Executive Briefings

Financial Relationships Go Through Some Changes as Supply Chains Stretch Around the Globe

As globalization of trade matures, the financial relationships are evolving. Some of the tried and true financial instruments of the past, such as letter of credit (LC), are giving way to more immediate straightforward processes, in particular, payment on open account (OA). LCs are useful during the initial push to overseas, when suppliers and buyers are not well known to each other and have yet to establish trust and a proven track record. But they are quite expensive and tie up lines of credit for importers. As importers and exporters do more business, relationships mature, trust increases, the risks of non-payment and nonperformance diminish, and importers are able to push trade payments off of LC and onto OA. (With an open account, the exporter simply bills the importer, who is expected to pay under agreed terms at a future date). This shift away from letters of credit is requiring everyone to readjust because banks made fees on LCs, importers used LCs to mitigate performance risk, ensuring that the exporter/supplier performed to the contract, and suppliers relied on LCs to secure pre-shipment financing, get paid sooner, and most importantly to mitigate the risk of non-payment, especially with customers that were not well known to them.

Exporters lose a source of financing under open account, because they could borrow against the LC they had before. To fulfill this now unmet need, import banks are stepping in and playing an increasingly important role, broadening their offerings to provide export financing which helps to create liquidity in the supply chain. The financing provided by the bank can be either for pre-export financing (paying the supplier before goods are received) or post-export financing (payment after goods received). To manage their risk of providing this upfront liquidity, the import bank requires a detailed and reliable understanding of the importer's credit-worthiness and payment track record-the bank often already has a good picture of this, since the importer is a client of the bank. The exporter's supply chain performance track record (on-time, quality, etc.) is important if the bank is providing pre-export financing.

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As globalization of trade matures, the financial relationships are evolving. Some of the tried and true financial instruments of the past, such as letter of credit (LC), are giving way to more immediate straightforward processes, in particular, payment on open account (OA). LCs are useful during the initial push to overseas, when suppliers and buyers are not well known to each other and have yet to establish trust and a proven track record. But they are quite expensive and tie up lines of credit for importers. As importers and exporters do more business, relationships mature, trust increases, the risks of non-payment and nonperformance diminish, and importers are able to push trade payments off of LC and onto OA. (With an open account, the exporter simply bills the importer, who is expected to pay under agreed terms at a future date). This shift away from letters of credit is requiring everyone to readjust because banks made fees on LCs, importers used LCs to mitigate performance risk, ensuring that the exporter/supplier performed to the contract, and suppliers relied on LCs to secure pre-shipment financing, get paid sooner, and most importantly to mitigate the risk of non-payment, especially with customers that were not well known to them.

Exporters lose a source of financing under open account, because they could borrow against the LC they had before. To fulfill this now unmet need, import banks are stepping in and playing an increasingly important role, broadening their offerings to provide export financing which helps to create liquidity in the supply chain. The financing provided by the bank can be either for pre-export financing (paying the supplier before goods are received) or post-export financing (payment after goods received). To manage their risk of providing this upfront liquidity, the import bank requires a detailed and reliable understanding of the importer's credit-worthiness and payment track record-the bank often already has a good picture of this, since the importer is a client of the bank. The exporter's supply chain performance track record (on-time, quality, etc.) is important if the bank is providing pre-export financing.

Read Full Article