The term forfaiting refers to a form of trade finance involving discounting of export bills receivables such as drafts drawn under LC, bills of exchange, promissory notes, or other instruments on without recourse basis. The export of capital goods involves account receivables of medium and long term maturities. It is a general practice that the exporter sells the claim of trade receivable on capital goods to an intermediary called forfaiter and gets an immediate payment of money for future receivable without recourse against him. It means that the exporter has no further interest in the transaction. It is the forfaiter who collects the future payments due from the importer and it is the forfaiter who runs all the risks of non-payment, as he cannot claim the payment back from the exporter. This type of relinquishing the right by an exporter to a forfaiter over trade receivables is called forfaiting.
Forfaiting usually takes place on trade receivable on capital goods, however, it can be applied to a wide range of trade related and even purely financial receivables and payment instruments. Finance can be arranged on a fixed or floating interest rate basis. Although discounted receivables often have maturities over medium terms of 1 to 3 years they can be as short as 1 month or as long as 10 years.
The exporter on receipt of export order from an importer, approaches a forfaiter with the details of the country of the importer, name of the importer, type of goods, value of the goods, expected shipment date, repayment terms sought by the importer and asks for an indication of whether the forfaiter is willing to provide this credit and how much it is likely to cost. The forfaiter provides the exporter with an indication of the costs involved based risk factor involved in the transaction. In case the importer’s obligation is guaranteed by a bank, the forfeiter gives a better quote. Upon negotiating and agreed upon on following matters, the commitment letter will be signed by the forfeiter binding him as well as the exporter.
- The details of the underlying commercial transaction.
- The nature of the debt instruments to be purchased by the forfaiter.
- The discount rate to be applied, together with handling charges
- The documents that establishes that the debt being purchased is valid and enforceable.
- The latest date that the exporter can deliver these documents to the forfeiter.
Once the goods are shipped to the importer, the exporter submits related documents to the forfaiter who verifies the documents and pays for them as agreed in the commitment. The forfaiter then takes over responsibility for claiming the debt from the importer. The forfaiter either holds the notes (negotiable instruments like promissory note, bill of exchange, draft etc.) till full maturity or he may sell them to another investor on a non-recourse basis. The holder of notes then presents each receivable to the bank at which they are payable on due date.
Forfaiting has many advantages to an exporter, as he not only gets 100 percent financing , but also escapes from various types of risks involved in export business viz. interest rate risk, currency risks, credit risk and political risk etc. involved in deferred payments. Forfaiting enables the exporter to accurately determine his financing cost and add this cost to the price while quoting to the buyer. The payment received in advance for the goods sold improves the cash flow position of the exporter.