Forfaiting as an export financing option
[This is authored by Vinod Sehgal. He is CFA & has 23 years of banking exprience at senior positions. He is an authority on forfaiting & working in this area for last 4 years.]
Forfaiting as an export financing option has been approved by the Reserve Bank of India vide its circular A.D ( G.P Series) No. 3 dated February 13, 1992. Apart from Exim Bank, all Authorised Dealers have also been permitted vide RBI's circular No. 42 A.D.( MA) Series dated 27th October 1997, to act as intermediaries between the Indian exporter and the overseas forfaiting agency, and provide necessary certification for GR Forms.
Forfaiting is the discounting of international trade receivables on a without recourse basis.
The word forfaiting is derived from the french term `` a forfait ''which means `` relinquishing a right``. Here it refers to the exporter relinquishing his right to a receivable due at a future date in exchange for immediate cash payment, at an agreed discount.
The characteristics of a forfaiting transaction are:
1. Credit is extended by the exporter for period ranging between 180 days to 7 years.
2. Minimum bill size should be US$ 250,000/-.( US$ 500,000/- is preferred)
3. The payment should be receivable in any major convertible currency.
4. An L/C or a guarantee by a bank, usually in importer's country.
5. The contract can be for either goods or services.
At its simplest the receivables should be evidenced by any of the following debt instruments:
1. Promissory Note.
2. Bill(s) of Exchange.
3. Deferred payment letter of credit.
4. A letter of guarantee.
There are three elements to the pricing of a forfaiting transaction:
1. Discount Rate:
This is the interest element, usually quoted as a margin over LIBOR.
2. Grace Days:
These are added on to the actual number of days until maturity for the purpose of covering the number of days delay normally experienced in the transfer of payment, applicable to the country of risk.
3. Commitment Fee:
This is applied from the date the forfaiter is committed to undertake the financing, until the date of discounting.
Eliminates risks like political, transfer and commercial risks.
Enhances competitive advantage. Ability to provide vendor financing making products more attractive
And enables the exporter to do business in risky countries.
Increases cash flow. Forfaiting converts a credit-based transaction in to a cash transaction.