EuroEximBank

The advent of blockchain is potentially revolutionary in the world of finance. For trade finance, in particular, the adoption of blockchain will increase speed and efficiency while concurrently reducing costs and the potential for fraud. It is also probably the only viable technology for a truly worldwide, compatible, decentralized system for the provision and tracking of trade finance.

Present Challenges & Risks

Whether digitally assisted or not, presently widespread systems for trade finance encounter a host of problems, hamper efficiency and introduce risks, including:

Manual Contracts – Banks need to manually draw up, execute and enforce contracts, which is time-consuming, resource-intensive, and diminishes efficiency.

Factoring – Some businesses will use invoices and accounts receivable to obtain financing. In doing so, these need to be manually verified and checked.

Delays – Due to these checks and the involvement of multiple intermediaries, shipping and payment timelines are often delayed, causing further stress to both importers and exporters.

Manual AML and Fraud Prevention – AML needs to be conducted manually, the potential for duplicated documents such as bills of lading and invoices is significant and as financials move from one party to another, the potential for alterations and changes grows.

Multiple Platforms – Due to the transnational nature of global trade, there are usually multiple platforms involved, further increasing the risk of fraud.

The Revolutionary Blockchain Model

With blockchain, the whole process of trade finance will occur online, using an incorruptible distributed ledger that is even capable of interfacing with different platforms. Smart contracts are a crucial part of the blockchain that is helping to transform the trade finance space. At each point during the journey of the goods from exporter to importer, all participants including financiers, customs, logistics, and law enforcement will all be able to interact in a seamless way using smart contracts. Once the goods are received, the payment process may be initiated in a timely manner.

Main Advantages

Everything in Real-Time, Fully Transparent – All documents and necessary information is available in real-time and only one version may exist. All this will be further searchable, trackable, and traceable to all parties. Whether it is invoiced for factoring, shipping documents, proof of ownership or any other relevant documents, everything will be available for all participants to view and access, dramatically reducing the propensity for fraud and counterparty risk. Blockchain’s decentralized nature also means that it is virtually incorruptible and indisputable.

Reduced Intermediaries and Automated Settlement – Fewer intermediaries are required within a blockchain-driven system. Furthermore, due to the nature of smart contracts, automated payment settlements can be initiated no sooner goods are received.Cheap – As a result of the mechanisms used and the freedom they provide, blockchain-driven trade finance, settlement, and tracking systems will provide unbeatable cost efficiency.

Performance Bonds are a type of guarantee provided by a bank or surety company to reduce the risk involved in major construction, infrastructure and other projects. It is one of many types of bonds used in the construction industry and can help to mitigate risk and relieve the construction project of liability in the event a contractor fails to deliver.  

How They Work 

The owner(s) behind the construction project will sign a performance bond with one or more of the contractors involved in the project, particularly the prime contractor. The bond contains detailed terms and conditions with regard to the contractor’s obligations and delivery timelines etc… 

Thus, if a contractor fails to deliver, or worse if the prime contractor goes bankrupt before the completion of the project, the company behind the project makes a claim on the performance bond. The bank or surety company will then be required to compensate the owners and or engage the services of an alternate contractor to complete and deliver the work in accordance with the performance bond. <./span>

The benefits of a performance bond, while largely accruing to the owners behind the construction project, will trickle down to everyone involved. Other contractors and subcontractors will be prevented from taking losses and or having their work delayed and workers will likely remain paid. Overall, they end up ensuring that construction projects are completed on time and to specification.  

Obtaining a Performance Bond 

Procedures may vary from jurisdiction to jurisdiction, but it is hard to go wrong when you choose a reputable international bank that is capable of acting as a surety. Depending on jurisdiction, some types of projects, particularly involving the government, or where the value of the project exceeds a certain monetary value, performance bonds become mandatory. At Euro Exim Bank, our team of financial specialists is capable of arranging performance bonds of any size, based upon the requirements of our clients, and has established a strong track record as an international financial services provider.  

Claims 

In the event of a claim, the bank or surety company may resolve the matter in a few different ways: 

A Payment – For the amount of the bond or the cost to complete the remaining work, whichever is lower.  

Financing – If the contractor was close to completing the work and is still able to do so with financial support, the bank may end up financing the contractor to complete the remaining work.  

Arrangement – The client and bank will work together to find a contractor and complete the work. 

Takeover – In the worst case, the bank will take over full responsibility and find and fund a contractor of its own choosing to complete the work.   

Bank guarantees are frequently used in international trade finance as a means to reduce risk. They can be simply defined as a promise by the bank to cover a loss in the event of either a buyer defaulting on payment or a seller failing to supply goods as agreed; depending on how the bank guarantee is drawn up.  

As a result, bank guarantees can provide virtually complete risk mitigation to exporters. They can also be used to protect importers, when drawn out as such. Note, however, that a single bank guarantee does not work both ways and will cover only one party. Thus, where two-way risk mitigation is required more than one bank guarantee is required, which is why more efficient mechanisms, such as Letters of Credit, are often used instead in such circumstances.  

Common Types of Bank Guarantees in Trade Finance 

Bank guarantees are used in many transactions and not only in trade finance. However, when it comes to import/export trade, these are the most commonly used forms: 

Payment Guarantees – These instruments ensure that the exporter will receive payment on a specific date; some may have additional conditions included and may be revocable in some instances.  

Confirmed Payment Orders – These are irrevocable and the bank must pay the exporter a specified amount on a specific date. 

Performance Bonds – These bank guarantees are more complex and allow the importer to recover incurred costs if goods are not provided as contractually agreed upon.  

Advance Payment Guarantee – This is a bank guarantee used to ensure that the importer will be reimbursed for any advance payments made in respect of the transaction, if the goods are not delivered as agreed.  

Simple Working Examples 

Suppose a new company in the UK wants to import tea from a major exporter in India, but the Indian exporter is not familiar with the UK buyer. In this case, the exporter may ask for a payment guarantee, just to be sure, which will provide them with the confidence and security to make the shipment as per the buyer’s requirements, without worrying about a potential default.  

Alternately, suppose a small exporter from a country in Africa is trying to supply some goods to the EU, but requires an advance to be sure of the buyer and also to fund working capital needs. In this case, the importer may ask the small African company to provide an advance payment guarantee to mitigate the risk of non-performance.  

Choice of Bank is Important 

When looking to use a bank guarantee, your choice of trade finance partner is important. Always look to work with a reputed international bank that is welcoming to SMEs, such as Euro Exim Bank. Our team of experts, wealth of experience and specialization in trade finance make us an ideal choice. We also use cutting-edge digital technology to provide next-gen services such as digital bank guarantees, which are faster and often more economical that traditional methods. 

Letters of Credit and Bank Guarantees are some of the most commonly used mechanisms to mitigate risk of default and or non-performance in international trade transactions. However, while both can help to achieve similar goals, they work differently.  

Letters of Credit 

A letter of credit (LC) is a form of documentary credit issued by the buyer’s bank and sent to the seller’s bank. It is a formal document confirming an undertaking that payment will be made to the seller, on behalf of the buyer, once documentary proof that terms and conditions contained within the letter of credit, to which buyer and seller have agreed, are fulfilled.  

Bank Guarantees 

A bank guarantee is contract that makes it obligatory upon the issuing bank to pay a certain amount of money, on behalf of the applicant (the person on whose behalf the guarantee is issued), to the beneficiary, on a specified date or in accordance with some other condition(s), if the applicant fails to make the payment. It is effectively insurance against non-performance.  

How They Are Different 

A key difference between the two is that, if an LC is used (except Standby LCs), it will be the mechanism used to settle the payment, while if a bank guarantee is used, it is usually only used as a mechanism of settlement in the event of default or non-performance. Here are some other major differences: 

Which Should You Choose? 

It all depends on your circumstances. An LC provides the best risk mitigation for both importers and exporters simultaneously, while a bank guarantee can help protect one party or the other from the risk of non-performance.  

Speak with our team of trade finance specialists at Euro Exim Bank to better understand which instrument will be right for you. We are dedicated to assisting SMEs and businesses around the world through the adoption of the latest cutting-edge digital technology to create accessible and flexible trade finance solutions.