Chapter 16 Summary

LO 16.1 Basic Aspects of International Trade Finance

• Finance is crucial for importers to make payments on time and exporters to buy materials and deliver as expected.
• International trade finance helps in mitigating risks for all stakeholders by providing monetary support and assurance, often with creative financing methods.
• International trade finance helps organizations with the strategic decision-making required to be successful internationally.

LO 16.2 Key Stakeholders in Trade Finance

• There are two categories of stakeholders: users and providers of trade finance.
• Users are the exporters and importers that need financial support during cross-border trading.
• Providers are the banks, financial institutions, and intermediaries that the help users with finance-related needs.

LO 16.3 Major Risks Involved in Trade Finance

• There are four categories of risk: technical risk, management risk, commercial risk, and external risk.
• Technical risk, for instance, highlights the importance of technology in creating contracts, understanding market by defining requirements, assessments, and assumptions.
• Management risk becomes even more important when organizations are dealing with international parties. The common issues that organizations face while managing international projects are trust, resource availability, communication, and bank risk.
• Commercial risk (non-payment and non-performance risk) plays a vital role in business success. It is one of the areas in trade finance that can make or break a business.
• External risk are the risks which are not in organization’s control e.g. country risk, foreign exchange risk, weather, and ecology etc.
• The risks that have direct role of play in trade finance are:
  • Commercial risk is divided into non-payment risk and non-performance risk. It is always hard to assess commercial risk if you are working with the other party for the first time.
  • Exchange rate risk refers to the potential to lose money because of changes in the exchange rate.
  • Country risk relates to any potential disruption of an international trade transaction because of a political or economic development in the country of either the exporter or the importer.
  • Bank risk arises when banks fail to perform their duties and pay as per the contract.

LO 16.4 Risk Management Cycle Used to Manage Trade Risk

• Foreign organizations need to use an effective risk management process that includes identifying, assessing, responding, communicating, and monitoring risks in trade. One process is called the risk management cycle, in which these five steps are followed in a continuous way
• Identifying Risk is about identifying warning signs and sharing it with stakeholders.
• Assessing Risk involves determining the scope of risk along with factors influencing severity of the risks identified.
• There can be five ways to responding to risk: accepting risk, reducing risk, risk avoidance, risk monitoring and risk transfer.
• There then arises a need to communicate the risk effectively to internal and external parties to help with effective decision making.
• Once the risks have been identified and have been communicated to stakeholders, next step in risk management cycle is to monitor the implementation of risk mitigation plan.

LO 16.5 Trade Finance Risk Mitigation Tools

• There are two risk mitigation strategies: International trade finance instruments and International financial institutions and aid agencies.
• There are four trade finance instruments that are commonly used: open account, advance payment, documentary collection and documentary letters of credit.
• The financial institutions and aid agencies can be banks, intermediaries or third parties providing financing to importers and exporters. These could be public and private funded organizations, could be operating at domestic or global level.

Check Your Understanding