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Trade Finance is basically related to 'Domestic as well as International Trade Transaction'.
The term "Trade Finance" means, finance for Trade. For a trade transaction there should be a Seller to sell the goods or services and a Buyer who will buy the goods or use the services. Various intermediaries such as (banks), (Financial Institutions) can facilitate this trade transaction by financing the trade.
While a seller (the exporter) can require the purchaser (an importer) to prepay for goods shipped, the purchaser (importer) may wish to reduce risk by requiring the seller to document the goods that have been shipped. Banks may assist by providing various forms of support. For example, the importer's bank may provide a letter of credit to the exporter (or the exporter's bank) providing for payment upon presentation of certain documents, such as a bill of lading. The exporter's bank may make a loan (by advancing funds) to the exporter on the basis of the export contract.
Other forms of trade finance can include Documentary Collection, Trade Credit Insurance, Factoring or Forfaiting. Some forms are specifically designed to supplement traditional financing.
Since secure trade finance depends on verifiable and secure tracking of physical risks and events in the chain between exporter and importer, the advent of new methodologies in the information systems world, has allowed the development of risk mitigation models which have developed into new advanced finance models. This allows very low risk of advance payment given to the Exporter, while preserving the Importer's normal payment credit terms and without burdening the Importer's Balance Sheet. As the world progresses towards more flexibility and growth in Trade Transactions, the demand for these new methodologies has increased amongst Exporters, Importers and Banks.
The following are the most famous products/services offered by various Banks and Financial Institutions in Trade Finance Segment.
1. Letter of Credit: It is an undertaking/promise given by a Bank/Financial Institute on behalf of the Buyer/Importer to the Seller/Exporter, that, if the Seller/Exporter presents the complying documents to the Buyer's designated Bank/Financial Institute as specified by the Buyer/Importer in the Purchase Agreement then the Buyer's Bank/Financial Institute will make payment to the Seller/Exporter.
2. Bank Guarantee: It is an undertaking/promise given by a Bank on behalf of the Applicant and in favour of the Beneficiary. Whereas, the Bank has agreed and undertakes that, if the Applicant failed to fulfill his obligations either Financial or Performance as per the Agreement made between the Applicant and the Beneficiary, then the Guarantor Bank on behalf of the Applicant will make payment of the guarantee amount to the Beneficiary upon receipt of a demand or claim from the Beneficiary.
3. Collection and Discounting of Bills: It is a major trade service offered by the Banks. The Seller's Bank collects the payment proceeds on behalf of the Seller, from the Buyer or Buyer's Bank, for the goods sold by the Seller to the Buyer as per the agreement made between the Seller and the Buyer.