Trade-Finance-SeatMedium

3 min read · 506 words

What the seat actually does

A seller wants to be paid when the goods leave; a buyer wants to pay when they arrive. Somebody has to stand in the gap, and that gap is measured in weeks on a ship. This seat is the bank that stands in it.

The instrument is a promise, and the security is paperwork. A letter of credit substitutes a bank's credit for a buyer's, and the bank pays against documents rather than against goods — it never sees the cargo. That distinction is the whole of the product and the whole of its fraud risk.

• Documentary credit — the letter of credit and its confirmations. See trade finance.
• Guarantees and standbys, where the bank pays only if something does not happen.
• Supply chain finance — paying a supplier early against an approved invoice from a stronger buyer.
• Receivables — see factoring and receivables finance.

A day, and where it goes

• Document checking, which is exacting and unglamorous and decides whether the bank pays.
• Discrepancies — documents that do not match the credit, and what the buyer is prepared to waive.
• Limits. Country lines, bank lines and what is left of them, because the counterparty here is usually another bank.
• Sanctions and vessel screening, which in this business is a daily operational step rather than a policy.

What it is measured on

• Fee income against the limits used, since the balance sheet is committed whether or not it is drawn.
• Losses, which are rare and, when they arrive, are usually fraud rather than credit.
• Turnaround — how fast documents are checked, because a delay is a ship waiting.
• Country and bank concentration, which is the exposure this business actually runs.

What it touches on this site

• The instruments — trade finance, factoring and receivables finance.
• Where the goods are priced — commodities, whose physical trade this finances.
• The currency and country risk — emerging market bonds and non-deliverable forwards.
• Who pays whom — the diagram on the trade finance page is this seat's own picture.

How it goes wrong

• The same cargo financed twice. Documents can be duplicated; a warehouse receipt is a piece of paper about goods nobody in the chain has seen.
• Paying against documents that are correct and false. The bank's obligation is to the paperwork, which is exactly what a forger exploits.
• Country risk arriving all at once. A currency control or a moratorium stops every transaction in a market on the same day.
• Supply chain programmes read as trade payables when they are borrowing — a presentation question with real consequences.

Concepts to master

• A letter of credit swaps one credit for another. The seller stops relying on the buyer and starts relying on a bank.
• Documents are the collateral, and their form is substantive rather than administrative.
• Short-dated does not mean low risk — see credit spreads.
• Operational risk decides more here than market risk — see which risk decides.