International Trade Finance
June 5, 2016 | Author: SK Munaf | Category: N/A
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ITF...
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“ ANALYSIS OF INTERNATIONAL TRADE FINANCE AT CATEGORY B BRANCH ”
A PROJECT STUDY SUBMITTED IN PARTIAL FULFILLMENT FOR THE REQUIREMENT OF THE TWO YEARS POST GRADUATE DIPLOMA IN MANAGEMENT 2010-2012
BY
HARSH KHANNA 09/10 F
UNDER THE GUIDANCE OF (Dr DEEPAK TANDON)
LAL BAHADUR SHASTRI INSTITUTE OF MANAGEMENT, DELHI FEBRUARY 2012
HARSH KHANNA, PGDM(F
)
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LAL BAHADUR SHASTRI INSTITUTE OF MANAGEMENT, DELHI
Dated: 01/02/2012
CERTIFICATE
Certified that HARSH KHANNA has successfully completed Project Study entitled “Analysis Of International Trade Finance at Category B Branch” under my guidance. It is his / her original work, and is fit for evaluation in partial fulfillment for the requirement of the Two Years Post Graduate Diploma in Management.
Mr. HARSH KHANNA Sig:
Dr. DEEPAK TANDON Sig:
HARSH KHANNA, PGDM(F
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Acknowledgements
First, I must acknowledge, Mr Subodh Kala Chief Manager Punjab National International Banking branch, Jalandhar and Mrs Geeta Khanna AGM Jalandhar Branch, Punjab National Bank for providing me the opportunity to have access on the confidential data regarding Trade Finance. My sincere gratitude to Mr. Jagpreet Singh who helped me to gather information and know about the intricacies involved in carrying out foreign exchange business transactions in any category B authorized dealer’s branch .My thanks to rest of the members of Forex department who always helped me in clarifying my doubts I am highly indebted to my project guide Dr. Deepak Tandon under whose consistent guidance I was able to complete my end term project report.
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Table of Contents 1. Objective of the study………………………………………………………..5 2. Rationale of the Study……………………………………………………….5 3. Methodology…………………………………………………………………..5 4. Literature Riview………………………………………………………………6 5. Indian Banking Industry………………………………………………………7 6. Indian Foreign Exchange Market……………………………………………10 7. Different categories of Authorized Dealers………………………………...11 8. Foreign Exchange Business Operations…………………………………...13 9. Exchange Arithmetic………………………………………………………….14 10. FEMA Vs FERA……………………………………………………………….15 11. Modalities of Trade Finance…………………………………………………18 12. Modes of Trade Finance……………………………………………………..19 13. Letter of Credit Process………………………………………………………26 14. Types of L/C…………………………………………………………………...28 15. Pre shipment Financing………………………………………………………30 16. Post Shipment Financing…………………………………………………….32 17. Factoring and Forfeiting……………………………………………………...35 18. Kinds Of documents in Trade Finance……………………………………..38 19. SWIFT………………………………………………………………………….41 20. Export Financing Case lets and Analysis…………………………………..42 21. Credit Appraisal and Technical Analysis…………………………………...46 22. Risk Management in International Trade Finance………………………...61 23. Recommendations and Conclusion…………………………………………65 24. Glossary………………………………………………………………………..66 25. References…………………………………………………………………….67 26. Bibliography……………………………………………………………………67 27. Annexure……………………………………………………………………….68
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OBJECTIVES OF THE STUDY The main broad objective of the study is to analyze each and every aspect of the international trade finance, but major focus has been put on the following sub objectives:
a) To study the Trade Finance at macro level at the PSU (category B branch) b) To understand the modalities and components of trade c) To analyze the export and import financing by the bank using case lets d) To perform Credit Appraisal of bank’s customer e) To Study the risk management in Trade Financing and possible solutions to hedge against the risk
Rationale of the study Since the authorized dealers deal in documents and not in goods there is a need for simplification and standardization of export credit documents and timely sanction of the export credit proposals for different stages of the export finance should be done on a proactive basis to the corporate exporters. All export credit in India is on a without recourse, irrevocable and thus there is definitely a bar on the banks to utilize in the foreign exchange resources available to them Methodology ·
Primary Research At Punjab National Bank GT road Jalandhar Branch – B branch · ·
Interaction with various importers and exporters at the bank
Secondary Research · ·
RBI Guidelines
·
FEMA Rules and Regulations
·
FEDAI Guidelines
I The Study has been substantiated by original cases related to trade finance ·
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REVIEW OF THE EARLIER STUDIES Extensive research has been conducted by various Academicians, Professionals and Journalists on International Trade Finance. Major concern has been shown by various researchers post 2008-09 recession. Some of the studies has reviewed here: Ahn JaeBin, Amiti Mary, and E. Weinstein David “Trade Finance and the Great Trade Collapse” (2010) In this study, researchers tried to examine the impact of Trade Finance by banks on Exporter as well as importer trade market. Also they tried to find the relationship between price movement and Exporter Supply Shock using various statistical techniques like regression test. They found out that exporters whose financial institutions became unhealthy cut back on exports more than other firms, and imports declined more in sectors that had greater external financial dependence. some of these shocks may\also have appeared in price movements. Export prices rose relative to domestic manufacturing prices during the crisis, and the prices of seaborne imports and exports—which are more sensitive to financial shocks—rose relative to goods sent by land or air
Korinek* Jane, Cocguic Le Jean,Sourdin Patricia “ The Availability and Cost of ShortTerm Trade Financeand its Impact on Trade” (2010) In this study, researchers tried to examines one potential reason for the drop in trade between mid-2008 and the first quarter of 2009 – changes in the cost and availability of trade finance to potential exporters and importers. Results from an econometric model developed to examine this question show that short-term trade finance availability has had an effect on trade flows during the crisis period, but that its impact has been smaller than that of falling demand. It also shows that the availability and cost of trade finance seem to have had a limited impact on trade outside crisis periods. During the crisis period, the cost of financing negatively impacted trade overall due to an increase in spreads. This indicates that financing was probably prohibitively expensive for some traders, thereby severely constraining their ability to trade. The researchers also highlighted one of the major difficulties regarding policymaking in the area of trade finance – that there is little reliable quantitative information. Appiah E. Asiedu “ TRADE FINANCE – AN INSTRUMENT FOR EFFECTIVE TRADE DELIVERY” (2009) In this study, researcher tried to study the behavioral attitude of the commercial banks towards the export sector and the evidences indicate that commercial banks in developing economies would
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rather invest their funds in less risky ventures than to place such funds in the development of the export sector which is seen as being very risky
The Indian Banking Industry India has a long history of both public and private banking. Modern banking in India began in the 18th century, with the founding of the English Agency House in Calcutta and Bombay. In the first half of the 19th century, three Presidency banks were founded. After the 1860 introduction of limited liability, private banks began to appear, and foreign banks entered the market. The beginning of the 20th century saw the introduction of joint stock banks. In 1935, the presidency banks were merged together to form the Imperial Bank of India, which was subsequently renamed the State Bank of India. Also that year, India's central bank, the Reserve Bank of India (RBI), began operation. Following independence, the RBI was given broad regulatory authority over commercial banks in India. In 1959, the State Bank of India acquired the state-owned banks of eight former princely states. Thus, by July 1969, approximately 31 percent of scheduled bank branches throughout India were government controlled, as part of the State Bank of India. The post-war development strategy was in many ways a socialist one, and the Indian government felt that banks in private hands did not lend enough to those who needed it most. In July 1969, the government nationalized all banks whose nationwide deposits were greater than Rs. 500 million, resulting in the nationalization of 54 percent more of the branches in India, and bringing the total number of branches under government control to 84 percent. After nationalization, the breadth and scope of the Indian banking sector expanded at a rate perhaps unmatched by any other country. Indian banking has been remarkably successful at achieving mass participation. Between the time of the 1969 nationalizations and the present, over 58,000 bank branches were opened in India; these new branches, as of March 2003, had mobilized over 9 trillion Rupees in deposits, which represent the overwhelming majority of deposits in Indian banks. This rapid expansion is attributable to a policy, which required banks to open four branches in unbanked locations for every branch opened in banked locations. Between 1969 and 1980, the number of private branches grew more quickly than public banks, and on April 1, 1980, they accounted for approximately 17.5 percent of bank branches in India. In April of 1980, the government undertook a second round of nationalization, placing under government control the six private banks whose nationwide deposits were above Rs. 2 billion, or a further 8 percent of bank branches, leaving approximately 10 percent of bank branches in private hands. The share of private bank branches stayed fairly constant between 1980 to 2000. Currently, India has 96 scheduled commercial banks (SCBs) - 27 public sector banks (that is with the Government of India holding a stake), 31 private banks (these do not have government stake; they may be publicly listed and traded on stock exchanges) and 38
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foreign banks. They have a combined network of over 53,000 branches and 17,000 ATMs. According to a report by ICRA Limited, a rating agency, the public sector banks hold over 75 percent of total assets of the banking industry, with the private and foreign banks holding 18.2% and 6.5% respectively.
TYPES OF BANKS Banks' activities can be divided into Retail banking, dealing directly with individuals and small businesses Business banking, providing services to mid-market business; corporate banking, directed at large business entities Private banking, providing wealth management services to high net worth individuals and families; Investment banking, relating to activities on the financial markets. Most banks are profitmaking, private enterprises. However, some are owned by government, or are non-profit organizations Central banks are normally government-owned and charged with quasi-regulatory responsibilities, such as supervising commercial banks, or controlling the cash interest rate. They generally provide liquidity to the banking system and act as the lender of last resort in event of a crisis
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Structure of the Indian Banking Industry INDIAN BANKING INDUSTRY SCHEDULED BANK
NONSCHEDULED BANK
CENTAL COOPERATIVE BANKS
PRIMARY CREDIT SOCIETIES
STATE COOPERATIVE BANKS
STATE BANK OF INDIA GROUP
COMMERCIAL BANKS
PRIVATE SECTOR BANKS
REGIONAL RURAL BANKS FOREIGN BANKS
SBI
SB of Patiala
SB of Indore
OLD SECTOR PRIVATE BANKS NEW SECTOR PRIVATE BANKS
SB of Hyderabad
SB of Mysore
SB of Bikaner & Jaipur
SB of Travancore
SB of Saurastra
NATIONALIZED / PUBLIC SECTOR
BANKS 19
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Indian Foreign Exchange Market - Basic Information Indian Rupee serves as the medium of exchange backed by legal tender status for making payments towards purchases and towards discharging all other types of payment obligations within the country. But as modern trade and commerce extend beyond the boundaries of a country, the question naturally arises as to how to settle payments for cross-border sales, purchases and other money dealings? We also need to incur expenditure in foreign countries towards travel and temporary halt, medical care, educational purposes, maintenance of an office at the foreign centre etc. This is a widespread and frequent need of many persons in every country. But each country has a different currency, serving as a medium of exchange exclusively within its boundaries. Then how to make payment in Indian Rupees in our country and enable the foreign seller to get payment in his currency? Let us look at the answer. If an exporter in India sells readymade garment, say to a Canadian firm, the Canadian importer can make payment in Canadian Dollars, while the Indian Exporter desires to be provided with Indian Rupees. This problem is solved by the Canadian Importer in the first instance purchasing Indian Rupees against payment of Canadian Dollars in his country from an authorized source dealing with foreign money (foreign exchange) and remitting Indian Rupees to the Indian Exporter. Or in case the consignment is invoiced in Canadian Dollars, the Indian exporter gets Canadian Dollars, which he sells in this country to an authorized dealer (of foreign exchange) to get Indian Rupees. Thus as money is used as a medium of exchange to secure supplies of goods and services, it can also be so used to secure supply of currency/money of another country, which can thereafter be used to discharge our payment obligations in that country.
Composition of the Indian Market Foreign exchange market in India is totally structured, well regulated both of RBI and also by a voluntary association (Foreign Exchange Dealers Association). Only Dealers authorized by RBI can undertake such transactions. All inter-bank dealings in the same centre must be affected through accredited brokers, who are the second arm in the market-structure. However, dealings between the authorized dealers and the RBI and also between the AD (Authorized Dealers) and overseas Banks are affected directly without the intervention of the brokers. In addition to the authorized dealers covering commercial banks, who undertake comprehensive transactions covering all spheres of foreign exchange, there are also a peripheral market consisting of licensed money changers and travel agents, who enjoy limited authorization especially for encashment of traveler’s cheques, notes. Specified hotels and Government owned Shops are also given restricted licenses to accept payment from non-residents in foreign currencies. IDBI, and Exim Bank are permitted handle and hold foreign currencies in a restricted way.
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AUTHORISED DEALERS Authorized persons are Banks and Institutions authorized by RBI to deal in FX. Certain financial institutions like EXIM, SIDBI etc have been given restricted authorization to deal in specific FX transactions incidental to their business.RBI has granted ―Money Changers‖ licenses to certain Firms, hotels and other organizations permitting them to deal in FX notes, coins and Travellers cheques. Full Fledged Money Changers [both purchase and sale] Restricted Money Changers [ only to purchase FX notes, coins and TC s, subject to the condition that all such collections are surrendered by them in turn to Ads in FX / Full fledged money changers].
For the purpose of Foreign Exchange business authorized dealers are classified as Category A – Branches maintaining independent foreign currency accounts in their own names Category B – Branches not maintaining independent foreign currency accounts but having powers of operating on the accounts maintained by A category branch. Category C – All other branches handling FX business through A or B branches. Category D – It included Money changers and regional rural banks
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Functions of Authorized Dealers: Authorized Dealer can handle all kinds of Foreign Exchange transaction as per FER Act 1947 under the instruction of Central Bank. Following are the main function of an Authorized Dealer. Exchange of Foreign Currencies. To make arrangement with Foreign Correspondent. Buying and Selling foreign Currencies Handling of Inward and Outward Remittance Opening of L/C and Settlement of Payment Investment in Foreign Trade Opening & maintenance of Accounts with Foreign Banks under intimation of Bangladesh Bank Export Documents handling.
International Trade Financing
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Foreign Exchange Business Operation
IB
REMITT
EXPOR T Pre Shipment
-ANCES Issue of DD, MT, TT etc.
STATIS IMPOR T-ICS
DEALIN
T
GS
Submission
Opening of
of returns
LC
Advances
Purchase of Foreign Bills
Negotiation of Foreign Bills
Export Guarantees
n Payment of DD, MT, TT etc.
Issue & encashmen t of TCs
Sale & encashment of Foreign currency Notes Non-
Advising / Conforming LC
Rate computatio
resident accounts
Collection of credit information
Advance Bills
Maintenanc e of foreign currency
Bills for
accounts Forward
collection
contracts
Import loans & guarantees
Exchange positions & Cover positions Arranging Foreign Currency
funding Advancemen t for deferred payment exports Advance against bills for collection
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Exchange Arithmetic Knowing the mechanism of exchange rates will give us insight into forex business and will helps authorized dealers in customer service Exchange rate is a rate at which one currency is converted into another currency The exchange rate for sale and purchase transaction will not be same . The foreign currency is purchased at a lower rate and sold at a higher rate which gives the margin of profit. It is therefore said ―Buy low Sell High‖ for direct quotation. The rates for the transactions are obtained from Forex market which consists of players like Banks, Financial Insitutions, Brokers, Central Banks, Corporates and the Public at large etc The foreign currency rates are quoted in two ways :1) Direct Quotation or Hom Currency Quotataion e.g 1USD = 47.5 INR i.e amount of foreign currency is fixed while the equivalent amount of home currency is variable. Bank always buy foreign currency at lower rate and while selling the foreign currency banks will acquire as much of home currency as possible e.g Buying Transaction 1USD = 47.5 INR Selling Transaction – 1USD = 47.7 INR 2) Indirect Quotation or Foreign Currency Quotation – In this case home currency unit is fixed while the foreign currency unit is variable e.g 100 INR = 1.97 USD i.e amount of home cuurency is fixed while the while the equivalent amount of foreign currency is variable. Bank always buy home currency at lower rate and while selling the home currency banks will acquire as much of foreign currency as possible e.g Buying Transaction - 100 INR = 1.9794 USD Selling Transaction – 100 INR = 1.9755 USD 3) Two way quotes – In all foreign exchange quotations offered by a dealer, there will always be two-figures – buying rate and the selling rate
The buying rate is also known as ―Bid Rate‖ and the selling rate as the ―Offer rate‖. The difference between the two is a profit margin and also known as spread between the two rates
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FEMA Vs FERA With the introduction of the Foreign Exchange Management Act 1999, (FEMA) with effect from June 1, 2000, the objective of the Foreign Exchange Department has shifted from conservation of foreign exchange to "facilitating external trade and payment and promoting the orderly development and maintenance of foreign exchange market in India". FEMA replaced the Foreign Exchange Regulation Act (FERA).
There are certain basic differences between the two – FEMA
FERA
Civil Offence – provides a fair
Violation under FERA - treated as
redressal machinery
a criminal offence
Onus on the enforcement agency Onus lies with the accused to to prove guilt
prove innocence
However, cases under FERA can be initiated within two years from repeal of FERA, i.e. up to May 31st 2002. * FEMA Guidelines: These guidelines oversee external payments and receipts. The FEMA 1999 incorporates directions of a standing nature to authorized persons etc. Directions on Project and Service exports are spelt out in separate Memoranda. Amendments / changes are informed to authorized persons from Time to time by RBI through AP (Dir) series circulars & other notifications /directions. The new law is more transparent in its application. It has laid down the areas Where specific permission of the Reserve Bank/Government of India is required. In the rest of the cases, no such permission would be needed and a person can remit funds and acquire assets, incur liability in accordance with the specific provisions laid down in the Act or notifications issued by the Reserve Bank/Government of India under the Act without seeking approval of Reserve Bank / Government of India. The new Act has brought about structural changes in the exchange Control administration. Regulations have been framed for dealing with various types of transactions. These regulations are transparent and have eliminated case-by-case approvals.
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Revised limits (in
Earlier Limits (in
US$)
US$)
Basic Travel Quota
5,000
3,000
Gifts
5,000
1,000
Donations
5,000
1,000
Employment
5,000
2,500
Emigration
5,000
3,000
Maintenance of close
5,000
5,000
relatives
* FEDAI [Foreign Exchange Dealers Association of India]- established in 1958 under the Section 25 of the Companies Act (1956).It is an association of Ads in FX operating in India. FEDAI aims at promoting sound FX policy and is closely associated with the developmental steps in respect of FOREX market. The objectives of FEDAI include, bringing uniformity in terms and conditions for FX business between Banks and Customers. An undertaking has been given by each AD to RBI to abide by the Guidelines and conditions prescribed by FEDAI for transacting FX business. * EXIM POLICY Every 5 year Ministry of Commerce, GOI notifies EXIM Policy. Like EXIM Policy (2007-2012) lays down the guidelines / procedures for Trade control, Relating to the physical movement of goods into / out of India. The Policy States, that exports and imports shall be free except in cases where they are regulated by the provisions of this policy or any other law for the time being in force. * ICC RULES [International Chamber of Commerce] ICC had in 1933 codified the rules regarding the operation of LC, which Received acceptance in about in about 115 countries. The UCPDC [Uniform Customs and Practices for Documentary Credit] was last revised by its Brochure number 600 and hence is now referred to as UCP 600.
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VARIOUS PRODUCTS IN Foreign Exchange Business Segment Import Services Letter of credit § Import Collection Bill Services § Advance Payment towards Imports § Arranging for Buyer’s & Supplier’s Credit §
Export Services Export Packing Credit § Export Bill Negotiation § Export Bill Purchase & Discounting § Rupee Advance against Export Bills § Bank Guarantees § Export LC Advising § Export LC Confirmation §
Remittance Services Inward Remittances § Outward Payments §
Deposit NRE NRO FCNR (B) Derivative Instruments Forward Contract
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MODALITIES OF TRADE FINANCE Key Factors in Trade Any trade transaction can be broadly broken down into: Ø Movement of Goods Ø Movement of Documents Ø Movement of Funds as consideration for goods Traditionally, Banks have played a role in the „Movement of Document‟ and „Movement of Funds‟, while „Movement of Goods‟ has been done through a whole range of logistics players operating at different levels of supply chain.
Simplified Process Flow in case of a typical International Transaction:
Banks are concerned with: Ø Movement of Funds Ø Movement of Documents
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Mode of Movement of funds can be as follows: Ø Wire Transfers or Money Transfer Ø Demand Drafts Ø Cheque Collections Ø Physical Currency received/ paid Ø Travellers Cheques Ø Payment received/ made through Credit Card/ Online Payment Systems
Documents ascertaining movement of goods, which consists of: Ø Financial Documents Ø Commercial Documents Ø Transport Documents Ø Regulatory Documents Ø Insurance Documents
Modes of International trade finance There are 3 major recognized ways of effecting payment in international trade: A. Clean payments Advance Payments I. Open Account II. B. Bills of Collection C. Documentary Credit
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A) Clean payments Clean payments are characterized by trust. Either the exporter sends the goods and trusts the Importer to pay once the goods have been received, or the Importer trusts the Exporter to send the goods after payment in effected. In the case of clean payment transactions, all shipping documents, including title documents, are handled directly by the trading parties. The role of banks is limited to clearing funds as required. There are two types of Clean Payments: I) Payment in Advance: The Importer sends payment directly to the Exporter and waits for the Exporter to send the goods and documents. This mode of transaction is demanded by the exporter/ seller when the selling party is a well-known and reputed company in its field. Thus the importer has a reasonable amount of trust on the exporter by virtue of the exporter‟s reputation.
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II) Open Account: The Exporter ships the goods and the documents directly to the Importer and waits for the Importer to send payment. A mutual level of trust between the two parties ensures that an open account system is carried on smoothly. It is to be noted that as long as the exporter can trust the importer to make his payment on time, an Open Account transaction is the simplest mode of doing long-term business.
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Risk Spectrum Least Risk
Highest Risk To exporters
Least Risk To exporters
Open Account
To importers
Advance Payment
Highest Risk To importers
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B)Documentary collections Documentary Collection or ―Collection against bills‖ is a method of payment used in International trade whereby the Exporter entrusts the handling of commercial and often financial documents to banks and gives the banks instructions concerning the release of these documents to the Importer. Banks involved
do
not
provide any guarantee of payment.
However,
collections are subject to the Uniform Rules for Collections published by the International Chamber of Commerce. After the Importer and the Exporter have established a sales contract and agree on a Documentary Collection as the method of payment, the Exporter ships the goods. In a Documentary Collection, the Importer is the ―drawee‖ and the Exporter is the ―drawer‖. After the goods are shipped, documents originating with the Exporter (e.g. Commercial Invoice) and the transport company (e.g. bill of lading) are delivered to a bank, called the Remitting Bank in the Collection process. The remitting bank sends these documents accompanied by a Collection Instruction, giving complete and precise instructions, to a bank in the Importer’s country, referred to as the Collecting/ Presenting Bank in the Collection process. The Collecting/ Presenting Bank acts in accordance with the instructions given in the Collection Instruction and releases the documents to the Importer against payment or acceptance, according to the Remitting Bank’s Collection instructions. Payment is forwarded to the Remitting Bank for the Exporter’s account. And the Importer can now present the transport/ title document to the carrier in exchange for the goods. The Exporter will ask the importer to settle the bill in one of two ways, either D/P or D/A. Document against Payment (D/P) This is sometimes referred to as Cash against Documents/ Cash on Delivery. In effect D/P means payable at sight (on demand). The collecting bank hands over the shipping documents including the document of title (Bill of Lading) only when the importer has paid the bill. The drawee is usually expected to pay within 3 working days of presentation. The attached instructions to the shipping documents would show ―Release documents against Payment‖.
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Document against Acceptance (D/A) Under documents under acceptance, the exporter allows credit to the importer; the period of credit is referred to as ―usance‖. The importer/ drawee is required to accept the Bill i.e, to make a signed promise to pay the bill at a set date in future. When he has signed the bill in acceptance, he can take the documents and clear his goods.
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The payment date is calculated from the „term‟ of the bill – the „term‟ is usually a multiple of 30 days and starts either from sight or from the date of shipment whichever is stated on the bill of exchange. The attached instructions would show ―Release documents against Acceptance‖. Documentary Collections offer more of a compromise in risk-taking between the Importer and the Exporter than Clean Payments.
RISK SPECTRUM Least Risk
Highest Risk To Exporter
Open Account
To Importer
Documents Against Acceptance Documents Against Payment Least Risk To Exporter
Advance Payment
Highest Risk To Importer
C) Documentary Credit Documentary Credits, otherwise popularly known as ―Letters of Credit‖ (LC), is an instrument of settling trade payments. LC is an arrangement whereby a bank acting at the request of the customer undertakes to pay a third party by a given date according to agreed stipulations and against presentation of documents, the counter-value of goods or services dispatched/ supplied, rendered or otherwise. A key principle underlying Letters of Credit is that banks deal only in documents and not in goods. The decision to pay under a Letter of Credit will be based entirely on whether the documents presented to the bank appear on their face to be in accordance with the terms and conditions of the Letters of Credit.
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Letter of Credit Process:
1. The buyer and seller agree on the terms of sale and enter into the requisite contract encompassing the type of goods, delivery schedule, mode of payment, etc. the buyer arranges for his bank to open a letter of credit in favour of the seller. 2. The buyer’s bank sends the letter of credit to the advising bank in the seller’s country. The seller may request that a particular bank be the advising bank, or the buyer’s bank may select one of its correspondent banks in the seller’s country. 3. The advising bank forwards the LC to the seller. The advising bank checks on the authenticity of the LC before forwarding it to the seller. The seller carefully reviews all conditions the buyer has stipulated in the letter of credit. If the seller cannot comply with one or more of the provisions, the buyer is immediately notified and asked to make an amendment to the letter of credit. 4. After final terms are agreed upon, the seller prepares the goods and arranges for shipment to the appropriate port. The seller ships the goods, and obtains a bill of lading and other documents as required by the buyer in the letter of credit. 5. The seller presents the documents to the Negotiating Bank, indicating full compliance with the terms of the letter of credit. The Negotiating bank reviews the documents. If they are in order, they are forwarded to the Issuing bank. If there is a confirming bank in the transaction the documents have to flow through the Confirming Bank. 6. The Negotiating bank forwards a reimbursement claim to the Reimbursing bank. 7. The Reimbursing bank pays the Negotiating bank as per instructions issued to it by the Issuing Bank. 8. On receipt of payment the Negotiating Bank makes payment to the Beneficiary if he has not discounted the bill earlier. 9. Once the Issuing bank receives the documents it notifies the buyer who then reviews them. If they are in order the buyer signs off, makes payment to the bank, and receives the documents, which enable the holder to take possession of the shipment. 10. The transfer of funds from the buyer to the bank, from the buyer‟s bank to the seller‟s bank, and from the seller‟s bank to the seller may be handled at the same time as the exchange of documents, or under terms agreed upon in advance.
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Risk Analysis Open Account
Highest Risk To Exporter
Documents against Acceptance
Least Risk To Importer
Documents against Payment Unconfirmed LC Confirmed LC Least Risk
Advance Payment
To Exporter
Highest Risk To Importer
Types of Letter of Credit There are seven types of Letter of Credit: 1. Revocable Letter of Credit Revocable Letter of Credit is a Credit, which can be revoked, i.e., cancelled or amended by the bank issuing the Credit, without the notice of other parties. Revocable Letter of Credit is rarely used. From an exporter’s point of view this type of LC is not a satisfactory one. But, it is advantageous to the importer and the Issuing Bank. 2. Irrevocable Letter of Credit Irrevocable Letter of Credit is a firm undertaking on the part of the Issuing Bank and cannot be cancelled or amended without the consent of the parties to LC, particularly the Beneficiary. From an exporter’s point of view this is more favourable. The irrevocable nature of the letter of credit has enabled building up an elaborate commercial system on the basis of irrevocable banker’s credit. 3. Confirmed Letter of Credit Confirmed Letter of Credit is a LC to which another Bank (Bank other than the Issuing Bank) has added its confirmation or guarantee. Thus, there is a double guarantee in such Credit and it is more favorable to Beneficiary. Generally, the confirmation is desired by Beneficiary from a bank known to him, preferably the one located in his country so that his risk becomes localised and he can deal easily with a local bank rather than deal with a bank abroad, which HARSH KHANNA, PGDM(F
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has issued the Credit. But this type of LC is costlier to the parties concerned, since there would be charges of confirming bank. 4. Sight Credit and Usance Credit Sight Credit states that the payment would be made by the Issuing Bank at sight, on demand or on presentation. In case of usance credit, drafts are drawn on the issuing bank or the correspondent bank at specified usance period. The credit will indicate whether the usance drafts are to be drawn on the issuing bank or, in the case of confirmed credit on the confirming bank. 5. Back-to-Back Letter of Credit When a LC is opened with security of another LC, the credit thus opened is termed as „Back-to-Back Letter of Credit‟. This original credit, which is offered as security for opening a back-to-back credit is called an over-riding credit/ principal credit. The practical use of this credit is seen when LC is opened by the ultimate buyer in favour of a particular beneficiary, who may not be the actual supplier or manufacturer. He will open another credit with near identical terms in favor of the actual supplier/ manufacturer offering the main credit opened in his favor as security and will be able to obtain reimbursement by presenting the documents received under back-to-back credit under the main LC. 6. Transferable Letter of Credit It is a credit, which can be transferred by the Original Beneficiary in favor of a second beneficiary or several second beneficiaries. As per UCPDC a LC can be transferred only if it is specifically stated as ―Transferable‖ in the LC. Further, such credit can be transferred only once (i.e., from the first beneficiary to the second beneficiary and not thereafter) and subject only to the original terms and conditions of the Credit. 7. Standby Letter of Credit There credits are generally used as a substitute for performance guarantee or for securing secured loans. The document generally called for under such credit is a simple statement of claim or proof of delivery of goods or certificate of non-performance.
Categories of Trade finance Two Broad categories of Trade Finance are: 1.Pre-shipment financing 2.Post-shipment financing
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Pre-shipment financing Pre-shipment finance is credit granted to the exporters by a financial institution. Preshipment credit is part of working capital finance. The main objective behind pre-shipment finance is to enable exporters to: a) Procure raw materials b) Carry out manufacturing processes c) Provide a secure warehouse for goods and raw materials d) Process and pack the goods e) Ship the goods to the buyers f) Meet other financial costs of the business
Different Stages of Pre Shipment Finance 1. Appraisal and sanction of Limits Pre-Shipment Finance, or Packaging Credit, is essentially a working Capital advance made available for the specific purpose of procuring/ processing/ manufacturing of goods meant for export. All costs before shipment would be eligible for being financed under the packaging credit. While considering Credit Facilities for export activities, Bank specifically looks into the aspects of product profile, country profile and commodity profile. The Bank also looks into the status report of the prospective buyer, with whom the exporter proposes to do business. In order to get the status report on foreign buyer, services of institutions like ECGC may be utilized. Bank extends the Packaging Credit facilities after ensuring the following: 1. The exporter is a regular customer, a bonafide exporter and has a good standing in the market. 2. The exporter has the necessary licenses and quota permits. 3. Whether the country with which the exporter wants to deal is under the list of Restricted Cover Countries (RCC).
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2. Disbursement of Packing Credit Advance After proper sanctioning of the limits, the bank ensures that the exporter has executed proper documents. On the basis of these documents, disbursements are normally allowed. Before disbursing the Bank specifically checks for the following particulars in the submitted documents: Ø Name of the Buyer Ø Commodity to be exported Ø Quantity Ø Value (either CIF or FOB) Ø Last date of shipment Ø Any other terms to be complied with The quantum of finance is fixed based on the FOB value of contract/ LC or on the domestic value of goods, whichever is lower. Normally insurance and freight charges are considered at a later stage, when the goods are ready to be shipped. Disbursals are made only in stages and preferably, not in cash. The payments are made directly to the suppliers by Drafts/ Bank Cheques. The period for which the packing credit is provided is decided by the bank depending upon the time required by the exporter for procuring and manufacturing/ processing the goods. Normally the Packing Credit period should not exceed 180 days. The Bank may provide a further 90-day extension on its own discretion. 3. Follow up of Packing Credit Exporters need to submit stock statement reporting the stocks, which are under pledge or hypothecation to the bank for securing the Packing Credit Advance. The bank decides the frequency of submission of the stock statements at the time of sanctioning the Packing Credit. The Authorized Dealers (Banks) also physically inspect the stock at regular intervals. 4. Liquidation of Packing Credit Advance Packing Advance will always be liquidated with export proceeds of the relevant shipment. Packing Credit Advance can also be liquidated with proceeds of payment receivable from Government of India or from any other relevant source. For any reason, if the export does not take place at all, the entire advance is recovered at commercial interest rate plus a penal rate as decided by the bank.
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5. Overdue Packing Credit If the borrower fails to liquidate the Packing Credit on the due date/ extended due date, the bank considers it overdue. In case the overdue position persists, the bank takes steps to realise its dues as per usual recovery procedures.
Post-shipment financing Post-shipment finance is a loan, advance or any other credit provided by an institution to an exporter of goods from India. This finance is granted from the date of extending the credit after shipment of the goods to the realization date of the export proceeds. Purpose of Finance: Post- shipment Finance is meant to finance export sales receivables after the date of shipment of goods to the date of realisation of exports proceeds. Basis of Finance: Post-Shipment Finance is provided against evidence of shipment of goods or supplies made to the importer or any other designated agency. Form of Finance Post-Shipment Finance can be secured or unsecured. Since the finance is extended against evidence of export shipment and banks obtain the documents of title of goods, the finance is normally self-liquidating. In cases that involve advances against undrawn balance, it is unsecured in nature. Quantum of Finance: Post-shipment Finance can be extended up to 100% of the value of goods. However, where the domestic value of the goods exceeds the value of the export order or the invoice value, finance for the price difference can also be extended if such a price difference is covered by receivables from the Government. Period of Finance: Post-Shipment Finance can be short term or long term, depending on the payment terms offered by the exporter to the overseas buyer. In case of cash exports, the maximum period allowed for realisation of export proceeds is six months from the date of shipment. Banks can extend post-shipment finance at lower rate up to normal transit period/ notional due date, subject to a maximum of 180 days.
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Financing for various types of Exports Post –Shipment Finance can be provided for three types of exports: Ø Physical Exports: In case of Physical Exports, Post-Shipment Finance is provided to the actual exporter or to the exporter in whose name the trade documents are transferred. Ø Deemed Exports: In case of deemed exports, Finance is forwarded to the supplier of the goods. These goods are supplied to the designated agencies. Ø Capital Goods and Project exports: In case of exports of Capital Goods and Project Exports, Finance is sometimes extended in the name of overseas buyer. The disbursal of money is directly made to the domestic (Indian) exporter.
Buyer’s Credit As seen in the case of capital goods and project exports, credit is sometimes extended directly to the foreign buyer. Buyer’s Credit is a financial arrangement whereby a financial institution in the exporting country, or another country, extends a loan directly or indirectly to a foreign buyer to finance the purchase of goods and services from the exporting country. This arrangement enables the buyer to make the payments due to the supplier under the contract. Supplier’s Credit Finance extended by suppliers to buyers in their own name is referred to as Supplier’s Credit. Hence, Supplier’s Credit is a financing arrangement under which an exporter extends credit to the buyer in the importing country to finance the buyer’s purchases. Types of Post-Shipment Finance The Post-Shipment finance can be classified as: 1. Export Bills purchased/ discounted 2. Export Bills Negotiated 3. Advance against export bills sent on collection basis
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4. Advance against export on consignment basis 5. Advance against undrawn balance on exports 6. Advance against receivables from Government of India 1) Export Bills purchased/ discounted (DA & DP Bills) Export Bills (Non LC Bills) representing genuine international trade transactions, strictly drawn in terms of sale contract may be discounted or purchased by the banks. Proper limit ahs to be sanctioned to the exporter for purchase of export bill facility. If the exporter is not covered under L/C, risk of non-payment may arise. This risk is more pronounced in case of Documents under Acceptance.
2) Export Bill Negotiated (Bills under L/C) Letter of Credit is a secure mode of trade transaction. Since the issuing bank guarantees payment, subject to the condition that the beneficiary meets the terms and conditions of the LC, hence the risk of payment is low. Also, if a reputed bank guarantees the payment by confirming the LC, the risk is reduced further. Due to this inherent security provided by this mode, banks are often ready to extend finance against bills under LC. However, it is to be noted that the bank still faces two major risks in this case. First is the risk of non-performance by the exporter, wherein in case the exporter is unable to meet his terms and conditions, the issuing bank would not honor the LC. Secondly, the bank also faces the Documentary Risk, wherein if the issuing bank notices some discrepancy in the documents supplied, it may refuse to honor its commitment. Hence, it becomes extremely important for the negotiating bank and the lending bank to thoroughly scrutinize the terms and conditions of the LC and the documents submitted by the beneficiary in support of the same.
3) Advance against Export Bills sent on collection basis At times the exporter might have fully utilized his bills limit and in certain cases the bills drawn under LC may have some discrepancies. In such cases, the bills will be sent on collection basis. In some cases the exporter himself may request the bill to be sent on collection basis, anticipating the strengthening of foreign currency. Banks may allow advance against these collection bills to an exporter.
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4) Advance against Export on Consignment Basis Goods are exported on consignment basis at the risk of the exporter. The overseas branch/ correspondent of the bank is instructed to deliver the documents against trust receipt. Advances granted against export bill covering goods sent on consignment basis are liquidated from remittance of the sale proceeds within 6 months from the date of shipment, conforming to relevant RBI Guidelines. 5) Advance against Undrawn Balance on Exports In certain line of export trade, it is common practice to leave a certain amount as undrawn balance. Adjustments are made by buyer for difference in weight, quality, etc, ascertained after arrival and inspection of goods. Authorized Dealers (Banks) can handle such Bills provided the undrawn balance is in conformity with the normal level of balance left undrawn in the particular line of export trade, subject to the maximum of 10% of the full export value. Such advances can be provided at a concessional rate up to a maximum period of 90 days.
6) Advance against Receivables from Government Where the domestic cost of production of goods is higher in relation to international price, the exporter may get support from the government so that he may compete effectively in the overseas market. Just as in the case of various foreign governments, the Government of India and other agencies provide support to the exporters under the Export Promotion Scheme. This can be in the form of refund of Excise and Customs duty, known as Duty Drawback. Banks can grant advances to exporters against their entitlements under this category at lower rate of interest for a maximum period of 90 days. These advances being in the nature of unsecured advances cannot be granted in isolation. These are granted only if other types of export finance are also extended to the exporter by the same bank. After the shipment, the exporters lodge their claims, supported by relevant documents to the relevant government authorities. These claims are processed and eligible amount is disbursed. Factoring and Forfeiting Forfeiting and factoring are similar services that serve to provide better cash flows and risk mitigation to the seller. It may be mentioned that factoring is for short-term receivables (under 90 days) and is more related to receivables against commodity sales. Forfeiting can be for receivables against which payments are due over a longer term, over 90 days and even upto 5 years. Both factoring and forfeiting are like bill discounting, but bill discounting is more domestic-related and usually falls within the working capital limit set by the bank for the customer.
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Forfeiting Forfaiting is a mechanism of financing exports: Ø By discounting export receivables Ø Evidenced by bills of exchange or promissory notes Ø Without recourse to the seller (such as the exporter) Ø Carrying medium to long-term maturities Ø On a fixed rate basis (discount) Ø Up to 100% of the contract value
In a forfeiting transaction, the exporter surrenders his rights to claim for payment on goods delivered to an importer, in return for immediate cash payment from a forfeiting agency. As a result, an exporter can convert a credit sale into a cash sale, with no recourse either to him or his banker. Process: Ø Exporter initiates negotiations with prospective overseas buyer, finalizes the contract and the importer opens an LC through his bank in favor of the seller (exporter). Ø Exporter ships the goods as per the schedule agreed with the buyer. Ø The exporter draws a series of bills of exchange and sends them along with the shipping documents, to his banker for presentation to importer for acceptance through latter’s Bank. Bank returns availed and accepted bills of exchange to his client (the exporter) Ø Exporter informs the importers Bank about assignment of proceeds of transaction to the Forfaiting Bank Ø Exporter endorses avalised Bill of Exchange (BOE) with the words ―without recourse‖ and forwards them to the Forfaiting Agency (FA) through his bank Ø The FA effects payments of discounted value after verifying the Aval‟s signatures and other particulars.
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Ø Exporter’s Bank credits Exporter’s Account Ø On maturity of BOE/ Promissory Notes, the Forfeiting Agency presents the instruments to the Aval (Importer’s Bank) for payment.
Factoring Factoring is a continuing arrangement between a financial institution (the Factor) and a business concern (the client), selling goods to trade customers. The Factor purchases the client’s book debts (account receivables) either with or without recourse to the client. For the factoring operations, the pre-requisite is the establishment of a factoring relationship between the client and the factor. On the basis of credit evaluation, the factor fixes limits for individual customers of the client indicating the extent to which, and the period for which the Factor is prepared to accept the client’s receivables for such customers. Ø The client (seller) sells the goods to the customer (buyer) and invoices him in the usual way – inscribing a notification to the effect that the debt due on the invoice is assigned to and must be paid to the Factor
Ø The client offers the assigned invoices to the factor under cover of a schedule of offer accompanied by copies of invoices and receipted delivery challans Ø The factor provides immediate prepayment up to 80% of the value of the assigned invoices and notifies the customer sending a statement of account. Ø Factor follows up with the customer and sends him the statement. Ø The customer makes the payment to the Factor Ø When the customer makes the payment for the invoice, the factor will pay the balance 20% of the invoice value.
Bank Guarantees Guarantees are given by bank on behalf of its customer regarding specific performance/ obligation by the customer to the other party. The guarantee ensures payment to the party with whom the bank’s customer is doing business. Under this, the bank acts as guarantor of a claim or obligation in lieu of the debtor. The bank cannot be held liable in the event that the debtor fails to ―perform‖. The banks obligation is
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limited to its pledge to pay a maximum specified amount on fulfillment of the terms of the commitment. One may note that even though both letter of credit and bank guarantee ensure that the issuing bank guarantees payment, the difference lies in the fact that while LC is a ―positive action‖ instrument, BG is a non performance instrument. Hence, payment is released under LC as and when all the terms of the underlying trade transaction are met. On the other hand, payment is released under BG if and when the terms of the underlying transactions are not complied with.
Kinds of Documents In Trade Finance various documents used are as follows: 1 bill of exchange: A bill of exchange is a negotiable instrument and can be defined as a document in writing drawn by the seller on the buyer for a stated sum of money. A bill of exchange may be drawn on the issuing bank or another drawee bank, but not the importer. D/A means document against acceptance, which means the collecting bank will deliver all the documents to the drawee on the acceptance of the bill of exchange. The payment will be made on the due date by the drawee. D/P means documents against payment; hence in this case unless the payment is made the collecting bank will not release the document to the drawee of bill. 2 Commercial Invoices: A commercial invoice is the most comprehensive commercial document among the entire set of export document or bills. It is the only document in the whole set that carries complete information about the specific commercial transaction between the buyer and seller. A commercial invoice although not a negotiable instrument is also a claim for payment of goods under the term of the commercial contract. It is addressed to buyer by the seller and signed by the seller. In addition a detailed description of the goods together with unit prices total amount payable showing discount or advance payment made if any, terms of payment, weight and packing details, shipping details and marks. It serves as a checklist to all concerned and help to identify a particular consignment. It is also used as main evidence in any assessment of custom duty. 3 Packing list: A packing list is usually accompanies an invoice if there are several packages in one consignment. A packing list identifies the content of each package and also its weight marking and measurement. As the name suggests the list for the convenience of inspection agency at the point of import or cartoon open a selected package, if needed. Packaging list
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is often required by the importing country for custom inspection. The details of the goods contained in the packing list must agree in general terms with those in other document. It must also be signed where ever necessary. 4 Certificate of inspection: A certificate of inspection lends a considerable degree of comfort to the importer with regard to the specification of the goods being purchased. Importer can thus safeguard their interest by arranging for the goods to be inspected by a reputed, independent organization prior to shipment. The inspection certificate forms a part of the document presented by the exporter to the negotiating bank .The certificate of inspection usually contains details such as weighs measurement, composition, quality, packaging and bear the signature and seal of the inspecting organization. 5 Bill of lading: In international trade shipping occupies an important place as a mode of transport. The document evidencing the carriage of goods by sea is called the bill of lading .A bill of lading is a document issued by the shipping company or its agent acknowledging the receipt of goods for carriage ,which are deliverable to the consignee or assignee in the same condition as they were received. A bill of lading is all of the following: 1. Evidence of contract of carriage. 2. Receipt of goods received by the carrier. 3. A document of title to goods, that is, a right to receive the goods therein mentioned.
6 Certificate of Origin: This is a declaration that specifies the country of origin of goods. They are called by the countries wishing to identify the origin of all imported goods for their own reason, i.e. statistical analysis, policy decisions or where there are quotas or other importer restrictions in force or to qualify for special rate of custom duty. It contents normally include: 1. The name and address of the consignor and occasionally the name and address of the manufacture if different. 2. The name and address of the consignee usually the buyer or issuing bank. If the bill of lading is issued to order it may also contain the actual buyer name and details. 3. The country of origin of the goods which may not necessarily be the country from which it‟s being shipped. 4. The mode of transport may be optional but if completed must show the details of the transport document. 5. The number of package, gross or net weight, relevant shipping marks and description of goods which should confirm to other documents.
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7 Bill of Entry: Bill of entry is the documents which are issued by custom department for import of goods and when goods can enter in the importer country .These documents specially detailed includes shipper name, importer and exporter name and details, goods declaration and custom duty explanation and authority sign of clearness of goods.
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SWIFT The Society for Worldwide Interbank Financial Telecommunication ("SWIFT") operates a worldwide financial messaging network which exchanges messages between banks and other financial institutions. The majority of international interbank messages use the SWIFT network. As of September 2010, SWIFT linked more than 9,000 financial institutions in 209 countries and territories, who were exchanging an average of over 15 million messages per day. SWIFT transports financial messages in a highly secure way, but does not hold accounts for its members and does not perform any form of clearing or settlement. SWIFT does not facilitate funds transfer, rather, it sends payment orders, which must be settled via correspondent accounts that the institutions have with each other.
Nostro, Vostro &Loro To facilitate dealings in foreign exchange, a bank in India maintains accounts with banks abroad. Similarly some foreign banks may maintain accounts with bank of India. In banking terminology these are known as Nostro account, Vostro account, and Loro account. a) Nostro Account: Nostro means our account with u. e.g.: Punjab national Bank maintains an account with JP Morgan Chase. b) Vostro Account: The account opened by a foreign bank in Indian rupee with an Indian bank would be referred by all correspondence by Indian banks as vostro account, meaning your account with us. c) Loro Account: Loro account means their account with you.
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ANALYSIS EXPORT FINANCING CASES CASE I On 29.01.05 punjab national bank jalandhar branch Purchased an Export bill for US Dollar 28000 from a party ABC LTD under invoice, packing list, certificate of origin, shipping bill of exports, bill of exchange, Form A.R.E 1. ABC Ltd is into business of ―Flat transmission Rubber belts‖. On 29.01.05 bank issued L/C to the party (ABC Ltd) who is exporting the goods to the party in Dar es Salaam, Tanzania. L/C is expiring on 15.03.05. All documents of negotiation are annexed in annexure 1. The shipment as been loaded on 20.02.05 on FOB (freight on board ) from Mumbai port and the payment is received from the importer in Tanzania by the exporter in Jalandhar .The exchange rate applied by the Punjab National bank is BC buying which Is Rs 44.0660/ USD as on 29.01.05. Bank has applied exchange margin of 0.15%. L/C amount = $ 28,000 Rate applied = Rs 44.0660/ USD Exchange Margin = 0.15% Net Rate applied = 44.0660 – 0.15% of 44.0660 = 44.0000
Amount in Rs= 28000 * 44.0000= Rs 1232000
Transit period = 45 days Bank Rate applied= 8.75% Therefore Interest charged by bank = (1232000*8.75*45)/ 100 *365 = Rs 13290.00
Net Amount Payable to L/C holder = Rs 1232000- 13290 = Rs 1218710 Amount Credited in L/C holder’s (ABC LTD) A/C is Rs 1218710 HARSH KHANNA, PGDM(F
)
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Amount Remunerated in Bank’s A/C in lieu of foreign exchange is ( Interest + Margin) which is Rs 15138
Amount Debited From Foreign Outward Bill Negotiated Under L/C (FOBNLC) by Rs 1233848
CASE II On 12.11.06 punjab national bank jalandhar branch Purchased an Export bill for US Dollar 45,000 from a party ABC LTD under invoice, packing list, certificate of origin, shipping bill of exports, bill of exchange, Form A.R.E 1. ABC Ltd is into business of ―Sports Goods‖. On 12.11.06 bank issued L/C to the party (ABC Ltd) who is exporting the goods to the party in London, U.K. L/C is expiring on 15.01.07. All documents of negotiation are annexed in annexure 2. The shipment as been loaded on 31.12.06 on FOB (freight on board ) from Mumbai port and the payment is received from the importer in UK by the exporter in Jalandhar .The exchange rate applied by the Punjab National bank is BC buying which Is Rs 46.0691/ USD as on 12.11.06. Bank has applied exchange margin of 0.15%.
L/C amount = $ 45,000 Rate applied = Rs 46.0691/ USD Exchange Margin = 0.15% Net Rate applied = 46.0691 – 0.15% of 46.0691 = 46.0000
Amount in Rs= 45000 * 46.0000= Rs 20,70,000
Transit period = 64 days Bank Rate applied= 8.75% Therefore Interest charged by bank = (2070000*8.75*64)/ 100 *365 = Rs 31759
Net Amount Payable to L/C holder = Rs 2070000- 31759 HARSH KHANNA, PGDM(F
= Rs 2038241
)
44
Amount Credited in L/C holder’s (ABC LTD) A/C is Rs 2038241 Amount Remunerated in Bank’s A/C in lieu of foreign exchange is ( Interest + Margin) which is Rs 34868.5 Amount Debited From Foreign Outward Bill Negotiated Under L/C (FOBNLC) by Rs 2073109.5
CASE III On 13.12.06 punjab national bank jalandhar branch Purchased an Export bill for US Dollar 23,020 from a party ABC LTD under invoice, packing list, certificate of origin, shipping bill of exports, bill of exchange, Form A.R.E 1. ABC Ltd is into business of ―Automobile Tyres‖. On 13.12.06 bank issued L/C to the party (ABC Ltd) who is exporting the goods to the party in Nigeria. L/C is expiring on 15.01.07. All documents of negotiation are annexed in annexure 3. The shipment as been loaded on 29.12.06 on FOB (freight on board ) from Mumbai port and the payment is received from the importer in Nigeria by the exporter in Jalandhar .The exchange rate applied by the Punjab National bank is BC buying which Is Rs 44.6770/ USD as on 13.12.06. Bank has applied exchange margin of 0.15%.
L/C amount = $ 23,020 Rate applied = Rs 44.6770/ USD Exchange Margin = 0.15% Net Rate applied = 44.6770 – 0.15% of 44.6770 = 44.6100
Amount in Rs= 45000 * 44.6100= Rs 10,26,922 Transit period = 33 days Bank Rate applied= 8.75% Therefore Interest charged by bank = (1026922*8.75*33)/ 100 *365 = Rs 8124 Net Amount Payable to L/C holder = Rs 1026922- 8124 HARSH KHANNA, PGDM(F
= Rs 1018798
)
45
Amount Credited in L/C holder’s (ABC LTD) A/C is Rs 1018798 Amount Remunerated in Bank’s A/C in lieu of foreign exchange is ( Interest + Margin) which is Rs 9666 Amount Debited From Foreign Outward Bill Negotiated Under L/C (FOBNLC) by Rs 1028464
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CREDIT APPRAISAL FOR INTERNATIONAL TRADE FINANCE
(S.H FIBRES LTD) Introduction- This is a Public Ltd. Company which is engaged in the manufacturing and export of Mink Blankets. The company is availing term loan and working capital limits from the bank. It has approached the bank for sanction of fresh term loan of Rs.5.00 crores for purchase of plant and machinery under Revised TUF Scheme and enhancement in the CC(H) limits from Rs.27.00 crore to Rs.32 crores.
YEAR OF INCORPORATION: 14.05.1993. DATE OF COMMENCEMENT OF PRODUCTION : 18.05.1993. ACTIVITY : Manufacturing and export of Mink Blankets, Non-woven/woven carpets. DIRECTORS : The following are the directors of the company : Sh. Shital Vij Managing Director 1. Smt. Vani Vij 2. Sh. Sheetesh Vij 3. Ms. Ruchi Vij. 4. Sh. Abhishek Vij. 5.
Sh. Shital Vij is in the line of activity for the last two decades.
RESOLUTION OF DIRECTORS : The directors have resolved on 23.04.2012, for sanction of fresh term loan of Rs.5.00 crores and enhancement in working capital limits from Rs.27 crores to Rs.32 crores from PNB Industrial Area Jalandhar. The proposed installed capacity of the units is as under : I. 2.8 millions mink blankets per annum. At the average sale price of Rs.1000/- per blanket , it comes out to be Rs.280 crores per annum. II. 2.80 millions metre of Polyester/polypropylene lining and non-woven carpets per annum. At the average sale price of Rs.103.75/- per non-woven carpet/lining , it comes out to be Rs.29.05 Crores per annum. III. The installed capacity of the weaving cloth is 2.20 million meters per annum. At the average sale price of Rs.124/- per metre , it comes out to be Rs.27.28 Crores per annum. HARSH KHANNA, PGDM(F
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Total installed capacity of the unit is around Rs.336.00 crores , after addition of the proposed machinery.
TECHNICAL ANALYSIS OF S.H FIBRES LTD PAST PERFORMANCE OF THE COMPANY: (Amt. in Lacs) Sr. No.
1
Particulars
2009-10
2010-11
2011-12
last Year
last year
current year
actual
actual
provisional
9081.51
10910.60
13727.09
815.37
867.32
906.53
29.72
40.47
28.10
Gross Sales i
Domestic Sales
ii
Export Sales
iii
Other Revenue Income
Total
2
Less: Excise Duty
3
Net Sales (items 1-2)
4
9926.60
0.00
11818.39
0.00
14661.72
0.00
9926.60
11818.39
14661.72
Profit Before Tax/ Loss
319.35
499.41
515.83
5
Net Profit /Loss
226.54
414.54
424.83
6
Tangible Net Worth
5136.21
5481.81
5901.76
7
Net Working Capital
1992.66
1328.08
1713.96
8
Current Ratio
1.47
1.29
1.26
9
Total Outside Liab/Tangible Net Worth
1.01
1.25
1.68
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10
Total Term liab/Tangible Net Worth
0.19
0.41
0.56
COMMENTS : SALES : The sales of the company have improved from Rs.11800.39 lacs to Rs.14661.72 lacs during 2011-12, showing a growth of 24.06%. NET WORIKING CAPITAL : NWC available with the company has increased from Rs.1328.08 lacs to Rs.1713.96lacs during 2011-12. CURRENT RATIO : Current ratio of the company has declined from 1.29:1 to 1.26:1 , but is still within acceptable parameters, being an export oriented unit.
DEBT EQUITY RATIO : Debt Equity Ratio of the company has increased from 0.41:1 to 0.56:1, during 2011-12, but it is well within norms. ALLIED CONCERNS : Details of allied concerns, alongwith balance sheets thereof , may be obtained from the company.
DETAILS OF EXISTING CREDIT FACILITIES : The following credit facilities have been sanctioned by the bank on 02.03.2011, the proposed credit facilities have been mentioned under the Head ―proposed
Nature
Existing
Proposed
CC(H/ BD)*
27.00
32.00
Packing Credit
3.50
3.50
FOBP/ FOUBP/ FAUBC
2.00
2.00
FBWC
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Nature
Existing
Proposed
FOBNLC
3.00
3.00
LOU Limit
5.00
5.00
27.00
32.00
FLC /ILC(DP/ DA) – Raw Material
15.00
15.00
FLC ( DP/DA) – Spares
0.50
0.50
FLC ( DP/DA) – Machinery
3.00
3.00
ILG/FLG
1.00
1.00
NFB Limit Ceiling
15.00
15.00
Total FBWC + NFB
42.00
47.00
Term Loans Existing to continue
25.34
25.34
Fresh Term Loan
0.00
5.00
Total Term Loans
25.34
30.34
Total Exposure
67.34
77.34
( To be allowed within PBF for FBWC limits) PBF Ceiling
Non Fund Based Limits
Term Loans
HARSH KHANNA, PGDM(F)
50
SWOT ANALYSIS :
STRENGTH Promoters have vast experience of textile industry Closely held public limited company Leader in manufacturing of mink blankets and carpets Location Advantages
WEAKNESS Unit not highly professionally organized. Similar types of units are not available locally, hence there may be problem of skilled labour at any point of time
OPPORTUNITIES Company has
diversified
into in-house manufacturing
of yarn and non-woven
carpets.
THREATS The unit is facing stiff competition from cheaper Chinese goods. Strong Indian rupee may affect exports adversely
HARSH KHANNA, PGDM(F
)
51
PROJECTED PROFITABILITY STATEMENT : Amt. in lacs
This has been explained as under
2009-10
2010-11
2011-12
2012-13
2013-14
last Year
last year
last year
Current year
following
actual
actual
provisional
project
year project
3
4
5
6
7
9081.51
10910.60
13727.09
16000.00
16200.00
815.37
867.32
906.53
1500.00
1600.00
29.72
40.47
28.10
20.00
20.00
Total
9926.60
11818.39
14661.72
17520.00
17820.00
Net Sales
9926.60
11818.39
14661.72
17520.00
17820.00
x
8922.15
10421.47
13057.88
15393.65
15579.96
8915.16
10454.91
13022.23
15319.19
15575.69
Sr. No.
1
2
3
Particulars
Gross Sales i
Domestic Sales
ii
Export Sales
iii
Other Revenue Income
Cost of Production
4
Cost of Sales
5
Profit Before Tax/ Loss
319.35
499.41
515.83
856.89
949.71
6
Net Profit /Loss
226.54
414.54
424.83
571.97
633.93
COMMENTS : The company has projected a sale figure of Rs.17520 lacs for the year 2012-13. During the year 2011-12, the company has achieved a sale figure of Rs.14661.72lacs, after achieving 24.06% growth. Now with the installation of proposed plant and machinery, sale of the unit is likely to get a boost, on account of balancing of machinery & variety available in the unit.
HARSH KHANNA, PGDM(F)
52
COST OF PROJECT & MEANS OF FINANCE: Cost of project and means of finance of the new unit have been shown under, which is considered to be in order.
Total estimated cost of project & Means of Finance is as under:(Amt. in lacs) COST OF PROJECTS As at end of
Addition / Deletion upto
Total
As at end of 2012-13
2011-12 Fixed Assets (Gross)
10062.84
711.63
711.63
10774.47
Long Term Investment
137.26
0.00
0.00
137.26
Margin Money for NFB
142.00
8.00
8.00
150.00
Security Deposit
62.80
0.00
0.00
62.80
Other Investment
0.00
0.00
0.00
0.00
550.05
-105.05
-105.05
445.00
0.00
0.00
0.00
0.00
1713.96
319.73
319.73
2033.69
1 Land i Building ii Plant & Machinery iii Furniture & Fixtures iv Other Fixed Assets v
2 3 4 5 Other Non Current Assets 6 Preliminary Expenses W/O 7 Net Working Capital 8 12668.91
0.00
934.31
934.31 13603.22
TOTAL
MEANS OF FINANCE Shareholders Fund 1 137.50
0.00
0.00
137.50
Share Application Money
0.00
0.00
0.00
0.00
Share Premium
0.00
0.00
0.00
0.00
5173.32
544.47
544.47
5717.79
590.94
0.00
0.00
590.94
Share Capital a d c Free Reserves d Deferred Tax Liabities e Loan Funds 2
a
b
Unsecured Loan Bank
Term Loans
909.02
0.00
0.00
909.02
2376.53
50.25
50.25
2426.78
HARSH KHANNA, PGDM(F
)
53
3
c
Debentures
0.00
0.00
0.00
0.00
d
Preference Share Capital
0.00
0.00
0.00
0.00
e
Deferred Payment Credit
0.00
0.00
0.00
0.00
f
Other Term Liabilities
0.00
0.00
0.00
0.00
3481.60
339.59
339.59
3821.19
Depreciation Reserves TOTAL
12668.91
0.00
934.31
934.31 13603.22
COMMENTS : The company has proposed to raise fixed assets amounting to Rs.675lacs (plus contingencies +pre-operative intt + up front fee) during 2012-13 and has requested for a fresh term loan of Rs.5 crores during 2012-13.
COMPUTATION OF WORKING CAPITAL REQUIREMENTS : The working capital limits (PBF) of Rs.27.00 crores ( for 2011-12) have been sanctioned by bank on 02.03.2011. Now the company has requested for enhancement in the PBF from Rs.27.00 crores to Rs.32 crores. The level of projected sales has been kept as per trend during 2011-12. The matter was taken up with the company who have given the justification as under : JUSTIFICATIONS : The company is in process of up gradation/ modernization of their existing manufacturing facilities. Quality improvement of the products and simultaneously making them cost effective to keep the price of finished products low with edge towards its competitors. In this process besides increase in turnover as well as cost reduction is seen. The company is adding plant and machinery to balance the existing set up, identify latest and hi-tech equipment as a continuous process and improve the quality of the finished products in terms of its lustrous looks and utility. For the proposed working of the units, level of current assets and current liabilities have been taken as under :
RAW MATERIAL
EXISTING LEVEL (Months) 20101.68
EXISTING LEVEL (Months) 3.40
PROPOSED LEVEL (Months) 2012-13 1.75
SPARES
8.81
6.40
9.00
STOCK IN PROCESS
0.50
0.50
0.50
FINISHED GOODS
0.17
0.17
0.20
RECEIVABLESDOMESTIC RECEIVABLESEXPORT
3.23
3.14
3.00
3.56
2.69
2.00
NATURE
HARSH KHANNA, PGDM(F)
54
1.90
CREDITORS
3.40
2.00
The level of raw materials & spares has been taken as per requirements of the unit., Levels of finished goods , debtors have been taken as per past trend. Level of sundry creditors is expected to come down after sanction of enhanced limits. The level of stock in process has been taken as 0.50months, keeping in view the processes involved. The PBF proposed by the company is within the acceptable norms of the bank. Therefore, proposed PBF is considered need based and reasonable at the proposed level of business activity of the company DEBT SERVICE COVERAGE RATIO : Average DSCR , comes out to 2.38:1, which is considered as satisfactory.
BREAK EVEN POINT : Break even point and cash break even point for the year 2012-13, come out to be 53.61 % and 35.23 % respectively, which is considered as satisfactory. ASSUMPTION FOR CALCULATION OF ESTIMATES OF PROFITABILITY
1. 2. 3. 4. 5. 6. 7.
The Unit will work for 300days in a year, 8 hours per day. The Unit will operate at 52.14% C.U. in the first year, 53.04% in the 2 nd year,53.93% in the third year , 54.82% in the 4th year, 55.71% in the 5th year and so on. The purchase will be made from global market. The expenses for the projected years are worked out on the basis of the past working of the company by keeping in view same trend for the future. Admn. & selling expenses have been taken at 3.50% of the total sale receipts. Depreciation on SLM basis has been calculated as per rates provided in the companies Act. Average interest on CC(H)/PC has been taken as 12.00%, Existing Term Loan at 13.50% and Fresh Term Loan at 13.50%. Repayment of term loan(mach) in 72 equal monthly installments w.e.f. April 2013.
MPBF ANALYSIS PARTICULARS
2009-10
2010-11
2011-12
2012-13
2013-14
2014-15
2015-16
2016-17
2017-18
2018-19
Total Current Assets
6223.49
5927.73
8326.56
7913.20
8297.53
8832.80
9225.81
9659.50
9989.34
11010.63
Other Current Liabilities
2448.50
2377.90
3535.36
2679.51
2727.82
2811.86
2891.44
2965.87
3034.97
3146.26
Working Capital Gap
3774.99
3549.83
4791.20
5233.69
5569.71
6020.94
6334.37
6693.63
6954.37
7864.37
HARSH KHANNA, PGDM(F)
55
NWC - Stipulated
1509.37
1417.68
2030.89
1915.80
2007.71
2137.37
2231.45
2335.71
2414.00
2665.16
NWC - Projected
1992.66
1328.08
1713.96
2033.69
2369.71
2820.94
3134.37
3493.63
3754.37
4664.37
PBF - I
1782.33
2221.75
3077.24
3200.00
3200.00
3200.00
3200.00
3200.00
3200.00
3200.00
PBF - II
1782.33
2132.15
2760.31
3200.00
3200.00
3200.00
3200.00
3200.00
3200.00
3200.00
MPBF
1782.33
2132.15
2760.31
3200.00
3200.00
3200.00
3200.00
3200.00
3200.00
3200.00
The company has requested a Fund Based finance of Rs. 3200 lakhs. As per the table above, the Fund Based finance (MPBF) available to S.H FIBRES LTD Ltd is Rs.3200 lakhs for financial year 2012 – 2013.
POSITION OF A/C
Nature
Limit
VS
DP
Balance
FB CC(H) 8716068
1500
2539 1904.3
1632.16
CC (Interchangeability)
700
Packing credit
350
470
350
349.47
FOBP/FOUBP/FAUBC(UF)27
200
32.16
32.16
8.47
FOBNLC/FOUBNLC
300
0
0
0
PBF Ceiling
2200.00 (1500+700)
1990.1
NFB FLC (DP)- Raw Mater FLC (DP) - Spares FLC (DP)-Machinery FLC (DA) Ceiling of FLC ILC (DA/DP)
600(1300-700)
285.71
50
17.34
300
*354.67
1000
0
600.00 (1300700) 150
657.72 150
HARSH KHANNA, PGDM(F)
56
ILG/flg
80
48.3 11.06
FLG CEILING NFB
Total Commitment
Term Loan – IB20207
1500.00700.00=800.00
867.08
3000
2857.18
120
133
52.57
500
767 374.81
52.57 374.81
Term loan - IB20377 Term loan – IB20386 Term Loan – IB 20465 Term loan – IB20553 Term loan – IB 20562 Term loan – IB 20571
66
135
52.22
900 1519.5 761.83 5.35
8.1
52.22 761.83
4.9
4.9
435 329.68
435
435
65 109.27
65
65
1746.33
PBF ANALYSIS
HARSH KHANNA, PGDM(F)
Calculation of PBF Actual
31.03.11
Last Accepted 31.03.11
Projected
Projected
31.03.12
31.03.13
by HO Chargeable current assets 74.26
64.48
Other current assets
69.53
70.40
9.61
12.58
7.32 9.01
Total Current Assets 83.27
71.80
79.14
82.98
28.87
21.89
20.19
20.26
Minus Creditors
Minus OCL
4.47
57
6.49
6.61
7.02
Working Capital Gap (A)
Minimum required NWC (25 % of CCA other than Export Receivables) - B
47.91
45.44
52.34
55.70
20.31
17.26
19.16
20.08
17.14
18.44
20.34
23.70
27.60
28.18
33.18
35.62
30.77
27.00
32.00
32.00
30.77
27.00
32.00
32.00
Projected NWC ( C )
Item A minus B
Item A minus C
MPBF Accepted
BALANCE SHEET ANALYSIS
LIABILITIES
Capital Authorised
Capital Paid Up
Audited
Audited
Prov.
Projected
Projected
31.03.09
31.03.10
31.03.11
31.03.12
31.03.13
1.50
1.50
1.50
1.50
1.50
1.38
1.38
1.38
1.38
1.38
57.17
63.24
5.91
5.91
64.46
70.53
9.09
9.09
24.27
18.17
97.82
97.79
32.00
32.00
Reserve & Surplus
46.91
51.73
47.53
Less Integible Assets Deferred Tax Liabilities
3.07
Tangible Net Worth
Unsecured Loans
5.91 51.36
5.91 59.02
54.82
5.51
6.32
4.01
16.08
9.09
Dealer Security Secured Loans
Total Long Term Funds
60.88
Bank Borrowing
17.82
77.22
22.22
23.76
91.87
30.77
HARSH KHANNA, PGDM(F)
58
S. Creditors - Trade
S. Creditors - Capital Goods
S. Creditors - Non Trade
18.07
0.83
1.66
2.18
5.79
Total Creditors
Adv. From Buyers
Taxatioin Prov.
Other current Liabilities
21.08
20.26
20.19
20.26
0.80
2.71
0.90
1.00
0.72
0.85
0.91
2.85
3.16
1.77
1.24
2.87
2.86
2.86
58.80
59.28
42.31
Total Liabilities
33.76
66.13
46.00
103.19
Fixed Assets - Net
Security Deposits
28.87
20.89
20.19
0.92
Total Current Liabilities
Investments
28.87
13.44
123.22
158.00
65.81
56.12
157.07
156.62
69.53
66.14
1.37
1.37
1.37
1.37
1.37
0.21
0.30
0.63
0.63
0.63
0.94
1.50
1.42
1.50
1.50
73.03
69.64
17.50
17.56
Debtor & adv. doubtful of recovery Margin Money for NFB
Total Long Term Outlay
36.28
Stocks in Hand- Raw Material
16.20
Stocks - Other Consumable Store
Stocks in Hand- S.I.P.
Stocks in Hand- Finished Goods
69.23
59.29
28.56
15.26
0.50
0.43
0.50
0.57
0.58
2.07
0.83
5.44
6.41
6.49
1.78
1.46
1.81
2.55
2.60
27.03
27.23
40.00
40.50
Stocks in Hand- Total
20.55
S. Debtors Inland
23.43
17.98
26.79
36.31
35.92
S. Debtors Export
HARSH KHANNA, PGDM(F)
59
1.86 Debtors Total
Loans & Advances
Cash & Bank Bl.
Other Current Assets
25.29
Profit After Tax
43.17
6.77
8.39
7.02
3.36
3.60
4.26
5.73
3.47
3.13
0.55
1.55
79.14
82.98
4.45
4.45
62.23
4.68
83.27
59.26
4.67
5.50
103.19
123.22
158.00
-
-
-
31.03.10
90.82
109.11
31.03.11 137.27
157.07
156.62 31.03.12
31.03.13 162.00
160.00
8.15
8.67
9.07
15.00
16.00
0.30
0.40
0.28
0.20
0.20
Gross Sales/ Receipts
Tax
42.50
5.46
Sales - Domestic
Profit Before Tax
2.67
2.52
31.03.09
Income Receipts Others
37.95
29.36
2.50
1.43
Total Assets
Sales - Exports
2.03
2.27
Total Current Assets
Non Current Assets
2.57
99.27
118.18
146.62
178.20
175.20
3.19
4.99
5.16
8.57
9.50
0.93
0.85
0.91
2.85
3.16
2.26
4.14
4.25
5.72
6.34
2.57
3.32
4.10
3.40
3.40
4.83
7.46
8.35
9.12
9.74
64.46
70.53
20.34
23.70
1.35
1.40
Intt. on capital + Partner salaries Depriciation
Cash Accrual - Post Tax
Net Worth
51.36
Net Working Capital
19.92
Current Ratio
1.47
59.02
54.82
17.14
13.26
1.29
1.26
Debt Equity Ratio HARSH KHANNA, PGDM(F)
60
TOL/TNW
0.19
0.41
0.56
0.52
0.39
1.01
1.25
1.68
1.43
1.23
COMMENTS Taking the past and projected financials of the enterprise into consideration it can be inferred that the future performance of the company is expected to be favorable. The sales of the enterprise are expected to rise. Ratios such as the Debt Equity Ratio, Interest Coverage Ratio and TOL/TNW Ratio are within the benchmark levels. In addition, Fixed Assets and Net Worth of the enterprise is rising which again indicates the strengthening financial position of the enterprise.
FINAL VERDICT the exports from India are rising and the potential of growth for international Trade for enterprises like SH Fibres Ltd is large. Therefore, the project can be considered promising and viable. The credit usage is technically feasible & economically viable. So bank should not think twice before increasing the credit limit and working capital requirement of the company.
HARSH KHANNA, PGDM(F)
61
RISK MANAGEMENT IN INTERNATIONAL TRADE: Risk is inherent in International transactions due to the following reasons: 1) Trade across countries involves dealings with parties – Importers and Exporters – who are unknown and whose creditworthiness is uncertain. 2) Foreign Trade involves dealing in currencies other than the domestic currency which is subject to fluctuations.
1. Creditworthiness of Importer: Exporters and Importers are unknown to each other, therefore, most of the International Trade transactions take place only with a Letter of Credit document issued by the importer’s bank and negotiated through the Exporter’s bank. In cases where there is no Letter of Credit document involved in the trade transaction it is because the parties involved in trade are known to each other. A bank would issue a Letter of Credit only after ensuring that the client is capable of fulfilling the financial liability involved in the contract. Kids Ware Pvt. Ltd. was approved a credit limit of Rs.5,482.5 lakhs for LC from all sources. Any credit required in the form of LC cannot exceed the approved amount unless there are any significant changes in the financial position or requirements of the enterprise.
2. Creditworthiness of Exporter:
Banks are subject to risk when the Exporter applies for Export Finance for procuring raw materials for manufacturing the ordered goods or other purposes. While disbursing credit to the exporter the banks ensure that the client has a sound financial position. An in depth study of the client’s past balance sheet, Profit and Loss Statements and Cash Flows is carried out. In addition,the future outlook of the sector in which the client is dealing is assessed. The credit facility is awarded only after suitable collateral is submitted to the bank. In case of a new project, the financial viability of the project is also an important consideration. Kids Ware Pvt. Ltd. was assigned a credit limit of Rs. 10,499.25 lakhs (from all sources) as fund based finance for Packing Credit, Foreign and Inland Bill Purchase/ Negotiation based on its past performance and the favourable outlook for manufacturing sector.
3. Country Risk:
Many countries are having political and economic problems, racial, and communal riots or other disturbances. There is no certainty about their economic and financial policies and their willingness and capacity to repay their loans or service them through their inward remittances. Fundamentals in the economy may be in doubt and there may be inflation and other problems of the country, such as unemployment, poverty, low rates of growth in the economy. They are unable to service or repay their debts to foreigners. To overcome this risk, the banks require the exporter obtain a cover from ECGC. ECGC helps carry the credit risk for the commercial banks and guarantees payment in case of risks relating to buyer, buyer’s country and other unforeseen contingencies.
HARSH KHANNA, PGDM(F)
62
4. Loss of Goods in Transit: After manufacturing, the exporter ships the goods to the importer. Goods are subject to risk of damage while in transit from the exporter to the importer. Therefore, to ensure that there are no losses incurred due to damage of goods in transit the banks require the exporter to obtain a marine insurance. The loss of goods increases the probability of bad debts for the bank. In case of any damage to goods while they are in transit, the marine insurance/ air insurance compensates up to the value of loss suffered or the sum assured whichever is lower. Marine Insurance/ Air Insurance, covers risk of loss only from the time the goods are loaded into the port of shipment and up to the time they arrive the port of delivery.
5. Exchange Rate Risk: Foreign Exchange is subject to fluctuations. As a result of continuous change in prices of currencies exporters and importers are subject to a high degree of risks. Appreciation in domestic currency result in loss for exporter and depreciation of currency results in loss for importers. Exporters and Importers can hedge against the risk of currency fluctuations in the following ways: 5.1. Currency Forward Contracts: When an importer has to make payments (in foreign currency) to the exporter at a future date, he can book a buy (long) position for currency forward by paying a premium. On the date when the payment is due to be made by the importer the required currency amount is available at the strike price of the currency futures. Hence, the importer is safeguarded from the any depreciation in the value of his currency. Similarly, when an Exporter is expecting payments from the importers in a foreign currency, they can invest in a sell (short) position for currency forward in which payment is to be received. When the payments are received by the exporter even if the domestic currency has appreciated in comparison to the currency in which payments have been received the exporter does not suffer any losses. The exporter can accept the payment and the sell the currency in the derivative market at the pre decided strike price. 5.2. Currency Futures Contracts: The futures contract work in the same manner as the forward contracts. The only difference in Futures contract is that the exchange traded contracts and the buyer has the freedom to liquidate the contract at any time before the date of maturity. The clearing house is the counter party which reduces the risk of default. Just as forwards, in futures the receipt of currency is hedged by booking a short position and payment of currency is hedged by booking a long position in the futures market. Kids Ware Pvt. Ltd. can hedge the risk for currency fluctuations for import payments and export receipts by booking long and short position respectively in the same manner as in case of currency forwards. Since currency futures are exchange traded therefore the possibility of counter party default is also taken care of.
HARSH KHANNA, PGDM(F)
63
5.3. Currency Options: Currency Forwards and Futures protect the holder against the adverse exchange rate changes, but they deny them the possibility of windfall gains. An Option gives the holder the right but not the obligation to buy/ sell. If an importer has to make payments at a future date, he can purchase a call option by paying a premium. On the due date, if the spot rate of the currency is greater than the call rate then the importer can utilize the call option. However, if the spot rate is less than the call rate then the importer may not utilize the call option and make payment by obtaining currency at the market exchange rate. Similarly, in case of exports a put option can be purchased. On the date when the payments are to be received, if the spot rate of the currency is lower than the put option then the exporter can utilize the put option and if the spot rate is greater than the put option then the exporter may not utilize the put option and sell the currency at market exchange rate. In future, if the spot rate is less than the call rate and if the spot rate is greater than the put rate the importer and the exporter make a windfall gain respectively. Similarly, to safeguard against the exchange value of export payments Kids ware Pvt. Ltd. Can book a put option at the spot rate which is USD 1 = Rs. 45. On the date when payments are received, then the put option can be utilized if the exchange rate is below Rs. 45. However, in case the exchange rate is greater than Rs. 45 for a dollar then the client may not utilize the put option and sell the received dollar payment in the open market. The expense for mitigation of risk of changes in the exchange rate is limited to the extent of premium paid for booking the currency options. 5.4. Currency Swaps: Currency Swap is the exchange of loan by one party in a particular currency with another party in another currency. In case Exporter I is expecting payment in a foreign currency and at the same time the exporter has obtained a Packing Credit in domestic currency. Now, another Exporter II is also expecting payment in the foreign currency and has obtained a Packing Credit in his domestic currency. To counter against the risk of loss due to currency fluctuations Exporter I and II can exchange their loans and fulfill each other’s loan obligation. By exchanging the loan obligations both the exporter are changing their liabilities in the currency in which they will be receiving their payment. On the due date when the payments are received by the Exporters then they can fulfill the loan obligations of the other party which is denominated in the same currency in which the payments are received and hedge themselves against currency exchange rate fluctuations.
6. Interest Rate Swaps: Loans taken by importers and exporters are subject to risk of interest rate fluctuations. If an exporter has borrowed in floating rate and expects that floating interest rate will increase, then it can swap the loan with an enterprise which has a loan commitment in fixed rate of interest and its expectations are vice versa. The option of Interest Rate Swap as a hedging mechanism is very convenient and does not involve any significant costs.
HARSH KHANNA, PGDM(F)
64
While disbursing credit to the exporter the banks ensure that the client has a sound financial position. The future outlook of the sector in which the client is dealing is assessed. Keeping in mind, elaborate mechanisms and International trade instruments have been developed over a period of time. These instruments are designed to minimize risks of each of the parties involved. Depending upon the level of trust between various parties and the International reputation of each of the parties, different modes of business are adopted.
HARSH KHANNA, PGDM(F)
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RECOMMENDATIONS CONSULTANCY IN INTERNATIONAL TRADE TO SMALL AND MEDIUM ENTERPRISES: Currently Indian Bank provides all services associated with International Trade to well established enterprises engaged in export and import of goods and services from abroad. In such cases bank’s role is limited to the extent of providing the specific service required by the client. However, in India there are a number of Small and Medium Size enterprises engaged in export and import which do not have the expertise required in the management of trade transactions conducted internationally. Recently, a number of export houses suffered huge losses due fluctuations in rupee dollar exchange rates. In addition, such Small and Medium Size enterprises cannot bear the expenses of hiring specialized personnel for taking care of these transactions. Indian Bank can provide consultancy services of supporting Small and Medium Sized enterprises in conducting their International Trade transactions effectively. Apart from advising on the regular export finance and import payment services, Indian Bank can also support the enterprises by advising them as to how should they mitigate the risks associated with International Trade transactions. The bank can guide them as to which financial product should they invest in with regard mitigation of Credit, Market or Operational Risks. PROMOTING GREATER RELIANCE ON TECHNOLOGY: Indian Bank is the most advanced bank as far as technology and its implementation in banking transactions are concerned. Despite this a good percentage of transactional work is carried out manually. There is huge scope for automation of process which can help the bank provide services with greater efficiency and accuracy. In addition a section of work is carried out manually and eventually transferred in the electronic format. This indicates that still complete reliability on the technology does not exist. Therefore, a training program explaining the technology and the contingency arrangements in place can help promote reliance on technology. Hence, it can greatly contribute in effective and efficient functioning of banking processes. Appointing more number of Relationship Managers: A relationship manager should be attached with each client, who not only will collect the documents required for processing but will also make the client aware of the risk associated with forex. Also bank should promote its employees working in Trade Finance to take up an exam in Documentary Credit so that they get a better understanding of the subject. Also they will find themselves growing. Organizing workshops related to trade finance Bank should organize workshops on import and export business credit facilities available for export and import of goods and services, risk management while exporting and importing, various opportunities available for benefits of existing and potential exporters.
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GLOSSARY OF TERMS 1. Invoice: A commercial document issued by the seller, indicating the products, quantities and agreed price for the products or services provided to the buyer. 2. Packing List: A document containing information regarding details of the goods shipped (materials contained, quantity and so on) to the buyer. 3. Certificate of Test: A quality certificate issued to confirm that the goods confirm to the quality standards as required in the original Purchase Order. 4. Certificate of Origin: A document issued by Chambers of Commerce and Industry confirming that the goods exported have been manufactured in India. 5. Bill of Lading: Issued by a shipping company to the shipper as a receipt for the goods, a memorandum of the contract of carriage and a document of title. 6. Bill of Entry: A document issued by the customs department indicating that the goods have arrived at the Port of Destination. 7. Shipping Bill: A document issued by the customs department indicating that the goods have reached the Port of Loading. 8. Airway Bill: It refers to a receipt issued by an international courier company for goods as an evidence of the contract of carriage. 9. Issuing Bank: Bank which issues Letter of Credit on behalf of the Importer to facilitate the contract of trade. 10. Advising Bank: Bank which scrutinizes the Letter of Credit issued by the issuing bank and confirms that the exporter can execute the contract of trade. 11. Fund Based Credit: A credit facility in which there is transfer of funds from the bank into the account of the borrower. 12. Non Fund Based Credit: A facility in which there is no transfer of fund from the bank to the borrower. However, the responsibility of the bank arises when there is a default on the part of the bank’s client. 13. Nostro Account: Used to facilitate international payments, this is the account of a bank with its agent or correspondent in a foreign country which is recorded in the currency of that country. 14. Vostro Account: Used to facilitate international payments, this is the account of a bank with an agent or correspondent in a foreign country which is recorded in the currency of the bank’s own country. .
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REFERENCES http://www.pnbindia.in/ http://www.dgft.gov.in/ http://www.eximguru.com/exim/guides/export finance/ch_1_payment_methods_in_export_import.aspx http://en.wikipedia.org/wiki/Trade_finance http://www.tradefinancemagazine.com/AboutUs/Stub/WhatIsTradeFinance.html http://www.tradefinance.com/ http://www.tradefinancepaths.com/4903.html http://en.wikipedia.org/wiki/Letter_of_credit http://banking.about.com/od/businessbanking/a/letterofcredit.htm http://rbi.org.in/ http://www.iibf.org.in/scripts/pns1_ru_ucp.asp http://files.myopera.com/eictms/files/UCP600vsUCP500.pdf
BIBLIOGRAPHY
Trade Finance, Indian Institute of Banking & Finance, 3rd Edition, Taxxman Publications (P) Limited Export Import Procedures & Documentations, khushpat S Jain, 8th edition, Himalyan Publishing House Cowdell P, Hyde D, International Trade Finance, 6th Edition
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