Foreign Trade

International Trade Finance And Its Importance

Blog Post

As of FY 2022, the international trade finance market was valued at $42.2 billion. This growth can be attributed to a multitude of reasons, including rapid urbanization around the world and a continuously growing global trade market. Additionally, technological integrations like Artificial Intelligence (AI), machine learning (ML) and the Internet of Things (IoT) with trade finance are making predictive analysis of market patterns, resolution of concern, and demand anticipation much easier.

The industry is predicted to grow further with a CAGR of 6.2% in the next five years to a valuation of $70 billion by 2028.

What is International Trade Finance?

International Trade Finance is a term used to describe financial instruments and products used by export businesses to enable international trade transactions. With International Trade Financing, exporters can generate working capital and mitigate risks associated with the industry, such as buyer defaults, delayed payments, etc. There are various instruments and products that an exporter can leverage to finance their cross-border transactions. The main objective of International Trade finance is to facilitate smoother cash flow cycles for exporters and protect against risks of cross-border trade.

Traditional Financing Vs International Trade Financing

Even today, nearly 80% of exporters in India use Traditional Financing options such as working capital loans to manage their cash flow cycle. However, Traditional Financing come with a number of disadvantages which can be avoided with International Trade Financing:

  • Strict Eligibility Criteria: Availing traditional financing for an export business can be stressful especially if the export business doesn’t have an established or healthy credit history. Financial institutions will see the business as a high risk credit and may set demanding terms or rates on the financing. International Trade Financing is not dependent on such factors. 
  • High Interest Rates: Most traditional financing options come with very demanding interest rates. This means that even though the immediate capital requirement is met, in the long run just the interest rates could become unmanageable. Whereas, in International Trade Financing options like export factoring on KredX GTX, brings together multiple financing offers with a transparent bidding system. So exporters can choose the lowest rates. 
  • Collateral Requirement: Depending on the export business’s credit score traditional financing options may demand exorbitant collaterals. And any non-payment due to extraneous circumstances can see the business lose valuable assets as part of the credit recovery process. On the other hand, most International Trade Financing options don’t require any collateral to be pledged to get funds.
  • Time Intensive Process: Availing traditional financing can be a very time consuming process where the exporter will have to physically visit financial institutions one after the other. Moreover, the documentation and paperwork required can also be a hassle. However, there have been significant technological advancements in the case of International Financing. For example, the exporter can get access to multiple financiers from across the globe on one single platform for their post-shipment financing. 

Types of International Trade Finance

As we mentioned earlier, there are many international trade finance instruments available to exporters in the market today. This allows exporters to choose the financing option that fits their business needs. Some of the most common types of trade finance include:

  • Letters of Credit (LCs)

Letters of Credit are one of the most commonly used financial instruments in international trade transactions. LCs are issued by banking institutions as a guarantee of payment for the exporter assuring that they will get their receivables once the agreed-upon trade terms are fulfilled.

  • Bank Guarantees

Bank Guarantees are very similar to Letters of Credit in the way they work. The key difference between LCs and Bank Guarantees is that they are issued by the importer’s bank to serve as an assurance of payment to the exporter, which will be fulfilled by the bank in case the importer defaults on the payments.

  • Export Credit Insurance

Export credit insurance protects the exporter’s business against the risks of non-payment by the importer. Usually, Export Credit Insurance is provided by government agencies or private insurance providers. It works much like any other insurance policy in mitigating the overall financial risk taken by the exporter.

  • Export Factoring

Export factoring is a financing option that exporters can avail where third-party financiers can provide funds against an exporter’s international receivables at a discounted rate. Simply put, the Financier provides a portion of the total receivables, usually 80% of the invoice, and assumes the responsibility for payment collection from the importer. Export Factoring can be very beneficial for exporters looking to capitalise on a growth opportunity and needs immediate working capital. Moreover, they do not have to worry about collecting payments from the importer. Export Factoring is traditionally provided by financial institutions but innovations like KredX GTX have made it easier for exporters to connect with a large pool of financiers from across the world and avail capital at the lowest rates.

Advantages of Trade Finance

Trade finance offers many advantages to exporters engaged in international trade transactions. Some of the most significant benefits include:

  • Liquid Working Capital

International Trade finance provides businesses with access to the necessary capital to carry out international trade transactions It also allows exporters to take advantage of expansion opportunities that may present themselves without compromising on their daily operations.

  • Minimizing Risks

International trade transactions are subject to various risks such as payment defaults, political unrest, currency fluctuations, etc. International Trade Finance protects exporters from these risks while minimizing the impact of these circumstances on their business.

  • Smoother Cash Flow Cycle

International Trade Financing options like Export Factoring let them convert their receivables into immediate working capital. This not only lets exporters extend more flexible payment terms to their customers and nurture a better working relationship with them but also frees up funds to explore growth opportunities.

Conclusion

International Trade finance plays a critical role in facilitating cross-border trade transactions. It provides exporters with access to the necessary capital and protection to carry out their operations and expand their businesses.

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Saddam Hussain

Saddam Hussain is a digital marketing and supply chain finance expert with over a decade's working experience. He specializes in areas such as invoice discounting, working capital management, cash flow forecasting, and risk mitigation and is passionate about sharing his knowledge and expertise with others. His writing is clear, concise, and accessible to both finance professionals and business owners. He believes supply chain finance is a crucial component of any successful business. His goal is to empower readers with the knowledge and tools they need to achieve these goals. When he's not writing or consulting, he enjoys traveling and trying new foods. You can reach him through LinkedIn or Twitter for a quick chat.