Abstract
Exports have an essential role in the development of the national and global economy. However, exporters are often faced with the challenge of maintaining their cash flow while fulfilling orders. Customers typically agree to contracts that allow them to pay for goods from 30 to 90 days after they were shipped, which means that an exporter has to invest in the production of the goods. Export finance is concerned with obtaining the loans to support the cash flow and ensuring that the exporter has a guarantee of payment if the contract agreement has been followed. This paper will review the literature on the topic of export finance and the role of financial institutions that provide financials for exporters.
Introduction
Export financing is a necessary element of foreign trade that allows businesses to negotiate their cash flow deals and obtain the resources needed to produce the items they will export. Businesses that sell goods to foreign companies can get access to capital to facilitate production before their customers pay. This makes export financing an important factor for the foreign trade and goods exchange since otherwise, companies would have to use their financial resources to pay for the production. This paper reviews the literature on the topic of export finance and specifically on the institutions that offer export finance services.
Literature Review
This literature review will focus on the articles and research of export finance and export finance institutions. The first paragraph will explore the role of export finance for the companies who want to engage in foreign trade and how varied financial instruments support these contracts. The following sections will address the different short, medium, and long-term tools that are used in export finance. The final section will focus on discussing the institutions that provide finances and guarantees to exporters and specifically will address the role of Eximbank since this institution has played a major role in enabling foreign trade both for the US and companies in other countries.
Export Finance Background: Terms and Purpose
Firstly, it is necessary to review the definitions of export finance and the purpose of this financing method. Velotrade explains that the need for export financing tools arises from the specifics of these agreements (“What is export finance? ” n.d.). Typically, payment terms allow for the buyer to send the payment within 60 to 90 days from when the order was received, which results in exporters having cashflow issues (“What is export finance? ” n.d.). Without cash flow, it is impossible to finance production and fulfill other orders.
Additionally, exporters need a guarantee that they will receive their payment since these trade deals are between foreign companies, and in case the buyer refuses to pay after the order is shipped, the exporter may suffer substantial losses and be unable to retrieve their payment. Thus, the purpose of export financing is to help companies that want to export goods to have the financial resources they can invest in the production and provide them with a guarantee that the customer will pay.
Another defining feature of export finance and its purpose in the modern business environment which necessitates business to compete globally and enter foreign markets. Greco and Murray (2021) argue that contemporary companies exist in a globalized environment, and the example illustrating this is the Word Trade Organization (WTO) and its growth. Moreover, the unitions and trade agreements between the states, such as NAFTA and the EU, show the importance of fair trade between nations. An essential factor is that with the development of these organizations, small businesses can now engage in foreign trade, despite the common misconception that this option is only available to large businesses.
According to Greco and Murray (2021), “when exporting, there are two different approaches small businesses can take: direct and indirect” (p. 10). In both cases, the manufacturers will need to finance their production costs, which is why they need loans and insurance from specific institutions. Therefore, the role of global trade has been increasing, as illustrated by the examples of WTO, NAFTA, and EU, which prompts businesses to export their goods, which is why they need export finance tools.
Although exporters have the option to invest their own money in the production of goods, it is more effective to obtain a loan. According to WTO’s (n.d. b) estimations from 80 to 90 percent of the global trade relies on export financings, such as trade credit and guarantees. Most of these financial instruments are short-term guarantees. Next, trade finance is defined by the WTO (n.d. a) as “the low-risk, high collateral end of the credit spectrum” (para. 1). Hence, export finance is a low-risk operation that provides multiple benefits to the exporters, which is the reason for the majority of them choosing to use this finance method.
Notably, the accessibility of export finance resources defines the competitiveness of the exporter. Although developed nations such as the US do not have a scarcity of export financing resources, it is a problem for smaller countries and developing states (WTO, n.d. a). Hence, the companies in these developed nations are more competitive when compared to those that do not have access to capital. Moreover, this accessibility affects the development of the domestic economy, making export finance an important tool for the economic development of the nations.
By definition, export finance implies that a financial institution becomes a third party in the trade contract between a customer and an exporter. According to Santander Finance (n.d.), “this is a credit operation in which the bank advances a specific amount, in any officially traded currency, to an exporter so that it can collect the value of deferred payment sales made to a foreign importer” (para. 1). Hence, the process of export financing requires three parties to be involved: the importer, exporter, and financial institution. With this process, the exporter receives an advance from the institution, which allows them to complete the order and deliver it to the importer. Next, the importer pays on the due date, which is after the goods have been delivered. At the final stage of this operation, the exporter repays the bank using the money from the importer’s payment. This scheme allows the exporter to finance the production of the goods without requesting the upfront payment.
Export Finance Tools
Export finance offers exporters a variety of tools that can facilitate their operations. Willsher (1995 examines several tools used in export financing: money transfer, factoring, forfeiting, and letters of credit. The letters are issued by banks as a guarantee on behalf of the company that payment will be made. This is the most commonly used financial instrument in foreign trade (Willsher, 1995). The letter specifies the conditions under which the exporter will be paid, such as the specifics of the products, delivery terms, and the specifics of the money transfer. This instrument is used to reassure the exporter that the buyer is trustworthy, and it is commonly used when the buyer’s credit history is insufficient or cannot be accepted by the seller.
Export factoring is an agreement between a factoring institution, which is a bank, and an exporter. The bank purchases account receivables or invoices in return for cash provided to the exporter. This instrument is suitable for exporters who have been in the market for a long time since factors typically do not agree to these deals on a short-term basis.
Types of Institutions
The exporter has to contact a specific institution to receive the financial support that will finance their operations until the buyer releases the payment. Generally, either a traditional financial institution or an alternative financing company can be contacted (“What is export finance? ” n.d.). The traditional institutions are typically banks, which have a thorough process of checking the documentation and additional procedures to ensure that the exporter is reliable (“What is export finance? ” n.d.). This is a primary disadvantage of using a traditional financial institution since t may take a lot of time for the bank to verify the information and provide a loan. Additionally, credit insurance companies may provide such services, but SMEs may have limited access to these tools due to the institutions’ reluctance to engage in activities with small businesses.
Examples of alternative institutions that provide export finance services are fintech companies. Typically, such facilitators have a verification process that is less vigorous than that of a bank, which makes it easier for SMEs to gain access to capital (“What is export finance? ” n.d.). Moreover, these lenders typically provide the working capital in a shorter amount of time, which is also helpful for the borrowers. Hence, the alternative financial institutions that have become popular recently are providing exporters with more choice when searching for a loan.
Additionally, it is important to review the definition and function of the Export Credit Agency (ECA). According to Barone (2020), ECAs offer domestic companies services that enable them to facilitate foreign trade. There are three types of services offered by these organizations: loans, guarantees, and insurance. Barone (2020) argues that ECAs play an important role in enhancing the domestic economy since they help local businesses find customers abroad and explore other markets. The beneficial impact of ECAs on the economy is the reason why some of them are owned by the government or formed as a partnership between a government and a private organization, although there commercial ECAs as well.
Typically, exporters choose to take loans from commercial organizations and not ECAs. However, the global financial crisis has impacted the role of ECAs since they “have taken on a greater role since the global financial crisis, providing the necessary support as increasingly risk-wary private lenders pulled back from export finance” (Barone, 2020, para. 5). Hence, national ECAs have played a vital role in supporting the global economy during the crises, and exporters continue to choose these organizations as opposed to privately-owned companies.
ECAs benefit from providing support to exporters not only due to the economic development but also because they charge a premium or interest from the loans they provide. OCED has acknowledged the role of ECAs for the development and national economies and even created a list of organizations that exporters can contact (Baron, 2020). One example of such an organization is EximBank, which has subsidiaries globally and provides support for export-import operations. In the United States, EximBank is the ECA institution that provides export finance services. In its mission, EximBank states that it wants to help the US exporters that face foreign competition and “match or counter the financing offered by approximately 85 ECAs around the world” (as cited in Barone, 2020, para. 25).
Financial Instruments
This section will discuss the types of instruments that export finance-oriented institutions offer to their customers. Firstly, the short-term credit export is an instrument used to protect exporters from the risk of an overseas customer defaulting on their payment obligations (Willsher, 1995). Notably, there is a difference in the risk assessment of different trade deals since, for example, a company requesting to insure only one deal is considered to be risky when compared to the one that requires insurance for multiple transactions.
As the banks or alternative financing institutions decide whether to provide a loan to an exporter, they gather information and request a guarantee that would prove the exporter’s intention and ability to repay. An importer can provide the exporter with a guarantee signed by a bank that will serve as a piece of evidence that the former party intends to repay the exporter and has the funds to do this. A bank benefits from providing this document since they receive a transaction fee for this operation.
The process of issuing a bank guarantee involves an importer contacting their bank and asking to freeze the funds that will be later transferred to the exporter as a payment for the goods (Willsher, 1995). Hence, the bank freezes the specified sum and provides a written guarantee to the exporter that the importer possesses these funds and that they will not be transferred until the order is fulfilled. Another element of this guarantee is that in case the importer refuses to pay the producer of goods, the bank has to release the frozen funds to the exporter. Hence, if the agreement is done correctly and the terms are specified, the exporter will receive the payment regardless of whether the customer agrees or refuses to uphold their part of the agreement.
An example of this guarantee is a tender bond, which is issued to support an international tender. The beneficiary, in that case, will receive the financials in case a contender fails to deliver the goods negotiated in this tender. Next, the performance bonds are the most commonly issued guarantees, and they secure the contractual agreement between the two parties, allowing the exporter to receive their finances upon the delivery of goods even if the buyer does not want to pay (Willsher, 1995).
A direct guarantee is issued by a bank in response to the customer’s request, and it does not imply the need to contact the exporter’s bank. This type of guarantee is typically used because it is the least expensive out of the ones discussed. The indirect bank guarantee requires the involvement of the beneficiary’s bank as well, which makes this type of guarantee more expensive and time-consuming. A combination of the direct and indirect tools is a confirmed guarantee, which requires a bank to send a document to the beneficiary’s institution to obtain a confirmation.
Next, the advanced payment guarantees are issued if the party wants some portion of the payment to be released before the order has been fulfilled, at an early stage of the contract. This document also allows them to gain access to the full sum in case the buyer fails to fulfill their payment obligations. Payment guarantees allow the beneficiary to obtain the money from a bank that guarantees the contract’s fulfillment. Letter of indemnity allows the carrier of the goods to avoid being responsible for the loss of items. A loan repayment guarantee is used to ensure that the borrower’s debt and interest are repaid in case they fail to deliver their obligations.
Other Facts about Export Finance
The researchers approach the studies of export finance from the perspective of its impact on the business and domestic economy. Rossi et al. (2020) examine the impact of innovation on the evolution of export instruments. Notably, companies that innovate are more likely to change their status from non-exporter to exporter. However, over the course of the analysis, Rossi et al. (2018) found that the ability to access the export finance instruments easily predetermines whether the firm will continue to be an exporter. For example, an SME enterprise that develops an innovative product is more likely to begin exporting it and enter a foreign market when compared to other SMEs in the same industry. However, if this company cannot access capital to finance its foreign trade deals, it will seize to be an exporter.
EximBank
Eximbank’s operations require more attention since this institution has become an important element of export finance in many countries, and as a commercial bank, it contributes to the development of national economies. According to Amin (2018), “financial intermediaries by performing the activities of assembling the funds from one party and lending the same to another while making a good amount of profit” (p. 1). Eximbank is the most significant exporting institution in the state. According to Agrawal and Wang (2017), it was founded in 1934 and has been “the official export credit agency of the United States (p. 1378). Although it is an independent institution, the bank is owned by the government of the state, which highlights its mission of supporting the competitiveness of domestic company since “in exercising its functions, supplements
and encourages, and not competes, with private financiers” (Agrawal & Wang, 2017, p. 1378). However, this bank typically chooses to involve another private organization in its export support operations, which is significant considering that this is a government-led institution. Hence, Eximbank plays an important role in facilitating foreign trade deals for US companies.
Notably, EximBank plays an important role in ensuring exporting operations. This bank was established to finance these types of transactions, and it provides financial support both to companies within the state and outside. According to Chand (n.d.), the EximBank “provides direct financial assistance to exporters of plant, machinery and related service in the form of medium-term credit” (para. 1). In addition, it provides exporters with instruments, such as a line of credit, which allows them to carry out their operations, and the credit is available either pre-shipment or post-shipment (Bhatt, 2018).
Low-interest loans are offered specifically for exporters that need additional financials, although these types of loans are typically offered to export-oriented companies only. Another option offered by EximBank is import finance, which allows importing raw materials that will be later used in production and exported. The only condition to receive this type of loan is the need to prove that all the raw materials imported will be used in production and will later be exported (Bhatt, 2018). The pre and post-shipment financing allow the exporter to maintain operations and fulfill orders until the payments for the previous orders are released. Hence, EximBank provides exporters with a variety of financial instruments that can be used to address the cash flow discrepancy while fulfilling orders and awaiting the payment release.
Although it is established that foreign trade is beneficial both for companies and for domestic economies, the impact of financial institutions on exports has not been studied extensively yet. Agarwal and Wang (2017) state that “industries other than aerospace parts and products are more likely to benefit from EXIM authorizations, and EXIM authorizations to larger businesses seem to be more effective in encouraging exports” (p. 1378).
Furthermore, the authors found that Eximbank in the United States provides more benefits to companies when compared to other ECAs, which sets it apart from the competition. Despite this, the authors doubt the generally accepted idea that Eximbank has a substantial positive effect on the foreign trade of the US-based companies. This is an important finding since Eximbank no longer offers cooperation to new businesses since 2015, which led to a controversy and a discussion of how this change will affect exports (Agarwal & Wang, 2017).
Conclusion
Overall, this paper focuses on the specifics of export financing and its benefits for foreign trade. Export financing allows businesses to access capital and receive guarantees that they will receive the payment for the goods they made and shipped to a foreign country, which strengthens the foreign trade. There is a variety of financial instruments that exporters can use to ensure that they receive a payment for goods and to support their cashflows. The export financing allows exporters to have the reassurance that their contract agreements will be repaid even in cases when the buyer fails to refuse to provide such payments.
There are a variety of guarantees that can support the buyers’ intention and ability to pay, such as the bank freezing the funds and issuing a statement that guarantees the release of these financials to the exporter once the order is fulfilled. Hence, exporters use the services of export finance institutions to ensure their cooperation since these institutions can provide a guarantee that the customers will pay or help exporters obtain funds needed for production.
Eximbank is among the most prominent financial institutions with subsidiaries globally that are engaged in export finance. In the United States, this institution’s mission is to support local businesses that want to compete in the global market. However, as the research finds, the Eximbank plays a limited role in supporting the economy of the state. Therefore, this report reviewed the specifics of export finance and how government and commercial, financial institutions support the ability of exporters to access foreign markets.
References
Agarwal, N., & Wang, Z. (2017). Does the US EXIM Bank really promote US exports? The World Economy, 41(5), 1378-1414. Web.
Amin, S. (2018). General banking activities of EXIM Bank Limited. BRAC University. Web.
Barone, A. (2020). Export Credit Agency (ECA) definition. Investopedia. Web.
Bhatt, H. (2018). RBI Concepts: Role and functions of EXIM Bank and ECGC #9. Oracle. Web.
Chand, S. (n.d.). Export-import bank of India: Management, functions and activities of Exim bank. Your Article Library. Web.
Greco, J. F. & Murray, B. (2021). The fundamentals of trade finance (3rd ed.). Bublish, Inc.
Rossi, S., Bonanno, G., Giansoldati, M., & Gregori, T. (2021). Export starters and exiters: Do innovation and finance matter? Structural Change and Economic Dynamics, 56, 280-297. Web.
Santander. (n.d.). Financing operations. Web.
What is export finance?. (n.d.). Web.
Willsher, R. (1995). Export finance: Risks, structures and documentation. Springer.
World Trade Organization. (n.d. a). The challenges of trade financing. Web.
World Trade Organization (WTO). (n. d. b). Trade finance. Web.