Finance choices at post-shipment stage

EXPERTEYE T R SHASTRI
Prof. Shastri is Dean, ICICI Manipal Academy, Bangalore

While banks are eager to extend post-shipment advances, it is advantageous to know the other options available
any credit facility, he can send the documents through the bank on collection basis, wait for the payment by the importer and get the foreign currency converted at the then prevailing rate. A great advantage is that if the foreign currency has meanwhile appreciated, he gets the benefit of it. He also saves interest by not borrowing though the interest rate may be low comparatively. He can also book forward contract to avoid uncertainty of exchange rate fluctuation. If the exporter has already availed loan from a bank for his pre-shipment activity like procurement of raw materials, etc then the exporter has to necessarily tender the documents to the bank and avail a credit facility. The bank will compulsorily create a bill advance in the name of the exporter and will clear the relative pre-shipment advance. This is because once a shipment is already underway, a bank cannot retain the outstanding balance as a pre-shipment advance. The bank generally calls this credit facility at the postshipment stage as bill discounting if it is a usance bill, bill purchase if it is a sight bill and bill negotiation if it is a bill under an LC (irrespective of the tenure of the underlying bill). The bank converts the foreign currency into

fter an export shipment is completed, an exporter has the full set of documents but not the hard cash. He has to wait for payment from his importer or avail a credit facility from his banker against this set of documents. There are many ways in which the exporter can bridge this cash-flow gap which banks call post-shipment credit facility. Each has its own significance. There are agencies other than banks that also meet this requirement. If the exporter is rich enough as not to avail

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rupee at that days appropriate bill buying rate or the forward contract rate, if it had already been booked. If the exporter has not booked a forward contract and desires to take a chance on a possible appreciation of foreign currency till the bill payment, he can request the bank not to purchase, discount or negotiate the export bill but can ask the bank to grant a rupee advance without applying an exchange rate. Thus effectively the bill will be on collection basis from the foreign exchange angle and the exporter faces the fluctuation in exchange rates, if any. Banks and other credit-providing agencies feel more comfortable in financing in a postshipment scenario rather than at the pre-shipment stage. While the pre-shipment advance is generally backed by tangible security like inventory, banks do not feel secured with such cargo produced specific to a foreign buyers requirements. On the other hand, at the postshipment stage, there is an additional assurance that the buyer is likely to pay and resort to the underlying cargo may not arise. Generally the date on which the post-shipment advance gets cleared is known in advance whereas the date on which the pre-shipment advance gets cleared, i.e. the date of shipment, is not precisely known. Financing institutions always are more at home with documents representing value rather than goods representing value. Thus there are more ready lenders at the post shipment stage. The RBI has also asked banks to be liberal in extending such finance in quantum, speed and rate of interest. In fact, RBI has specified the ceiling interest rates for such finance. However, factoring and forfeiting are options other than bank finance, available at this stage to an exporter. Factoring services is offered by factoring agencies called factors. Factoring is defined as an agreement in which receivables arising out of sale of goods/services are sold by a firm (client/exporter) to a financial intermediary (Factor). The title passes on to the Factor. Full range of services is provided by the factor such as collection, credit protection and sales ledger

maintenance along with short term finance. Thus factoring is much more than mere bill discounting. If a seller has a large number of sale transactions, say of small value and is a techno entrepreneur concentrating on his core competence of manufacturing rather than maintenance of sales records and follow up of bills with buyers, then it is advisable to outsource this accounting work to an outside agency. Factoring is an ideal solution in such situations. Factor normally buys the receivable up to 80 percent of the total sale value and passes on the remaining 20 percent on payment by the buyer on maturity. Factoring is normally for short term receivable say maximum of 150 days. Factoring can be with or without recourse. In case of with recourse factoring, on maturity if the buyer does not pay, the client is required to repay the amount. In international trade, two-factor system is also prevalent i.e. Export factor and Import factor. Under this process exporter sells goods on open credit i.e. something like on consignment basis. Thereafter, like in any factoring service, export receivables are factored. This export factor extends the service of credit collection and sales ledger accounting. Import factor collects the money due from the customers concerned and effects the payments to the export factor on assignment or maturity or as per the agreement. Banks in India were originally permitted to handle only the core banking activities. Over the years with liberalised approach, banks were permitted to undertake different other allied financial activities like leasing, factoring etc. Factoring in India was allowed by Reserve Bank of India based on the recommendations of the Kalyanasundaram Study Group appointed by the RBI in 1989. Based on these recommendations, the RBI issued guidelines for factoring services in 1990. The Kalyanasundaram study group had estimated the value of outstanding open account credit sales available for financing during 1989-90 at Rs12,000 crore in respect of SSIs and Rs4,500 crore for the medium- and large-scale sectors. Even if a part of this out-

standing business was to move into factoring, the potential demand for factoring was expected to be fairly large to make this business space viable for new entities. Accordingly the first factoring company SBI Factors and Commercial Ltd started operation in April 1991. Thereafter several factoring companies have come up in India mainly as subsidiaries of banks. For the factoring companies all over the world, there is a global umbrella organisation viz.: Factors Chain International (FCI) which is the world's largest factoring network of leading factoring companies, whose common aim is to facilitate international trade through factoring and related financial services. Established in 1968, its network has 244 factors in 65 countries covering more than half of the world's cross-border factoring volume. As per the FCI webpage, when FCI was founded, domestic factoring services were available only in North America and a few European countries. The concept of international or cross-border factoring was still new and restricted in scope by its lack of geographic coverage. FCI was established with two main objectives: to introduce the concept of factoring in countries where the service was not yet available; and to develop a framework for international factoring that would allow factors in the country of both the exporter and the importer to work closely together. The volume of factoring business globally has since grown substantially. During 2007, the global factoring business of members of FCI aggregated to Rs86 lakh crore. Currently the following factoring companies in India are members of FCI. SBI Factors and Commercial Services Pvt Ltd (including Global Trade Finance Limited merger underway) Canbank Factors Limited IFCI Factors Ltd (earlier known as Foremost Factors Limited) Export Credit Guarantee Corporation of India Ltd; Factoring Division

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million Domestic 4,715 factoring turnover International 340 factoring turnover Total factoring 5,055 turnover

Rs crore (approx) 31,000 2,000 33,000

Broad differences between different types of post-shipment finances

Factoring Normal maturity Recourse Cost for a/c of Coverage Financing % Risk counterparty Services short term with or without seller full portfolio say 80% seller comprehensive Forfeiting medium term only without forfeiter case wise full Aval bank only finance Bill Finance generally short term with seller bill wise full seller only finance

Standard Chartered Bank The Hongkong and Shanghai Banking Corporation Ltd These companies have together handled total business of over Rs33,000 crore during the year 2007 as under: As a percentage of the total factoring business, international factoring in India (which includes both import and export factoring) is only 7 percent compared to the global figure of 11 percent of international factoring. Apart from getting RBI permission for handling the factoring business, if the subsidiary of a bank or any other financial institution wishes to handle export factoring, it should also have an authorised dealer licence (category III) from RBI. Export factoring can be offered only with recourse basis. There is a very attractive interest rate offered by banks on post-shipment finance as per RBI guidelines whereas factoring agencies offer marketrelated interest rates, fees besides the burden of stamp duty. Significant part of the export business is done under LCs, which do not require any factoring facility. As mentioned earlier, banks are more than eager to extend post-shipment finance. In many banks, conversion of any other fund based limit to post-

Maturity factoring of ECGC

ECGC has introduced a scheme of maturity factoring under which 100 percent credit guarantee protection against bad debts is offered apart from sales register maintenance in respect of factored transactions; regular monitoring of outstanding credits, facilitating collection of receivables on due date and recovery, at its own cost, of all recoverable bad debts. In the event of non-realisation of dues on factored export receivables, ECGC will promptly make the payment in Indian Rupees, of an equivalent amount, immediately upon the crystallisation of dues by the bank (generally on 30th day) at the exchange rate as on the date of crystallisation. It is more a credit guaranteeing than credit delivery.

shipment finance or negotiation of export bills under prime bank LCs is done without any hassle and at the branch level itself. RBI itself has advised banks to vest adequate sanctioning powers in branch managers to assist exporters. Companies in India do not consider the ledger maintenance, export follow-up and other incidental work as something alien and do not like the idea of outsourcing these for a price. Export on open account is anyway not permitted and hence only DA exports can be offered to be factored. In view of these reasons, export factoring services is not popular in India still. Forfeiting is another possible financing option available to exporters. It is different from factoring mainly in the tenure of credit. Forfeiting is availed in case of long-term receivable and is generally on a nonrecourse basis. Being for long term, it is resorted to in case of larger transactions. The minimum amount prescribed by foreign banks offering forfeiting services is $100,000 to $1 million depending on the cases. Generally the procedure for forfeiting is like this: the importer draws promissory notes and gets it availed by his bank which is something similar to co-acceptance by the bank. Thereafter those availed notes are sent to the exporter who sells them to a forfaiter on a nonrecourse basis and obtains finance. The forfaiter holds the notes till maturity and gets the funds from the importers bank which has accepted it. Alternatively, the promissory note is traded in the market through the process of securitisation since basically it is a negotiable document carrying the risk of a bank. Forfeiting as an export financing option in India has been approved by RBI vide its circular AD (GP Series) No. 3 dated 13 February 1992. The forfeiting facility is to be

provided by an international forfeiting agency through an authorised dealer. Forfeiting proceeds, on a without recourse basis, are to be received in India as soon as possible after shipment but definitely within the stipulated period (e.g. 180-day period for cash exports) specified by RBI for all exports. A forfeiting transaction is to be routed through an authorised dealer. Initially RBI permitted Exim Bank to introduce a scheme for forfeiting (with charges/fees not exceeding 1.55 of the transaction amount) and later permitted other banks (authorised dealers) also to introduce forfeiting on similar terms. Exim Bank promoted a new company called Global Trade Finance Limited for providing international factoring, domestic factoring and forfeiting services under one roof in India. However, during 2007-08, the Bank sold its entire equity stake in GTF to State Bank of India. With this, the providers of forfeiting services in India are the limited number of factoring agencies in India and a few banks. The utilisation of forfeiting services, therefore, continues to be very low. In the present global scenario, it is agreed that getting a good export order itself is the major challenge and not arranging finance. Even then, it is advisable to know the alternatives available in financing. It strengthens the exporter in extending customised quotations under competitive conditions. An export order which would not have been taken up due to the underlying credit risk may be acceptable under maturity factoring of ECGC. An export order asking longer credit period may materialise due to forfeiting offered by a financing institution. Thus these alternatives may ultimately be handy products in this competitive environment.

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