods that were not previously subject to it. Revaluation of the contract currency in relation to the buyer’s currency makes the execution of the contract unprofitable for the buyer. Example: an increase in the exchange rate of the Euro against the US dollar reduces the volume of American imports from Europe. Inability to receive payment under guarantees or return of advance payment. Example: defaults of Russian banks and companies in 1998. The introduction of export quotas or taxes (fees) makes it impossible or unprofitable for the seller to fulfill the contract. Example: the introduction of export quotas for grain in Ukraine. Devaluation of the contract currency in relation to the seller’s currency makes the execution of the contract unprofitable for the seller. Example: European companies are renegotiating long-term contracts for which the payment currency is the US dollar.
9 In order to optimize risks, payment is accompanied by financial instruments. In order to reduce risks, payment is accompanied by financial instruments, letters of credit and guarantees. How can you reduce risks? If you make an advance payment (prepayment), you have the risk of non-fulfillment of the contract by the seller and the risk of non-return of the advance payment. Advance payment guarantees and contract performance guarantees, which are issued by a reliable bank in your favor, will reduce your risks, since the obligation to pay in this case lies with the bank, and not with the seller. You can also avoid the risk associated with upfront payments by choosing documentary letters of credit as your payment instrument, which are accepted by the vast majority of sellers and manufacturers. If you are shipping goods and receiving advance payment from the Patel buyer is not possible, ask the buyer to open a letter of credit or payment guarantee in your favor, which will reduce the risk of non-payment. Pivdenny Joint Stock Bank will help you agree on the terms of such instruments.
10 You can persuade the buyer to make an advance payment in your favor against an advance payment guarantee, which can be issued either by our bank or by one of our European partner banks. If you want to make payment after receiving the goods or even get a deferred payment from the seller, but the seller is not ready to take on the risk of non-payment on your part, invite your partner to open a guarantee in his favor to secure your payments. You can also offer him a letter of credit with deferred payment. If your partner wants to receive payment immediately after shipment, it is still possible to defer payment on your part for up to 1 year from the date of opening the letter of credit through financing from foreign banks. If you are importing machinery or equipment, and the seller (manufacturer) is not ready to provide you with a deferment due to the risk of non-payment or for financial reasons, it is possible to finance such exports by foreign banks under the insurance of a national export insurance agency. In this case, you can receive installment payments for up to 5 years.
11 Thus, the use of bank obligations, guarantees and letters of credit will help not only to reduce the risks of the parties during settlements, but also to carry out settlements on terms more favorable than the use of own or credit funds. When financing using documentary obligations, bank commissions are ALWAYS lower than the interest on the loan for the corresponding period.
12 Bank guarantees A bank guarantee is a monetary obligation of the guarantor bank to the Applicant’s creditor for the fulfillment of his obligation in full or in part. A bank guarantee, unlike a letter of credit, usually does not require the provision of documents to the bank to confirm the validity of payment under the guarantee. The guarantee is usually paid against the creditor's presentation of only a demand for payment. A bank guarantee is an instrument to ensure the fulfillment of obligations, while a letter of credit is an instrument of payment. A bank guarantee is intended, first of all, to protect the interests of the creditor.
13 Types of bank guarantees: Payment guarantee is the most common type of bank guarantee used to secure obligations to pay for goods and services. Typically, payment guarantees are used to obtain a commercial loan. The seller (beneficiary) agrees to defer payment if receipt of such payment is ensured by a bank guarantee. If the buyer (applicant) does not pay on time, the seller sends his payment request to the bank and receives the required amount within the guarantee amount. Performance guarantee is a type of bank guarantee used to ensure the fulfillment of contractual obligations for the supply of goods, works, and services. Tender guarantee is a type of bank guarantee opened in favor of the tender organizer (beneficiary) to ensure the obligations of the tender participant (applicant) to sign an agreement for the supply of goods, performance of work, provision of services on the terms specified in the tender proposal of the participant, in the event of such participant’s victory in tender. Advance payment guarantee is a type of bank guarantee, according to which the bank undertakes to pay the buyer (beneficiary) the amount of the advance payment in favor of the seller (or part thereof) in the event of non-fulfillment or partial non-fulfillment by the seller (applicant) of its contractual obligations for the supply of goods, performance of work, provision of services.
14 Bank guarantees give you the following advantages in your business: deferred payment for the supply of goods from domestic and foreign manufacturers; the opportunity to participate in tender procedures and enter into contracts with government organizations; receiving an advance payment (prepayment) from counterparties
15 Scheme of settlements using a payment guarantee 1. Agreement Joint Stock Bank "Pivdenny" 3. Product 2. Bank guarantee 4. Deferred payment Seller Buyer
16 Documentary letters of credit A documentary letter of credit is a monetary obligation of a bank issued on the basis of an order from its client-buyer in favor of the seller. The issuing bank must make the payment to the seller or ensure that another bank makes the payment. This obligation is conditional, since its implementation is associated with the seller’s fulfillment of certain requirements (primarily with the submission to the bank of documents provided for in the letter of credit confirming the fulfillment of all its conditions). It is the conditionality of this obligation that makes the letter of credit a settlement instrument that simultaneously protects the interests of the buyer and seller. The seller is confident of receiving payment after delivery of the goods, since the bank will pay him the amount due against the shipping documents. The buyer knows that the bank will pay for the documents only if they comply with the terms of the letter of credit, that is, after the seller fulfills his delivery obligations.
17 Documentary letters of credit will allow you to: Make payment for the goods only when the shipment of the goods is confirmed by the relevant documents. Ship goods to counterparties when payments on their part are guaranteed by banks. Finance the production and supply of imported goods without making an advance payment. Receive a deferred payment for up to 1 year through post-financing under letters of credit from partner banks of Pivdenny Joint Stock Bank at a rate BELOW THE CORRESPONDING LOAN RATE.
18 Scheme of settlements using letters of credit 1. Agreement Joint Stock Bank "Pivdenny" 2. Letter of credit 3. Goods + documents to the bank 4. Bank payment under the letter of credit within the agreed period Seller Buyer
19 Export insurance using documentary letters of credit Export insurance is a unique tool for Ukrainian importers of machinery and equipment, which has the following advantages: Obtaining installment payments for the import of equipment for a period of up to 5 years from the date of delivery. Interest rates are BELOW RELEVANT CREDIT RATES, which is of particular importance given the duration of the financing. nia. Foreign manufacturers, banks and national export insurance agencies are interested in working under such conditions. Restrictions: It is not possible to finance the supply of consumer goods under the specified conditions. The approval procedure with a foreign bank and export insurance agency may take considerable time. The contract amount must be at least 500 thousand euros.
20 Interaction scheme 1. Importer’s application for the provision of services by Pivdenny Joint Stock Bank 2. Contract between the exporter and importer 3. Ukrainian importer’s request to open a letter of credit with Pivdenny Joint Stock Bank 4. Pivdenny Joint Stock Bank issues a letter of credit and sends it to the executing bank 5. Insurance policy of the export insurance agency in favor of the executing bank 6. Advising the letter of credit to the exporter by the executing bank (with or without confirmation from the executing bank) 7. The exporter makes the shipment and submits documents to the executing bank 8. The executing bank pays proceeds under the letter of credit to the exporter 9 Reimbursement to the executing bank with payment in installments for a period of up to five years and corresponding payments by the importer in favor of the Joint Stock Bank "Pivdenny"
21 Insurance of the executing bank National Export Insurance Agency letter of credit Importer 5 Pivdenny Joint Stock Bank Executing Bank Exporter
22 Contacts Likhota Dmitry Sergeevich, head of the department of correspondent relations and documentary operations. tel Vityuk Vladimir Aleksandrovich, head of the documentary operations department. tel Dobriy Andrey Anatolyevich, head of the international business department. tel
23 Note: Letters of credit and guarantees described in this presentation are credit transactions, the implementation of which is accompanied by appropriate credit procedures.
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