A new mechanism to open International Trade Finance Services (ITFS) platforms in India is expected to draw in trade finance opportunities for India’s exporters and importers from international sources.
The latest move is expected to streamline the process of securing working capital to conduct trade, thereby reducing the cost of trade. It will also lay down the rules for the proposed ITFS companies and create a more favourable ecosystem for trade finance in the country.
What is trade finance?
It represents the financial instruments and products used by companies to facilitate international trade and commerce. Any transaction involves a seller of goods and services as well as a buyer. When these transactions are made over thousands of miles across oceans, trade finance reduces the risk of doing business with entities that are unlikely to be familiar with one another.
Trade finance is an umbrella term. It covers many financial products that banks and companies utilise to make trade transactions feasible.
According to the World Trade Organization, some 80-90 percent of world trade relies on trade finance, including trade credit and insurance or guarantees, mostly of a short-term nature.
How does it work?
Due to the large financial nature of global trade, exporters require an importer to prepay for the goods shipped. He uses this to produce the goods and pay for his own costs as working capital. The importer naturally wants to reduce risk by asking the exporter to document that the goods have been shipped.
The importer’s bank assists by providing a letter of credit to the exporter (or the exporter's bank) providing for payment upon the presentation of certain documents, such as a bill of lading. The exporter's bank may make a loan to the exporter on the basis of the export contract.
The type of document used in the process depends on the nature of the transaction and how evidence of performance can be shown (i.e., bill of lading to show shipment). It is useful to note that banks only deal with documents and not the actual goods, services or performance to which the documents may be relating to.
What is the situation in India?
Exporters and importers face constraints in obtaining adequate finance, particularly in terms of their ability to convert their trade receivables into liquid funds or to obtain short-term funding for their payments for import of goods/services.
Smaller firms and MSMEs are especially affected as they often struggle to secure channels to process the cash, even after finding a global buyer who is willing to send over pre-payment.
What has happened now?
The finance ministry has approved the setting up of the ITFS platform. The framework is aimed at enabling exporters and importers to avail various types of trade finance facilities at competitive terms for their international trade needs, most crucially from international sources.
A dedicated electronic platform, ITFS, is set to help then in converting their trade receivables into liquid funds and to obtain short-term funding.
How will it work?
This tentative step towards more liquidity for exporters and MSMEs is being headed by the International Financial Services Centres Authority (IFSCA) at Ahmedabad's Gujarat International Finance Tec-City (GIFT City), a project being closely monitored and pushed by the Prime Minister’s Office.
The ITFS framework will provide an opportunity to the participants to avail trade finance facilities for trade transactions such as Export Invoice Trade Financing, Reverse Trade Financing, Bill Discounting under Letter of Credit, Supply Chain Finance for Exporters, Export Credit (Packing Credit), Insurance/Credit Guarantee, Factoring and any other eligible product, on the ITFS platform.
Most importantly, it will allow any entity desirous of setting up and operating any company as an ITFS in any IFSC. Currently, the only IFSC in India is in GIFT City.
The companies set up as ITFS shall provide electronic platforms to all participants. It shall disseminate the information about bills/invoices, discounting and quotes in real time basis, supported by a robust MIS (Management Information System) to all relevant parties. It shall also have a suitable Business Continuity Plan (BCP), including a disaster recovery site.
Who can set up an ITFS?
A bank or a finance company has to incorporate as a separate company to be set up as an ITFS in an IFSC. The parent entity or promoters or promoter groups of the company applying to set up a company as ITFS should have a minimum net worth of $1 million.
The company, proposed to be set up as ITFS, should have a minimum paid-up equity capital of $0.2 million or equivalent in any other freely convertible currency.