What is Trade Finance?

Learn more about International Trade Finance

The main methods of international trade finance are letters of credit and collections. Letters of credit provide for a third party, in most cases a bank, to “stand between” the buyer and seller to guarantee payment to the seller provided he complies with the terms of the letter of credit. In a collection transaction a third party, again most often a bank, receives documents from the seller for onward delivery to the buyer which are only delivered against his payment of the invoice which is one of the documents presented.

Trade Finance may or may not involve banks. For example, a Letter of Credit, to all intents and purposes, must be issued by a bank but that is mostly a matter of acceptability.

For cash against documents or cash against acceptance transactions banks have traditionally been used as the “post office” for delivery of documents and receipt of payments. Cash against documents means that the buyer is only able to receive documents against which he can clear his goods from customs upon payment of the seller’s invoice. In a cash against acceptance transactions, the buyer will “accept” his liability to pay the seller at some future date against which he will be able to obtain the documents and clear his goods.

Trade finance is considered to be the guarantee that payment will be received by the seller in line with the terms of the sales contract and the buyer, as much as is possible, will receive the goods he ordered.

As an adjunct to trade finance involving the shipment of goods or raw materials, letters of credit can be used to guarantee a service.

For example, a firm may sell a technically complicated piece of machinery which requires regular service/maintenance. In order for the buyer to ensure that the service takes place the seller may be required to provide a “standby letter of credit” which simply guarantees performance against a monetary penalty.