Trade Finance Roles of Banks

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TRADE FINANCE ROLES OF BANKS
Prepared by Goodluck Nkini Manager Trade Finance CRDB Bank Limited. March 2005

Definition: Trade financing is the provision of any form of financing that enables a trading activity to take place and which may be made directly to the supplier, to facilitate procurement of items for immediate sale and/or for storage for future activities,or it could be provided to the buyer, to enable him meet contract obligations.

Importance of Trade Finance

The availability of trade finance, particularly in developing and least-developed countries, plays a crucial role in facilitating international trade. Exporters with limited access to working capital often require financing to process or manufacture products before receiving payments. Conversely, importers often need credit to buy raw materials, goods and equipment from overseas.

The Role played by a Commercial Bank

Provide Information to buyers and sellers (advisory role)

Settlements for Trade Transactions

Provide Financing

Manage currency risks

Take market risks

Settlements for Trade Transactions Open Account

Advance Payments

Documentary Collections

Letters of Credit

Provide Financing Working capital loans or overdraft, term loans. Issuing Bank Guarantees Issuance of Letters of credit (L/Cs) Accepting and Confirming Letters of Credit Discounting Export documents Structured finance

Manage Currency risks Banks are capable of minimizing Exchange rate fluctuation risk between major traded currencies through a hedging operation by taking a reverse position in the forward market or using options (to buy or to sell) foreign exchange in the futures market, thereafter be able to provide importers and exporters with competitive rates for : Spot Markets Forward Markets Options Swap Etc.

Take Market risks One risk caused by forces of demand and supply is related to price volatility. Banks are capable of selling price hedging options to exporters to guarantee price in the future. Here we are emphasizing commodity options because while commodities are believed to be price volatile by nature, they account for more than 75% of exports from Tanzania.

Financial Impediments for Import and Exports Financing problems: Lack of Security/Collaterals •Bank and Financial institutions act requires lending to the limit of 25%, 10% and 5% of the lending bank’s or financial institutions core capital if its fully secured, partly secured or unsecured respectively. Banks perceive high risks associated with small scale lending, because of high costs of administering such loans and difficulty of enforcing contracts, partly due to cultural behavior of not re-paying loans and as the result of an inadequate legal framework and inefficient court system

Financial Impediments for Import and Exports Financing problems: Absence of counter party financing alternatives outside the banking system •Promissory notes, Bill of Exchange, Counter trade, Forfeiting, Suppliers credit etc. High costs of borrowing to compensate banks for credit risks (Interest rates, application fee, facility fee) Regulatory issues •Difficulties for importers and banks to comply with Foreign currency externalization documentation requirement.

Other Impediments for Import and Exports Compliance to terms of Trade •Documentations Absence of reliable Market information about •Counter party risks and trading requirements. Missing link to buyers and sellers (Financial institutions link) Infrastructure gap •Transportation, Storage, Clearing & forwarding. Price Volatility for export especially commodities Absence of Quality verification leading to quality risk

Financial Impediments for Import and Exports Countries belonging to different trading blocks especially neighboring countries leading to restricted trading between traders of the countries in different block e.g. Tanzania is not a member of COMESA unlike its neighbors such Burundi, Rwanda, Zambia etc....
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