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Importance of trade finance

Trade finance is important

Trade finance gets cash to exporters at shipment. They get paid before delivery, against their shipping documents. The importance of trade finance is because of this simple outcome.

Most exporters take pre-shipment finance from their local banks. This is to finance the making of the goods which are shipped to international buyers.

  • An exporter who gets paid before releasing the goods to the buyer has greater access to pre-shipment finance at a lower cost - directly increasing the efficiency of the supply chain and reducing prices for buyers.

  • An exporter who gets paid after delivery has to juggle a collateral gap. The goods are handed over and then he waits for the money. His local bank is usually not comfortable in this situation as pre-shipment finance is outstanding; the buyer now has the goods, but he may or may not pay. This results in higher costs and can even mean that the exporter's credit lines get blocked.

The importance of trade finance is that it gets cash to the exporter before control over goods is released to the buyer.

Importance of trade finance - it makes trade work

What is trade finance?

Trade finance is the process by which:

  • The exporter ships goods and gets paid

  • The buyer pays later

Note that trade finance pays the exporter before he releases control over the goods. This is before delivery to the buyer. Trade finance is important.

What are basic principles of trade finance?

Trade finance has worked on this basis for centuries:

  • The exporter provides evidence of the goods and their shipment.

  • This is done by presenting a pack of documents (bill of lading, packing lists, inspection reports, certificates etc).

  • Payment is made on the basis of the documents and before the goods arrive at the buyer.

  • In fact, the buyer cannot land the goods without the documents.

  • If the payment does not come, the exporter still controls the goods.

This is why it is also called a "documentary credit".

Why is trade finance important?

Trade finance is not just about financing the goods in transit - for the period when they are being shipped. Whilst this can easily be 30 days, most exporters have the resources to fund this period with the support of their local banks.

The main issue is that most exporters borrow money from their banks to make the goods. This is often called "pre-shipment finance" and it takes a number of forms: packing credits, back-to-back loans or LCs, loans for materials, supplier credits and so on.

And so they need to get paid for the goods before handing them over to the buyer in order to access pre-shipment finance and to control the financing cost involved.

Local banks that provide these crucial pre-shipment facilities to factories, especially in South and East Asia, want to see a "joined-up" process.

  • They lend money to the factory to make the goods.

  • Repayment of these loans comes from the sale of the goods.

  • They do not want to see the goods being handed over to the buyer without the cash arriving.

  • If this happens, there is a collateral gap that is hard to cover in the local market.

This collateral gap is hard to cover because a local bank in the exporter country can struggle to understand the credit standing of an international buyer who is far away. It is hard to get comfortable on the buyer credit, or to take action if no payments arrive.

So getting paid at shipment is essential for exporters. This reduces the cost of their pre-shipment finance and increases its availability.

How do banks provide trade credit?

Banks have, historically, worked in pairs to provide a working capital solution to get cash to the exporter at shipment, and to let the buyer pay later.

There is a buyer bank and an exporter bank. With plenty of variations, a common theme of the arrangements is:

  • The buyer's bank takes the buyer's credit risk and vouches for his bona fides

  • The exporter bank assembles documentary evidence that the goods meet the buyer's requirements and have been shipped

  • The buyer, with sight of the documents, approves the trade through his bank

  • Exporter gets the money upfront via the coordination of the two banks involved; the buyer may pay later supported by his own bank.

This is the documentary credit process. And it certainly works. But, apart from technology upgrades, it is largely unchanged since Victorian times.

Why are letters of credit falling in popularity?

The market share of documentary credits in trade flows has fallen from maybe 50% decades ago to less than 8% today (source: ICC 2019 Trade Review).

The letter of credit (LC) works. But it is complicated, expensive, and it can be slow.

Involving two banks and coordinating them means two P&Ls, lots of hidden communication processes, plenty of fees and potentially delays. Moreover, for most exporters and their buyers, they typically have to hire specialist staff as the products are complicated and there are plenty of pitfalls.

Who is providing trade finance then?

Typically buyers are paying early or exporters are giving credit.

When suppliers give credit, pre-shipment finance gets much more difficult.

  • Local banks, especially in South and East Asia, find it difficult to rely upon buyers in foreign countries who have deferred payment terms - so this restricts pre-shipment finance and makes it more expensive.

  • Many suppliers have been able to manage up to a point, but the recent interruption in trade has exposed many risk positions in the local banks that have led to over-exposure on clients and potential losses.

  • Local banks in exporter countries are retrenching fast - and starting to insist on payment at shipment as a condition for the availability of pre-shipment finance.

On the buyer side, a common misconception is that supply chain finance is filling the gap. Supply chain finance enables early payments to suppliers.

  • But supply chain finance is an invoice-finance product, not trade finance.

  • Payment is post-delivery not post-shipment.

  • That is because the buyer does not want to overpay the supplier, and supply chain finance platforms do not support staged payments, integrated shipping documents, and handle credit notes. So buyers are reluctant to approve invoices before delivery.

Platforms are the future

Supply chains are hurting because of the lack of a customer-friendly, low-cost trade finance product. This leaves a gap for exporters that, in turn, restricts availability of pre-shipment finance and therefore makes their products more expensive and makes supply chains less stable.

Our simple trade finance platform ( does the job, powered by the importer who can drive the process to get exporters paid at shipment:

  • Exporters ship

  • Trade and other documents are uploaded and digitised

  • Invoices are automatically approved using our "3-way match at shipment process"

  • Approved invoices are paid early or the supplier gets supply chain finance.

  • Buyers pay later


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