Forfaiting

What is Forfaiting?

Forfaiting is a kind of international trade finance wherein export bills receivables are discounted, with which the exporters can get instant cash by selling their receivables. ‘Forfait’ is a French word, which refers to ‘relinquish a right’.

Therefore, in financing ‘forfaiting’ implies giving up of the right to receivables, which are due at a future date, by the exporter, to get quick cash, at a discount. Further, all the risks and responsibilities as to the collection or non-payment of the bills, or notes are passed on to the purchaser, i.e. forfaiter, who is the third party to the transaction.

So, the exporter does not have any interest in the transaction further and so, the forfaiter receives the payments in future.

Salient Features of Forfaiting

Upcoming points will discuss the salient features of forfaiting:

  • In forfating credit is advanced to the importer of capital goods for a certain period.
  • The amount of payment is receivable in any convertible currency.
  • The letter of credit or bank guarantee is given by the importer’s bank.
  • Finance is provided on a fixed or floating interest rate.

The forfaiter can be an individual or an entity, like a bank or a financial institution. The risks associated with the forfaiting are credit risk, transfer risk, foreign exchange rate risk or interest rate changes.

Moreover, it involves buying of international trade receivables such as the bill of exchange or promissory notes at a discount, on a 100% without recourse basis. This means that the seller (client) is eligible for complete credit protection and the exporter has no liability if the importer defaults in the payment.

Along with that, all the segments of the services such as short term finance, administration of sales ledger are available to the seller of the receivables.

Forfaiting Process

When the exporter receives an export order from the importer, he/she approaches the forfaiter with necessary details like importer’s country, type of goods, value of goods, shipment date (expected), terms and conditions of repayment, etc.

The exporter expects commitment that whether the forfaiter will allow credit or not. And if the forfaiter allows the same, what amount will it cost.

On the basis of the risk involved in the transaction, the forfaiter states the cost involved. However, if a bank or financial institution takes guarantee of the importer’s obligation, the cost involved will be less. Now, we will discuss the entire process in detail, when the importer’s obligation is guaranteed by the bank:process-of-forfaiting

  1. Goods are sold by the exporter (seller) to the importer (buyer), based on deferred payment distributed over three to five years.
  2. A series of promissory notes are drawn by the importer in favour of the exporter, for the amount to be paid in future, which includes the amount of interest.
  3. Further, the promissory notes issued are guaranteed by a recognized international bank, often importer’s banker. The guaranteeing bank assures that it covers the failure in payment of the buyer if any.
  4. The notes so availed, are sold by the exporter to the forfaiter (exporter’s banker), at a discount on a non-recourse basis to the seller.
  5. Now, when the forfaiter buys those notes, it can hold these notes until it gets matured or he can sell them to the investor’s group, who may be interested in buying an unsecured note having high-yielding potential or freely trade the debt instrument in the secondary market.
  6. The unconditional trade bills and notes hold legal enforceability, which ensures security to the forfaiter or next buyer of the instrument. The maturity of these instruments may lie between one month to ten years.

Advantages of Forfaiting

  • Forfaiting ensures immediate cash to the exporter who is protected from the risk of non-payment by the importer, as well as it eliminates collection cost.
  • It is a way of earning for the commercial bank, which purchases the instrument yielding high return, can earn a good amount when the currency is appreciated.
  • As the banks of both exporter and importer are involved, the risk becomes very low.
  • Forfaiting makes the transaction easy by converting the credit sale into cash sale.
  • It is flexible in nature, in the sense that the forfaiter can customize the offering according to the requirement of the seller of the capital goods. As well as, it can be changed to a number of international transactions.

Disadvantages of Forfaiting

  • Only major selected currencies are taken for forfaiting, as they possess international liquidity.
  • Forfaiting reduces the risk for exporters, however, it is more expensive as compared to the basic financing provided by the banks or financial institutions, which results in higher export cost.
  • The higher export cost is borne by the importer, which is included in the standard pricing.
  • Not all the transactions can avail the forfaiting facility. Meaning that transactions more than equal to a definite sum are eligible for forfaiting.

Forfaiting converts the supplier’s credit granted to the imported into cash transaction for protecting him in full, from all the risks involved with the selling goods abroad on a credit basis.

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