COVID-19 has had a major negative impact on the GDP of Singapore. The country’s banks might end up tapering lending to businesses in case the macro economy continues to slow. As a trade-reliant economy, the SMEs of Singapore are expected to experience the credit crunch first, due to their superior credit risk profile. Hence, it is prudent for SME owners to manage their working capital cash flow smartly, as well as plan ahead on financing to ensure the security of their business. For this purpose, they must have a proper insight into the system of trade financing and its facilities.
Trade financing is a system where the exporters get paid for the goods before they are shipped to the importers. Typically, the importer issues a trade finance payment instrument like a transferable letter of credit to the exporter. The latter only receives the payment after furnishing the relevant transport documents that confirm that the goods have been shipped to the buying party. Trade financing is advantageous for both buyers and sellers who want to reduce the risks associated with funding cycle gaps.
Use of Letter Of Credit (LC) for trade financing
A letter of credit acts as a guarantee instrument from the importer’s bank and ensures that the buyers would have to pay for the goods sold to them. The bank guarantees that the seller shall receive the amount mentioned in the contract at the correct time. In the situation that the importer somehow fails to make the payment, it shall be the responsibility of the bank to cover the purchase amount. There additionally are multiple types of letters of credit used for international trade, depending on the diverse trading situation.
The bank tends to issue a letter of credit after obtaining the pledge of cash or securities as collateral from the buyer. Usually, a percentage of the amount involved in the transaction is charged by the bank as their fee.
Trust Receipt (TR)
This is a notice through which the bank allows the importer to take possession of the goods while its ownership title remains with the bank. Till this arrangement is in place, the bank provides the importer with a short-term import loan to make payment of the amount involved in the Letter of Credit. In most cases, the credit terms granted by the financial institutions range from 60 to 20 days.
The Trust Receipt can be beneficial for the importer as with it, they don’t have to make their payment immediately after the contract documents are presented. Moreover, they can even enjoy 100 % finance of the invoice value or documentary credit.