4.6 How TradFi addresses credit gaps for exporters today?
Inter-company and bank-intermediated credit
Last updated
Inter-company and bank-intermediated credit
Last updated
Given $BRICS' initial focus on export finance risk, its worthwhile considering how TradFi addresses the USD-illiquidity shortage today, despite regulatory burdens
'Trade finance' provides the credit, guarantees, and insurance needed to facilitate international transactions that satisfy both importers and exporters. Since importers prefer to pay after receiving and examining goods, while exporters want payment upon shipment, only 20% of trade is paid ‘cash in advance’. According to the World Trade Organization, there are two primary forms of trade finance practised today:
Inter-company credit (33%): The exporter typically grants this to the importer. Large exporters enhance their ability to extend credit by either (a) purchasing trade insurance to mitigate the importer’s payment risk or (b) ‘factoring’, whereby the exporter receives immediate cash by selling its accounts receivable to a third party at a discount. Factoring providers use their superior credit rating to secure cheaper funding (typically from banks). Long-standing buyer-seller relationships may also produce ‘open account’ agreements, where credit for delayed payment is granted intra-company.
Bank-intermediated finance (48%): Letters of Credit (LCs) are common in commodity trading, where the importer’s bank issues a commitment to guarantee payment for the exporter. Indeed, ChinaAI may be said to offer a type of “synthetic letter of credit” as defined by the International Trade Association. Another form of bank-intermediated trade finance includes outright lending, such as pre-shipment export finance, providing working capital for the exporter to purchase raw materials needed to manufacture final goods.
Inter-company credit and bank-intermediated finance facilitate trade by relying on creditworthiness and local bank liquidity. Letters of credit, typically used for large trades, replace the buyer’s creditworthiness with that of their bank. LCs mitigate risk by carrying obligations for the exporter (delivery conditions, customs documentation) and the importer (a bank guarantee of payment if the buyer defaults) to facilitate the trade. Of course these traditional forms of bank finance fall short of closing the liquidity gap.