Session Agenda

• What is Import Finance?
• Buyers’ Credit
• Suppliers’ Credit
• External Commercial Borrowings
• Forex Trade Finance
• Bank Guarantees
• Withholding Taxes

 Import Finance

• Import Finance is, to put it simply, the funding of the gap between receiving the goods, and sending the payment. Furthermore, it is usually seen as a short-term type of finance and is provided by a third party.
• Uniquely, the need for import financing arises due to the difficulties that businesses face when trading overseas alone, however when importers are exploring different financial options this can add further complication.
• The implementation of Import finance has helped encourage, and indeed shape the world of trade. 
• The level of risk and amount of moving variables involved in trading overseas is ever present, however, the application of certain Import finance instruments can help protect businesses.
• Many transactions, and often large sums of money, depend on a certain level of trust with the counterpart involved. 
• Throughout the years, as economies and businesses expand, the mutual trust required for these transactions is built over a period of time (called as track record & in statistics called as Confidence Level), which is where instruments of Trade Finance come into play.
• Due to the differences in regulations and the distance between countries, it can take a considerable amount of time for businesses to receive goods after placing their order from overseas vendors. This can be challenging for small businesses as they may have insufficient funds to meet their short-term cash requirements while waiting on their import deliveries.
• In this circumstances, banks help the importers in India by providing financial assistance through import financing.

Import Financing: Meaning

• Import finance refers to trade financing solutions that are available to import businesses for funding the purchase of goods internationally.
• As a result, import financing allows traders to eliminate their cash flow troubles and fund their growth plans.

An Example of Import Finance: 

• For instance, company A, a steel goods manufacturer from the US plans on importing a large amount of raw steel from company B in China, where steel is cheaper.
• Since company A does not have enough cash at hand to pay for the raw materials, it decides to opt for import financing. It can consider all its available import financing options, of which it decides to use buyer’s credit from the EXIM bank of China.
• Here the EXIM bank can offer credit to company A, in the US which it can use to pay company B as soon as the steel is delivered. 
• Company A can even leverage its ability to make an instant payment because of the finance from Exim Bank, China to get more favorable rates from company B. 
• Then, after selling its manufactured steel goods, company A can repay the EXIM bank.

Uses of Import Financing:

• In addition to optimizing cash flows, the need for import financing occurs for several other reasons, including risk hedging (liquidity hedging as also forex hedging). 
• Import finance is also considered an excellent financial option that comes in handy to meet working capital requirements. 
• Most of these loans also come with flexible repayment timelines, which helps businesses plan their finances to repay their debts conveniently.
• Import financing also enables businesses to maintain strong and long-term supplier relationships. 
• The import financing helps importers to pay their overseas seller promptly, ensuring healthy relationships, enabling efficient, and faster supply chain operations.

Parties involved in an Import Finance Transaction

• There are several parties involved in an import finance transaction, including-
  • Banks
  • Trade finance companies
  • Importers and exporters
  • Insurers
  • Export credit agencies
  • Other service providers

Requirements:

• Import finance and all of the tools which the term covers are reviewed on a case-by-case basis. This being said, a financier will generally ask for the following:
  • Audited Financial Statements
  • Full business plans
  • Future Financial Cash Flow forecasts
  • Credit reports (Dun & Bradstreet Reports)
  • Details and references for the Directors of the Company
  • Information surrounding the liabilities of the company.

What are Popular Import Finance Techniques?

• Businesses can receive import financing through a number of methods:

Import Financing Method # 1 : Advance Payment:

• Also known as cash in advance, this is not strictly considered a method of import financing. Here, the importer simply pays the exporter in advance for the goods.
• The upside of this method is that it is simple and straightforward. The downside is that the importer assumes all the risk (what happens if the goods are not up to standard?) and consumes a lot of the seller’s working capital, which can prevent the business from scaling and even lead to cash flow problems.
• In some parts of the world exporters usually demand advance payment. In China, for example, the standard procedure is a 30% upfront deposit and the remaining 70% to be paid before shipment—essentially a 100% advance payment. These sorts of requirements thus create the need for the other methods of import financing below.

2. Inventory Finance:

• Inventory financing is an import financing option where businesses procure funding to purchase inventory. These loans are typically taken to support the purchase of products that are not meant for immediate sale. Inventory financing can be done in the form of loans, lines of credit, etc
• The collateral against which the loan is taken is the inventory itself. If the businesses cannot repay the loan, the financial institution or the lender can seize the stock that was purchased using the loan.
• Hence, for this method, the resale value of the goods is of utmost importance. Businesses take up inventory loans to keep up with unpredictable spikes in demand or to update their product lines. These loans can also be used to stock up on products that have seasonal demand.
• Companies prefer this type of financing because it does not require lenders to rely on personal or business credit history and is comparatively easy to get approved.

3. Letters of Credit (LCs):

• LCs are one of the most prevalent trade finance instruments. An LC is a legally binding, irrevocable commitment from a financial institution, made on behalf of the importer, undertaking/guaranteeing payment for the goods so long as certain terms are met. In this way, the exporter is now assuming the credit risk of the bank, instead of the importer.
• The pros of using LCs are that they are widely accepted and highly customizable. Although straightforward import/export transactions need no more than the ‘basic’ LC, the terms of LCs can be varied to suit a range of transaction types. The importer can also build in safeguards in the LC, such as stipulations on quality, delivery etc. as conditions for payment.
• The cons are that they are expensive and difficult to obtain—especially for smaller import businesses who do not have collateral to pledge—as the bank now must assume the credit risk of the importer.
• If a bank opens an Import LC on behalf of its import customer, it has to carry out the due diligence exercise on part with funded exposure because, on due date if the importer is not meeting his commitment, the banker has to meet it.
• Further, whatever safeguards the importer can build into the LC are solely based on documentation, rather than actual physical inspection of the goods. (Principle: Banks deal only in documents and not in goods)
• Finally, issuing LCs can also be an extremely cumbersome and time-consuming process—this is a common complaint of the customers.

Steps involved in Import LC transaction: 

1. The Buyer and seller enter into a business contract. The seller needs a letter of credit to guarantee payment on due date

2. Buyer applies to his bank (Issuing bank) for a LC in favor of the seller.

3. Buyer’s bank approves the buyer’s credit risk, issues and forwards the LC to the seller’s bank (Advising bank) usually located in the same geography as the seller.

4. Seller’s bank will authenticate the LC and advise the LC to the seller.

5. Seller ships the goods, and prepares documentary requirements (invoices, bill of lading, insurance certificate etc.) in line with the terms and conditions of the LC.

6. Seller presents required documents to his bank to check and forward the same to the LC issuing bank for payment.

7. Seller’s bank examines the documents for compliance with LC terms & conditions.

8. If the documents are correct, the seller’s bank will forward the ‘compliant documents’ to the LC issuing bank and claim the funds under LC.

9. Buyer’s bank examines documents within 5 banking days and if compliant makes the payment/acceptance to pay on the due date. If the documents are discrepant, the same is advised to the buyer for acceptance of the discrepancies.

10. The buyer’s account will be debited on payment date as per terms mentioned in the LC (sight/usance).

11. In case importer has already asked for finance support from the bank, then the following procedure is adopted on due date/commitment date:

• • • In case of Capital goods imports, it is backed by a Term Loan.
    • In the case of raw materials which form part of the working capital cycle of Importer, it would be backed by a Cash Credit facility.

12. The buyer takes delivery of the goods.

Supply Chain Finance: 

• Supply chain financing (SCF) is when a third party enables a trade transaction by financing the supplier on the buyer's behalf. It is also referred to as supplier finance or reverse factoring.
• Contrary to the traditional transaction, the buyer or importer opts for supply chain financing solutions and approaches the lender when a supplier requests early payment for their goods.
• One of the cases where importers might use SCF is when their vendor requires the payment to be done before the due date. In such a case, the third party will pay the amount to the seller (exporter), and the buyer (importer) will pay the third party when the due date arrives.
• This way, both parties are secured — the seller has the cash to fulfill the purchase order and the buyer can retain their cash until the goods are delivered. Until recently, SCF was only available to large businesses, but is now available to all businesses, making it an easy import financing option.

 Import Finance – Buyer’s Credit

• Buyers' Credit is a short-term working capital trade credit loan or term loan extended to an importer by an overseas lender such as a bank or financial institutions in International Financial Services Centers located in India (Gift City) as well as  from banks in overseas financial centers to finance the import purchase for working capital and capital expenditure.

How it works ?

1. Buyer (Importer) approaches a Bank with the requirement of financing.

2. Bank in India provides a quote from the funding Bank, say HSBC, Hong Kong to the import client.

3. Post acceptance of quotes by the client, the importer's bank proceeds with Documentation and LC issuance.

4. Copy of LC is sent to the funding bank before the payment date.

5. Funding Bank funds our Nostro account of the Exporter’s Bank as per LC terms and Exporter’s Bank makes payment to the Exporter.

6. A loan account is opened in the name of the importer by the funding bank with a counter-guarantee provided by the importer’s bank.

7. On due date the Importer client pays his bank Principal plus applicable Interest and the same is remitted to Funding Bank.

Benefit: 

1. Addresses funding gaps of Importer in cash flow and avail extended credit period subject to the working capital cycle.

2. Importers can also seek better pricing terms from the exporter since the exporter is paid on a cash basis by virtue of a loan backing from the funding bank.

3. Cost effective financing option in foreign currency for imports. Normally, interest rates overseas are cheaper when compared to Indian interest rates.

 Import Finance – Supplier’s Credit

• Normally, all the credit facilities extended to an exporter would fall under general suppliers credit. 
• Supplier credit is a commercial agreement that outlines the exporter’s willingness to provide goods or services to a foreign buyer on credit. 
• The exporter is commonly referred to as the supplier, hence the term “supplier credit”. The technique allows exporters to provide goods or services on credit to foreign buyers/customers.
• Supplier credit facilitates trade expansion as it enables the exporting country to promote exporting its goods including capital goods and services. Another advantage is that such agreements help expand the exporter’s financial channels. Additionally, the cost of financing for exporters through supplier credit, whether under insurance, guarantee, or direct financing, is generally lower than that of consumer loans.
• Exporters normally get a concessional rate of interest in our country as they bring in foreign currency for our country. 
• Suppliers' Credit is a product where in Supplier and Buyer agree on payment terms so that the Supplier (exporter) gets paid at sight/ as per payment terms from his Bank through LC Negotiation and Buyer (importer) gets credit period to make payment as per the tenor of the LC.
• Therefore, Supplier credit is an arrangement for credit extension between an exporter and a buyer.
• Payment on credit terms denotes the foreign buyer’s (importer’s) agreement to pay a single sum at a later time or in several installments on a range of mutually agreed future dates.
• The financing plans are divided into supplier and buyer credits The main difference is that in buyer credit, an importer (a buyer) is responsible for providing the financing; in supplier credit, the supplier is responsible for providing the financing depending on who provides the money.

Steps in Supplier’s Credit:

1. Importers enter into a contract with the supplier (exporter) for import.

2. With transaction details the importer approaches the arranger to get suppliers credit for the transaction.

3.Arranger gets an indicative pricing from an overseas bank, which the importer confirms.

4. Importer approaches his bank and gets LC issued, restricted to overseas bank counters with other required clauses.

5. Overseas Bank confirms the LC and advises LC to Supplier’s (exporter’s) Bank.

6. Exporter’s Bank provides the copy of the LC to the exporter.

Exporter ships the goods and submits documents at his bank counter.

7. The Exporter's Bank sends the documents to the Overseas Bank.

8.Overseas Bank post checking documents for discrepancies (As per UCP 600) sends the document to importer’s bank for acceptance.

9. If documents are as per order, the same is discounted and transferred to the exporter's bank.

10. Incase of discrepant documents, documents are sent on acceptance basis. On receipt of Importer bank acceptance, the same is discounted and transferred to the supplier's bank.

11. Exporters receive the payment for the LC from the Overseas Bank. Overseas Bank creates a loan account in the name of the exporter.

12. If the importer is bearing interest cost, the supplier receives full payment.

13. If the exporter is bearing interest cost, the supplier will receive LC amount minus Interest.

14. The Importer's Bank receives the documents. Importer’s bank and Importer accept documents. Importer’s Bank provides acceptance to Overseas Bank, guaranteeing payment on due date.

15. On maturity, Importer makes the payment to his bank and Importer’s bank makes payment to the Overseas Bank, which closes the exporter’s loan account.

Differences between Buyer’s Credit & Supplier’s Credit

 Import Finance – Supplier’s Credit

RBI Regulations: 

• Over the years there has been many changes in norms. Summary of current rules are given below and for further details please refer article “RBI Trade Credit (Buyers Credit / Suppliers Credit) Circular Extract“
• Maximum Amount Per transaction : $20 Million
• Above $20 Million, RBI Approval required.
• Maximum Maturity in case of import of non capital goods (Raw Material, Consumables, Accessories, Spares, Components, Parts etc): upto 1 year from the date of shipment or operating Cycle whichever is less.
• Maximum Maturity in case of import of capital goods : upto 5 years from the date of shipment (Beyond 3 years banks are not allowed to provide Letter of Undertaking / comfort)
• No Rollover / Extension will be permitted beyond permissible limits
• All-in-cost Ceilings: 6 Month Libor + 350 bps or after Libor regime, left to the interest of the country concerned. 

 External Commercial Borrowings (ECBs)

• External Commercial Borrowings (ECB) are debts taken on by an eligible entity in India from external sources for strictly commercial purposes, i.e. from any recognized entity outside India. These loans are expected to follow the RBI's rules and regulations.
• External commercial borrowing (ECB) are loans made in foreign currency by non-resident lenders to Indian borrowers.
• ECB have proven to be valuable tools in assisting Indian firms and organizations in raising funds from outside of India's borders, particularly when it comes to attracting new investments.
• Debtors/Lenders may include the government, corporations, or citizens of foreign country.
• Money owed to private commercial banks, foreign governments, or international financial institutions such as the IMF and World Bank is included in the debt.
• External commercial borrowings typically have a three-year minimum maturity length.
• The Department of Economic Affairs of the Ministry of Finance, in collaboration with the Reserve Bank of India, supervises and regulates ECB guidelines and regulations.
• Commercial borrowings account for the largest majority of India's external debt.
• The majority of the external debt is still denominated in US dollars.
• Methods to Avail External Commercial Borrowing
• There are currently two methods for using ECB to raise funds: the approval/permission route and the automatic approach.
• Automatic route: The government has created a number of eligibility requirements for people who want to use the automatic method of receiving money. These rules govern, among other things, amounts, industries, and the final use of funds.
• Approval route: The approval method, on the other hand, necessitates explicit authorization from the RBI or the government before obtaining funds through External Commercial Borrowing.
• The RBI has specified the borrowing structure in circulars and formal guidelines.
• The RBI has established the categories of "eligible entities" among borrowers and "recognized non-residents" among potential lenders to ensure that the inflow remains clean.
• Furthermore, it has implemented safeguards such as the ECB, end-use restrictions, minimum maturity periods, and so on.

Eligible Borrowers and Recognized Lenders

• The ECB come in two configurations:
  • Foreign Currency ECB (FCY ECB)
  • Indian Currency ECB (INR ECB)
• The eligible borrower is a catch-all term for any entity that is eligible for Foreign Direct Investment (FDI). Port Trusts, Units in Special Economic Zones, the Small Industries Development Bank of India, and the EXIM Bank of India are examples of specific entities that can be included.
• The ECB will be obtained from "recognized lenders." These terms could refer to any organization that is a member of the International Organization of Securities Commissions (IOSCO) or the Financial Action Task Force (FATF) (FATF).
• In addition to IOSCO and FATF, recognized lenders include multilateral and regional financial institutions of which India is a member, foreign subsidiaries of Indian banks (subject to applicable prudential norms), and individuals (if they are foreign equity holders).
  • RBI has amended ECB framework (March, 2022) clarifying that any widely accepted interbank rate or alternative reference rate (ARR) applicable to the currency of borrowing may be used as a benchmark rate in case of foreign currency denominated ECB.
  • For existing ECBs and TCs linked to London Interbank Offered Rate (LIBOR), the existing all-in-cost ceiling has been revised from 450 bps to 550 bps and from 250 bps to 350 bps respectively, over the ARRs.
  • For new foreign currency ECBs and TCs, the all-in-cost ceiling has been revised from 450 bps to 500 bps and from 250 bps to 300 bps, respectively, over the ARRs.

Understanding the Alternative Reference Rates Committee (ARRC) 

• LIBOR, the London Interbank Offered Rate, was once a key benchmark for setting interest rates worldwide, but after a rate-rigging scandal became public in 2012, banking regulators phased out LIBOR by 31/12/2021.
• In the United States, the Federal Reserve Board and the New York Fed established the Alternative Reference Rates Committee (ARRC) to recommend and help implement a new benchmark to supplant/replace the LIBOR. 
• The AARC currently consists of private-sector members, including the American Bankers Association, Bank of America, Goldman Sachs, JPMorgan Chase, MetLife, and Wells Fargo. Governmental entities, such as the Consumer Financial Protection Bureau, Federal Deposit Insurance Corporation, Federal Reserve Board, National Association of Insurance Commissioners, and U.S. Securities and Exchange Commission, serve as ex-officio members.

External Commercial Borrowings (ECBs)

Advantages of External Commercial Borrowing

1. Low Interest Rate: To begin with, the value of funds borrowed from external sources is generally lower.

• For example, there are numerous economies with lower interest rates; if Indian firms and organizations could borrow at lower interest rates from Europe and the United States, they would undoubtedly benefit.
• For example, Japan had sanctioned India, a 50-year loan at just 0.1% interest to fund the Ahmedabad-Mumbai bullet train link.

2. Borrowing without giving control: Another advantage is that ECB is, at their most fundamental level, simple loans.

• The company's stakes shall not be diluted, despite the fact that they do not have to be of an equity nature.
• Because debtors will not have voting rights in the company, the borrowers will be able to raise funds without relinquishing control.

3. Global Exposure: While ECBs allow borrowers to diversify their investor base, they also provide borrowers with greater exposure to global markets, which can help our business people to cross sell their products.

4. Economic Growth: The government of India can direct inflows into the sector, increasing the sector's potential for growth. For example, the government can allow a higher percentage of ECB funding for the SME and infrastructure industries, thereby contributing to the country's growth.

Disadvantages of External Commercial Borrowing

• Reckless Borrowing: One could speculate that the company's attitude may soften as they increasingly come across funds available at lower rates. This may lead to companies borrowing recklessly, resulting in higher debt on the company's balance sheet and a negative impact on financial ratios.
• Low Creditworthiness: The fact is that rating agencies view companies with more debt on their balance sheets negatively, which could result in a market downgrade for such companies.
• Stock Decline: Furthermore, the company's stock may experience a decline in market value over time.
• Currency Swap: Because funds are raised through External Commercial Borrowing in foreign currencies, the principal and interest must also be paid in foreign currencies. As a result, the company exposes itself to the forex risks associated with currency exchange rates as well as interest rates.
• Restrictions to Borrowing: Although it is established that ECBs can be obtained at lower rates, there are several guidelines and restrictions that must be followed.

 External Commercial Borrowings (ECBs)

• Changes in ECB Rules - July 2020
• Funding of up to 50% (through ECB) is authorized for telecom, infrastructure, and greenfield projects.
• The RBI has issued a rule indicating that through the automated route, all qualifying borrowers can raise ECB up to USD 750 million or equivalent per financial year (earlier it was applicable only to corporate companies).
• The Ministry of Finance's Department of Economic Affairs, in collaboration with the Reserve Bank of India, supervises and regulates ECB guidelines and regulations.

 Bank Guarantees

• Bank Guarantee a promise made by the bank to any third person to undertake the payment risk on behalf of its customers. Bank guarantee is given on a contractual obligation between the bank and its customers. Such guarantees are widely used in business and personal transactions to protect the third party from financial losses. This guarantee helps a company to purchase things that it ordinarily could not, thus helping business grow and promoting entrepreneurial activity.
• For Example- Xyz company is a newly established textile factory that wants to purchase Rs.1 crore fabric raw materials. The raw material vendor requires Xyz company to provide a bank guarantee to cover payments before they ship the raw material to Xyz company. 
• Xyz company requests and obtains a guarantee from the lending institution keeping its cash accounts. The bank essentially cosigns the purchase contract with the vendor. If Xyz company defaults in payment, the vendor can recover it from the bank.
• The Contractors normally take performance guarantees from the bank. Banks guarantee the performance of the contractors to the beneficiaries like Municipalities, Governments etc.
• There are two major types of bank guarantee used in businesses, which are as follows:

Financial Guarantee

• These guarantees are generally issued in lieu of security deposits. Some contracts may require a financial commitment from the buyer such as a security deposit. In such cases, instead of depositing the money, the buyer can provide the seller with a financial bank guarantee using which the seller can be compensated in case of any loss.

Performance Guarantee

• These guarantees are issued for the performance of a contract or an obligation. In case, there is a default in the performance, non-performance or short performance of a contract, the beneficiary’s loss will be made good by the bank.