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Forfaiting - A protective tool |
This is a more pronounced requirement especially in countries where protection against credit, economic and political risks has become more difficult.
Credit insurance cover provided by government and private institutions usually requires partial risk retention by the exporter and the payments are also delayed in the event of the exporter's default. Forfaiting provides a better cover than insurance as it provides the exporter with cash at the time of shipment, and that too, on a non-recourse basis.
Forfaiting - For trade receivables
Forfaiting is a convenient form of trade involving the purchase of trade receivables from the holder. Trade receivables are the most common and accepted form of payment for exporters who supply goods or services to foreign buyers. Trade receivables are usually bills of exchange or promissory notes, book receivables, deferred payments under letters of Credit and other freely negotiable instruments. Forfaiting or purchase of these trade receivables is on a non-recourse basis, which implies that there is no returning to the exporter if the importer does not pay. Forfaiting converts this kind of credit granted by the exporter to the importer or buyers into a cash transaction for the exporter, providing protection against credit, political, transfer and currency risk or even the responsibility of collection.
Forfaiting – The Procedure
The Forfaiter has the responsibility to claim the debt from the importer and may either hold the notes until full maturity or sell them to another forfaiter, again on a non-recourse basis. The holder eventually redeems these at the bank at which they are payable.
The forfaiter deducts interest at an agreed rate for the full credit period covered by the trade receivables. Usually forfaiting is fixed rate and medium term (3-5 years) although it can be structured on a floating rate interest-bearing basis and for longer periods of up to 10 years or for shorter periods of 360 days with minimum amounts being US$1 Million (or equivalent in other major currencies).
The debt instruments are drawn by the exporter and accepted by the importer. The aval or irrevocable, unconditional and fully transferable guarantee of the foreign buyers’ local bank is a necessity. If, however, the buyer is of an esteemed quality, a guarantee is not quite necessary. The trade receivables can be denominated in a variety of currencies but mainly the transactions are in US Dollars, Deutsche Marks or Swiss Francs since these three currencies are used extensively in the Euro markets.
Advantages of Forfaiting
Exporters have many advantages accruing to the business through forfaiting transactions.
• Easy conversion of credit sale into a cash transaction
• Political and credit risk is completely eliminated
• Speedily available finance due to simple documentation
• Avoids interest and exchange rate risk
• Avoids the balance sheet of contingent liabilities and improves liquidity
• Avoids possible losses through partial state or private insurance cover and liquidity problems during claims periods
• Relieves the exporter from administration and collection problems
• Financing cost can be included into price if BP Aval is involved at an early stage in the contract negotiations
• Forfaiting also proves to be a beneficial and alternative form of finance for the importers or buyers
• No publicity
• Increases and diversifies borrowing capacity
• Speedy closure of commercial contract
• Avoids restrictive borrowing covenants
• Avoids administration and legal costs incurred in buyers’ credit loan agreement
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