Trade finance involves the funding necessary for services and goods to flow between countries internationally. Banks and companies cause international trade to occur through trade finance, and there are number of financial products and instruments which are necessary to make this happen.
How Trade Finance Works
The idea behind trade finance is to reduce the risk of payment and supply for both exporters and importers, thereby providing a guarantee that each component of the trade will come off as planned. This is usually accomplished by involving a third-party such as a bank, a trade finance company, insurers, service providers, export credit agencies, or other importers and exporters.
Trade finance itself serves as a solution for protection against the risk involved with trade conducted internationally. Some of this risk is associated with political instability or other issues, risk of non-payment, credit ratings of companies, and sometimes even currency fluctuations. As opposed to conventional financing, which generally only involves liquidity management and solvency, trade finance has a number of other factors which can influence it significantly.
How Risk is Reduced in Trade Finance
One of the most common documents used for trade financing is the letter of credit, and this can be used to demonstrate how risk is lowered in trade finance. Any letter of credit will serve the role of providing the exporter’s bank with a statement that guarantees the exporter will be paid once the importer receives documents for an actual shipment. There is often a third party associated with any transaction such as this, and this will be a confirming bank.
The confirming bank generally operates within the exporter’s country, and has the responsibility of confirming the letter of content gets issued by the exporter’s bank. This same principle is generally applied to all other areas of risk involved with trade finance, so that both importers and exporters are protected against default or non-compliance by the other party.
Is Your Company Involved With International Commerce?
If so, you’re probably familiar with how trade finance works, and you may even require financing yourself. Contact us at Lighthouse Capital if you are in need of funding for your next commercial venture in trade.