Trade Finance Workflow

Trade finance is a critical element of global commerce, facilitating international transactions by mitigating risks for both buyers and sellers. The workflow, though seemingly complex, follows a logical progression designed to ensure secure and efficient trade.

Initiation and Agreement

The process begins with a commercial agreement between the buyer (importer) and the seller (exporter) outlining details like goods, quantity, price, payment terms, and delivery schedule. Crucially, the payment method, often a letter of credit (LC) or documentary collection, is agreed upon during this stage.

Letter of Credit (LC) Application

If an LC is chosen, the buyer applies to their bank (the issuing bank) for an LC in favor of the seller. The application includes all details from the commercial agreement. The issuing bank assesses the buyer’s creditworthiness and, if approved, issues the LC.

LC Issuance and Advising

The issuing bank transmits the LC to the seller’s bank (the advising bank), usually located in the exporter’s country. The advising bank authenticates the LC’s validity and then forwards it to the seller. This ensures the seller knows a reputable bank guarantees payment if they fulfill the LC terms.

Goods Shipment

Upon receiving the LC and being satisfied with its terms, the seller ships the goods according to the agreed-upon schedule. The seller then obtains the necessary shipping documents, such as the bill of lading, commercial invoice, packing list, and insurance certificate.

Document Presentation

The seller presents these documents to their advising bank. The advising bank scrutinizes the documents to ensure strict compliance with the terms and conditions of the LC. Discrepancies, however minor, can lead to payment refusal.

Document Examination and Payment

If the documents are compliant, the advising bank forwards them to the issuing bank. The issuing bank again examines the documents for compliance. If all is in order, the issuing bank debits the buyer’s account and makes payment to the advising bank. The advising bank then credits the seller’s account.

Goods Release

The issuing bank releases the documents to the buyer. The buyer uses these documents, particularly the bill of lading, to claim the goods from the shipping company upon arrival at the destination port.

Alternative: Documentary Collection

Documentary collection offers a less secure alternative to LCs. The exporter sends shipping documents to their bank (remitting bank), which forwards them to the importer’s bank (collecting bank). The importer only receives the documents after paying for the goods (documents against payment – D/P) or accepting a bill of exchange, promising future payment (documents against acceptance – D/A).

In conclusion, the trade finance workflow involves multiple parties and steps to mitigate risk and facilitate international trade. While LCs offer a higher level of security, documentary collections are a simpler and potentially cheaper option. The specific method chosen depends on the risk appetite and relationship between the buyer and seller.