Forfaiting

Forfaiting



Forfaiting is a method of trade finance that allows exporters to obtain cash by selling their medium term foreign account receivables at a discount on a “without recourse” basis. A forfaiter is a specialized finance firm or a department in banks that performs non-recourse export financing through the purchase of medium-term trade receivables. Similar to factoring, forfaiting virtually eliminates the risk of nonpayment, once the goods have been delivered to the foreign buyer in accordance with the terms of sale. However, unlike factors, forfaiters typically work with the exporter who sells capital goods, commodities, or large projects and needs to offer periods of credit from 180 days to up to seven years. In forfaiting, receivables are normally guaranteed by the importer’s bank, allowing the exporter to take the transaction off the balance sheet to enhance its key financial ratios. The current going minimum transaction size for forfaiting is $100,000. Most users of forfaiting have been large established corporations, although small- and medium-size companies are slowly embracing forfaiting as they become more aggressive in seeking financing solutions for countries considered high risk.


Key Points


• Eliminates virtually all risk to the exporter with 100 percent financing of contract value.
• Allows offering open account in markets where the credit risk would otherwise be too high.
• Generally works with bills of exchange, promissory notes, or a letter of credit.
• Normally requires the exporter to obtain a bank guarantee for the foreign buyer.
• Financing can be arranged on a one-shot basis in any of the major currencies,
usually on a fixed interest rate, but a floating rate option is also available.


How Does Forfaiting Work?
The exporter approaches a forfaiter before finalizing a transaction’s structure. Once the forfaiter commits to the deal and sets the discount rate, the exporter can incorporate the discount into the selling price. The exporter then accepts a commitment issued by the forfaiter, signs the contract with the importer, and obtains, if required, a guarantee from the importer’s bank that provides the documents required to complete the forfaiting. The exporter delivers the goods to the importer and delivers the documents to the forfaiter who verifies them and pays for them as agreed in the commitment. Since this payment is without recourse, the exporter has no further interest in the transaction and it is the forfaiter who must collect the future payments due from the importer.



Cost of Forfaiting
The cost of forfaiting is determined by the rate of discount based on the aggregate of the LIBOR (London Inter Bank Offered Rate) rates for the tenor of the receivables and a margin reflecting the risk being sold. The degree of risk varies based on the importing country, the length of the loan, the currency of transaction, and the repayment structure – the higher the risk, the higher the margin and therefore the discount rate. However, forfaiting can be more cost-effective than traditional trade finance tools because of many attractive benefits it offers to the exporter.


Three Additional Major Advantages of Forfaiting


Volume: Can work on a one-shot deal, without requiring an ongoing volume of business.


Speed: Commitments can be issued within hours/days depending on details and country.


Simplicity: Documentation is usually simple, concise, and straightforward.





Characteristics of Forfaiting


Applicability
Ideal for exports of capital goods, commodities, and large projects on medium-term credit 


Risk
Risk inherent in an export sale is virtually eliminated.


Pros
• Eliminate the risk of nonpayment by foreign buyers
• Strong capabilities in emerging and developing markets


Cons
• Cost can be higher than commercial bank financing