What is Trade Finance ?
Banks offer trade finance products to traders in order to facilitate the smooth transaction of trading, and such trade finance products can be bought by a trader for an agreed fee. What is trade finance? Trade finance denotes the items used to finance a trade deal, and the term encompasses both domestic and international trading deals. It takes a seller and buyer to enact a trade transaction involving goods and services and intermediaries like banks facilitate them by financing them.
In a trade transaction, a seller (or exporter) would expect the buyer or importer to pay for the goods that are to be shipped to them, in advance. Likewise, the importer (or buyer) would want to receive the entire consignment in full before paying for it. Here a stalemate or standoff can take place, but the situation is avoided if a bank steps in between and assures the seller of their payment by providing them with a letter of credit which will empower them to draw the payment by producing documents such as a bill of loading after they have dispatched the goods to the buyer’s destination. The seller (or exporter) can also get a loan or advance by producing the export contract to his bank.
Risk mitigation has evolved to a great extent giving birth to advanced finance models. These largely reduce the risk of paying the exporter in advance without upsetting the balance of the importer’s financial status. There is a huge demand for these advanced trade financing tools, as it allows flexible and voluminous trades to take place. Letters of credit and Bank guarantees are the two common trade financing models used by traders around the world. A trader can choose one of these two methods or others mentioned above, to conduct a trade transaction to import safely the goods they have ordered from a trader operating in a remote place.