LC vs Forfaiting - Indian Context - Part 2

There are bankers who however feel that an LC and forfaiting in combination can be helpful to the exporter; an export LC is not, of course, a substitute or direct competitor to forfaiting. Rather, forfaiting supplements the export LC as it provides financing in case of deferred payment or acceptance LC. Reinhard Langerich, a retired banker from Denmark who is still a member of the ICC Banking Commission, also says an LC can be forfaited. Bankers feel that where an acceptance LC calls for a bill of exchange, the bill of exchange should be avalised by the same bank that has issued/confirmed the LC.

Where the LC is available for acceptance or deferred payment, the exporter – that is, the LC beneficiary – can get a commitment from a reliable forfaiting house to discount the LC proceeds, which is assigned (under article 49 of the UCP) to the forfaiter on a non- recourse basis. The LC itself can serve as an evidence of debt/guarantee for forfaiting purposes where it is available for deferred payment and does not require a bill of exchange and thus obviates avalisation.

Is Forfaiting Negotiation?

Or, vice versa, is negotiation forfaiting? No. Negotiation may or may not be without recourse as forfaiting is. In negotiation there may be no assignment. In negotiation the exporter may not be free from LC payments administration and collection as in forfaiting. For negotiation, a bill of exchange or promissory note is not required, nor is avalisation or a letter of guarantee. Negotiation may be under reserve or against the exporter’s indemnity, but still it is popular because negotiation requirements are not difficult to comply with.

The avalisation or letter-of-guarantee requirement in forfaiting is cumbersome. In negotiation, full-face value may be advanced and interest may be charged on the value given later when LC payment comes in, for a period between the date of value given and the date of trade payment received. Negotiation is cost-effective for short-term financing.
In the case of even medium or long- term financing, for which forfaiting is suitable, forfaiting may still not be preferred because of pricing, and alternate methods may be used to secure financing, like tangible collateral from the exporter or a bank guarantee. Guarantee and negotiation play an important role in India’s export financing market.

LCs may remain a better option than forfaiting for the following reasons: LC usage is governed by UCP rules and facilitated by the ISBP. The existence of UCP rules and ISBP clarifications help exporters prepare and assert compliance. There are non- legal LC payment dispute resolution mechanisms available to the exporter, such as Docdex.

An LC has the advantages of irrevocability, transferability, assignment, negotiation, confirmation, discrepancy waivers and amendment with the exporter’s consent or
initiative, all offered by the UCP – which make the LC a safer payment mechanism and a more cost-effective financing mechanism. There is a risk of discrepancies, but the discrepancies can be rectified or waived.

Negotiation under LCs for post- shipment finance is easily workable, easily available, and easily affordable. It may be without recourse. Banks have skills and experience for
negotiation. Negotiation is thus a popular and traditional local alternative to forfaiting, which may be a foreign service for which local skills may not be available. Negotiation is indigenous; forfaiting may or may not be indigenous. In India, there is an attempt to “Indianise” forfaiting: the RBI rules to regulate foreign forfaiting is an attempt in this direction. Local bankers in India are developing forfaiting skills, but still negotiation is popular – and more popular in India’s banking system, which is the country’s leading LC market. Nothing succeeds like negotiation in India.

An LC has the potential to cover the risks forfaiting covers. It can be confirmed to cover political/transfer risks. It can be issued in the home currency of the exporter to cover foreign-exchange risk. If not in the home currency then with the help of hedging techniques, the LC can work well as a risk-management mechanism.

An LC can serve as collateral for back-to-back LC and pre-shipment finance, called packing credit in India’s banking language. An LC can facilitate credit insurance with maximum cover at minimum cost. An LC can be issued and handled by indigenous banks, even in developing countries or emerging economies – that is, LC service is not imported for local marketing. Forfaiting, on the other hand, may be a foreign service.

An LC is easily accessible, affordable, usable and more beneficial – hence preferable. India’s exporters are mainly small businesses. They don’t offer long credit periods, so they don’t need pricey and cumbersome forfaiting. For them, an LC is a tr ade necessity while forfaiting is a luxury. Its self-handling by the exporter can be learned easily, or its handling can be outsourced.

LC stipulations can be mutually contracted by the exporter and his or her buyer for specificity, clarity and relevancy; for convenient LC compliance management and ustoms compliance management; and for effective cost management, delivery management and risk management. The best example of LC popularity and forfaiting failure is India, where forfaiting has not become popular because of its faulty marketing – faulty because it is not consistent with the businesscharacteristics of India. You may be able to take your forfaiting service to India because the RBI permits it, but you may not be able to take the exporter in India, who is an LC addict, to your localised forfaiting service if you set up arbitrary or ineffective eligibility and marketing criteria.

Foreign forfaiters must acclimatise forfaiting to the Indian environment. The same criteria set in Europe or the United States may not work in India. So it is necessary to adopt the marketing approach - to sell what the buyer needs, the way the buyer likes it - and not the selling approach - to sell what you want to sell, the way you want to sell it.

Read the first part of LC vs Forfaiting - Indian Context here!