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Risks Involved in International Trade Finance: A Banker's Perspective

By Peter J. Boland

Traditionally, international trade has always been considered "low risk", and this is attributed to the four "S's". Compared with other forms of bank lending, financing trade transactions is popular because these deals are:

  • Short term
  • Self liquidating (e.g., banks finance the import of goods which are then resold to repay the bank)
  • Secured (by the underlying goods)
  • Speedily completed (e.g., within
  • the short life of a documentary credit, there may be several transactions which are completed quickly, at "high velocity")

Nevertheless, there are three main areas of risk. This article will focus on these risk factors and suggest ways to counteract them.

The three main areas are micro risks, macro risks, and product risks.

Micro risks are encountered at the individual customer level and are confined to the financial (credit) and operational risks associated with their business.

Macro risks can be defined as those external factors which have a tendency to impact adversely on a customer's international trade business. Some of the more frequent problems in trade financing are caused by a lack of appreciation of country risk, foreign exchange risk, industry risk, bank risk and fraud.

Let's examine some of these macro risk areas in more detail.

Country Risk

The factors usually associated with this type of risk are the political and economic stability of a country, exchange controls, if any, and the country's penchant for protectionism of domestic industry at short notice. All these factors will determine whether the country can and will honor their payment commitments-in time. For example, from many a first world country point of view, Sri Lanka is seen as a reasonable short term risk, (i.e., an export exposure up to two years is considered in order, provided the Sri Lankan importer can produce a documentary credit, preferably confirmed by a "first class" bank.) This is because Sri Lanka has liberalized exchange control, has no history of default on foreign debt commitments and has a reasonably robust economy. What holds the country back from being seen as a "more comfortable" level of risk is the political problems caused by the separatist issue.

Most banks have specialized units dealing with country risk and they control the level of exposure that bank will assume for each country. This system of policing is vital where balancing the stability of the institution against the greater profitability of transactions with higher risk areas. However, there is often a lot of friction between commercial bankers and these units where the former feels that the latter is too strict at times and business considerations are overlooked.

Foreign Exchange Risk

Payments and receipts in foreign currency are an everyday occurrence in international trade and the trader is always at the mercy of exchange rate fluctuations due to various economic, politicaland even purely speculative reasons. The astronomical volume of the global foreign exchange market leaves the importer/exporter with no control and an adverse movement in the transaction currency vis-a-vis the local currency can wipe out the entire profit and more of the deal.

It is vital that traders forge links with foreign exchange trading rooms in banks as then they will be able to stay abreast of the dynamic market and, more importantly, enter into forward foreign exchange ontracts to protect their profit margin. Surprisingly, many lending officers in banks consider the dealing room of a bank as a place of mystery and leave their customer to discuss any exchange rate issues with the dealer. This should not be the case and lenders must make efforts to gain at least a basic understanding of the workings and trends in the market.

Bank Risk

We do not need a rocket scientist to tell us that the world is full of banks of varying degrees of stability and strength and indeed the business pages of major magazines and newspapers are filled with articles on bank performance and bank collapse. When financing an importer or exporter, a bank often looks to the security of a backing document issued by another bank, be it a guarantee or a documentary credit. It is important to realize that the documentary credit issued by Bank A may not be as secure as that issued by Bank B, due to Bank A.

  • having a history or delaying or actually reneging on payment.
  • having a habit of rejecting documents iting tribial discrepancies;
  • being domiciled in a country notorious for foreign exchange restrictions and mortoriums; and
  • being domiciled in a country classified as high risk.

Dealing with bank risk is quite complicated and can be a sesitive issue most of the time, even more than country risk. Again, many banks leave this problem to a specialized unit and seek their guidance from time to time. In fact, many international banks produce and distribute instructions for their branches, setting limits for the various institutions they traditionally deal with. Anything outside such parameters has to be referred to this specialized unit for clearance.

A contribution to the business decision is also required from the management of the branch and if they feel that the branch can maintain recourse to a valued customer, then there is some flexibility to deal with the higher risk bank.


To cover the various aspects of maritime and indeed any other type of trade fraud requires volumes of paper. There are various types of fraud like documentary fraud, counterpart fraud, insurance scams, cargo theft, scuttling and piracy. Unfortunately, there are some countries which are renouwned for harbouring fraudsters. The golden rule is "if the deal looks too good to be true, it probably is" and one should be cautious when dealing with transactions which are much larger in value than the norm. Forged documentary credits are always in circulation and fortunately, an experienced trade services officer can detect a dud credit more often than not.

If goods are released against an undertaking by the importer to pay in the future - usually by accepting a draft - then the exporter/financing bank loses control over the goods and this method of release termed D/A (documents against acceptance) is more risky than D/P.

Documentary Credits

Here we will consider the bank in two roles: (1) as the institution financing the importer, and (2) as the exporter's bank.

1. Imports Under Documentary Credit (DC)

Before undertaking to establish a DC for an importer, the bank should consider:

The financial standing of the importer. The bank has to look to the importer to pay the import bill drawn under the DC and therefore should be sure that the latter has or will have the funds to pay.

The goods. Trade finance is supposed to be self-liquidating and the goods must be readily saleable. Consideration should also be given to the risks associated with perishability of the goods, possible obsolescence, import regulations, packing and storage, etc.

The status of the exporter (or beneficiary of the DC). There is always the risk that an arrant exporter could ship substandard goods or, worse still, complete rubbish, and one always guards against this by finding out as much possible about the exporter using status reports and other confidential information from banks and credit rating agencies such as Dun & Bradstreet. It is always wise to request a reliable third party like SGS (a firm of international cargo inspectors) to inspect the goods prior to shipment and produce a report called an inspection certificate. Such a document is often called for under a DC.

There has been many an instance where the exporter has shipped rubbish and still produced a compliant set of documents. Under the Uniform Custom and Practice for Documentary Credits (UCP), ICC publication No. 500, all parties deal in documents and a tender of compliant documents to the issuing bank means that the bank will have to pay. The only redress that is available to the importer is if he can conclusively prove fraud and get the courts to issue an injunction restraining the bank from making payment.

(Remember: the DC itself is a contract between the importer's bank (the issuing bank) and the exporter. It makes a lot of sense to find out about the party you are contracting with prior to issuing the contract, doesn't it?!)

One must also consider the various macro risks and it is imperative that the goods are suitably insured by & reputable insurance company. The bank should endeavor to retain control over the goods until release to the importer and this can usually be achieved with a suitable transport document like the Bill of Lading or the Air Waybill.

2. Exports Under DC

One of the greatest services a bank can do for its exporter in advising the DC it receives from an overseas bank is to check carefully whether it is workable and that the exporter will be able to comply with its terms and conditions. This is called checking the workability of a DC and very often one encounters exporters finding that they cannot produce a compliant set of documents under the DC. Payment is thus delayed due to discrepancies between the documents and the DC or, worse still, not forthcoming at all.

Many exporters submit documents to their bank and request that the bank negotiate the documents, i.e they want the bank to give value for the documents prior to reimbursement by the issuing bank. Provided bank risk and country risk considerations have been dealt with, the exporter's bank - now termed the negotiating bank - will have to check the documents carefully against the DC and if they are in order, i.e, no discrepancies, the bank will discount the export bill. The documents are then sent to the issuing bank, which will check the documents and then reimburse the negotiating bank. If the issuing bank finds discrepancies overlooked by the negotiating bank, they will reject the documents and if the applicant is also unwilling to take up the documents, the negotiating bank will have to turn to the exporter for reimbursement-usually not an easy task as the exporter may have already used the funds other trading activities. The situation is more serious if the negotiating bank is also the confirming bank, Here, the negotiating bank takes on the same liabilities and responsibilities of the issuing bank and therefore has no recourse to the exporter.

To mitigate the above risks of non-payment, the negotiating bank must understand the underlying transaction and be comfortable that the trading parties will honor their commitments. Very simply the importer wants the goods and the exporter wants to be paid in time. No DC, however worded, will prevent the actions of a fraudster. The operational competency and integrity of the issuing basic must be considered carefully, since it can be very trying dealing with banks who habitually reject a document and delay payments due to trivial discrepancies.


The myriad of situations that one encounters when financing international trade defies the writing of any one publication covering all problems. Like any other form of commercial banking there is no substitute for good old common sense.

Peter Boland is former Senior Vice President, Trade Services for HSBC Trade Services, New York. Mr. Boland is now based in Hong Kong. He has been succeeded by Jonathon Addis.

Incoterms for Americans by Frank Reynolds, is available for $43.00 through his company, International Projects, Inc. in Toledo, OH. The telephone number is 419-865-6201.

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