Forfaiting and factoring
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Transcript of Forfaiting and factoring
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Factoring and forfaiting
International financial settlements 120881-1165
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Lecture outline
Factoring as trade finance methodForfaiting as trade finance method
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Factoring
Factoring is a transaction where the exporter
sells its receivables to an institution
The factoring institution buys the receivables
without recourse
Due to increased risk factors demand
discount on the receivables
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Types of factoring
Maturity factoring- the factor pays the exporter at maturity of the accounts receivable
Advance factoring- the factor pays the exporter in advance a specified share of the receivables
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The mechanism of factoring
The factoring transaction involves three parties: The seller-the exporter The debtor-the importer The factor
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The mechanism of factoring
The receivables sold are usually invoices for the delivered products
Factoring can take place with or without notification of the debtor
In the case of notification the factor carries out the collection, in the case of lack of notification the exporter carries out the collection
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Advantages
Factoring is advantageous for exporters because this way they can obtain cash
This can especially beneficial if companies struggle with liquidity problems
In some industries factoring is the historic method of finance e.g. in textiles or apparel branches
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Advantages
Factoring enables risk-free export sales The exporter can offer more attractive
transaction termsExporters are relieved from administration
duties
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When to use factoring?
Factoring is more expensive than a bank loan
In fact it is not a loanIt can happen that banks would refuse a loan
to an exporter to provide him with cash but a factor would buy his receivables
The factor checks the creditworthiness of the debtor and not of the seller
Especially beneficial for small exporters
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Would factors always buy the receivables?
The credit history of the debtor is a crucial condition
The current creditworthiness of the debtorUsually even average credit rating of the
debtor is refused by factors
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Is the debtor affected by factoring?
Some types of debtors- usually large firms or governments have specified procedures when it comes to transferring the payment from the seller to debtor
This matters especially due to the obligation of the factor to perform the collection
The distinction between assignment of the responsibility to perform the work and the assignment of funds to the factor influences largely the debtor’s processes
Sometimes the debtor wants the seller to perform the collection
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Forfaiting (1)
A transaction where a forfaiting institution buys without-recourse the debt resulting from a trade contract which is due in the futureForfaiting is usually aimed at medium-term capital goods financingThe subject of forfaiting transactions are usually fixed assetsAs this type of goods are usually expensive the financing period may account for several years
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Forfaiting (2)
Exporters are not willing to finance importers over such a long period
This is why the debt of the importer is sold to forfaiters (usually banks)
Forfaiting financing usually refers to transactions exceeding 500000 USD
For larger transaction more than one forfaiting institutions can be involved
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Forfaiting (3)
The forfaiting institution takes over the risk of the sales transaction.
The exporter is liable for the quality and reliability of the project
The forfaiter has an unconditional payment obligation
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Source: E. Bishop, op. Cit.
The forfaiting process
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Does the bank always agree to forfaiting?
The bank needs a guarantee that the debt will be paid off
The debt should be freely transferableThe forfaiting bank requires the debt purchased
to be secured by a credible bank guarantee or the importer to be a prime buyer, e.g. government agency or a multinational company
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Required documents
The guarantee can take the form of: promissory notes bills of exchange, book receivables deferred payments under a letter of
credit
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Forfaiting paper
All documents guarantying the transaction e.g. bills of exchange and promissory notes become the property of the forfaiter
The documents are called forfaiting papersThey are liquid assets with comparatively high
yields
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What are the costs of forfaiting?(1)
The forfaiting institution demands cash for buying the debt
The value of the debt is discounted at a specified rate,
The forfaiting institution demands also a risk premium on the transaction
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What are the costs of forfaiting? (2)
The discount margin is the one of the principal costs of forfaiting
Besides the discount margin the bank charges a commitment fee
The discount can be computed as straight discount or discount to yield basis
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Advantages of forfaiting for the exporter
Conversion of a credit transaction into a cash transactionIncrease of liquidity Risk elimination (market, transaction and political risks) Relieve of administration duties
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Advantages of forfaiting for the importer
The flexibility to pay for his goods Deferred paymentFixed interest cost
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Summing up
Factoring and forfaiting can be beneficial methods of
trade finance
Both allow to transfer credit transactions into cash
transactions
Factoring serves financing short term transactions while
forfaiting medium term transactions
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Discussion
Factoring and forfaiting are without-
recourse methods of trade finance. Is this
always beneficial? Name examples when
recourse financing would be more
beneficial.
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Literature
E. Bishop, Finance of international trade, Chapter 10. Publication available via Science Direct Database
International financial settlements 120881-1165