Forfaiting, the literal meaning is to give up (something) as a necessary consequence of something else. In Trade Finance, “Forfaiting” is a mechanism of financing short to medium terms post-shipment exports.
Capital goods exported usually come with credit terms from the importer , due to which exporter finds issues with his current cash flows. To address this issue, Forfaiting product was introduced in 1960. In simple words, it's a medium term foreign currency loan extended by foreign bank (also termed as forfaiter) against shipped goods by exporter.
Forfaiting is usually carried out by-
a. Discounting export receivables
b. Bills of exchanges or promissory notes
There are 5 parties involved in Forfaiting-
iii. Exporter’s bank
iv. Importer’s bank
v. The Forfaiter
Modus operandi :-
Post negotiating invoice (referred as sales contract), Exporter approaches Forfaiter ( foreign Bank ) to ascertain contract terms for funding.
Forfaiter does due diligence about importer, supply and credit terms, documentation, country risk, credit risk etc.
Forfaiter quotes the discounting rate usually quoted in LIBOR/EURIBOR.
The Exporter quotes a contract price to the overseas buyer/Importer by adding cost of funds,commitment fee,arrangement fees etc. on the exported goods.
Upon acceptance of the above pricing, Exporter and Forfaiter sign a contract.
Export takes place against documents guaranteed by the importer’s bank.
Forfaiter discounts the bill and presents the same to the importer’s bank for the payment on due date or even sell it in secondary market.
Costs of Forfaiting:
Forfaiting typically involves below costs
Commitment Fees :- Ranges between 0.5% -1% Pa
Discount Fees :- Interest cost charged in LIBOR/EURO
Arrangement Fees – Facilitator fees will be charged by Bank/Consultant in India.
BENEFITS OF FORFAITING SERVICES
The benefits to importer are abundant, some of them are listed here:
1) Seller receives immediate credit of funds in account, thus increasing liquidity position.
2) Since risk is borne by the forfaiter, payment default from importer will not affect the Seller.
3) Exporter is hedged against any interest rate risk and exchange rate risk since contract is executed at a fixed rate.
4) 100 per cent of the invoice/contract value can be credited
5) Cost of Forfaiting can be borne by Importer as well , depending on the credit terms.
For more details on RBI policy, please refer