Overview
In today’s global economy, businesses need to regularly undertake export and import of goods as part of their business functions. However, not every business is able to access funds as and when required for larger imports so easily. Failure to avail funds timely could impact import of goods, affect goods deliveries, late client payment, etc. all of which could threaten businesses goodwill and business relationships.
This is where the buyer’s credit comes into picture. It enables necessary funding for imports without meddling with its cash inflows or payment delays to suppliers.
Buyer’s Credit – An Understanding
Generally, securing funds for import purposes from local lending institutions could be challenging for smaller businesses. However, Buyer’s credit is a type of finance facility that allows short-term borrowing to businesses to fulfill their import requirements from an international financial institution. Such credit facilities which assist businesses to purchase capital goods or manage payments for larger imports.
In a typical buyer’s credit transaction, there are multiple parties included such as – the buyer/importer, the exporter/seller and the lending institution. If the importer fails to repay the loan within the due period, there is also a guarantor to assure timely loan repayment to the foreign lending institution. Additionally, it empowers importers to seek financing in stable and reliable foreign currency if their local currency is declining.
Importers normally employ buyer’s credit facilities to avail loan facilities at favorable terms from foreign lenders. It could be used by businesses to procure capital- intensive as well as non-capital goods depending on the mutually agreed terms. Buyer’s credit gives importers the option to pay down bigger sums over a pre-agreed period in accordance with the agreement.
How Buyer’s Credit Works: Step-by-Step Explanation
In a typical buyer’s credit arrangement, the buyer/importer enters into a contract providing all significant terms of contract (i.e. payment method, payment tenure and repayment security, etc.
Next, the importer approaches a foreign lending institution to seek a credit facility for fulfilling import requirements. The exporter’s credit agency typically guarantees these loans, shielding the lending institution from any payment default.
Following the completion of the items shipment, the lending institution makes payment to the exporter in line with the agreement. The buyer/importer pays back the loan along with interest to the lending institution as per the mutually agreed period.
Buyer’s Credit – A Complete Understanding
Buyer’s Credit Benefits
Here are some other benefits of buyers’ credit for exporters as well as importers-
Lower financial risk
Buyer’s credit reduces financial risk significantly by allowing them to defer payments until the goods are received and accepted. As a result, importers may be able to circumvent the potential risk of paying for subpar or unreceived goods.
Lower financing costs-
The financing costs associated with buyer’s credit are typically lower than those of other financing sources such as commercial loans. Generally, the credit facility is guaranteed by the Export credit Agency who backs credit, lowers bank’s risk and enables loan facilities at cheaper interest rates.
Extended terms of payment-
Importers may be able to efficiently manage their cash flows by negotiating longer repayment tenure with their suppliers through buyer’s credit. It could be especially relevant for importers required to retain inventories for a longer period or those dealing with lengthy production cycles.
Higher sales-
Securing buyer’s credit by importers also aids exporters to achieve higher sales with minimal financial risks. It could be specifically advantageous for exporters competing with sellers not offering any similar financing option.
Improved cash flows-
Next, buyer’s credit enables exporters to receive faster payments for export of goods. Hence, exporters who need to make advance payments to their suppliers or involve longer manufacturing processes are benefited from such credit facilities.
Guarantees prompt payment to exporters-
Buyer’s credit ensures prompt payment to the exporters within the timelines agreed by parties. This undoubtedly benefits the exporters in efficient financial management resulting in robust business partnerships.
Normal Buyer’s Credit vs. Buyer’s Credit – Key Differences
In the realm of international trade finance, the expressions ‘Normal Buyer’s Credit’ and the Buyer’s Credit are used interchangeably. However, it is to be noted that there are some key differences which have been pointed below-
Normal Buyer’s Credit |
Buyer’s Credit |
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| Meaning | Normal Buyer’ s credit implies a simple financing arrangement between the lender as well as borrower’s belonging within the same domestic boundaries. | Buyer’s credit is a short-term financing arrangement between an importer as well as a foreign lending institution to fulfill procurement of goods or services from the exporter entity. |
| Purposes | The primary purpose of a Normal is to aid immediate finance requirements for a business to procure goods or services. | Some of the typical purposes for availing Buyer’s credit includes-
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| Working mechanism | Under a normal buyer’s credit transaction, the borrower seeks financing from a local financial institution to meet funding needs to fulfill supplier payments. | By enabling direct payments to the exporters, buyer’s credit considerably lowers exporters risk. |
Letter of Credit and Buyer’s Credit – Comparative Overview
Letter of Credit |
Buyer’s Credit |
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| Meaning | A Letter of Credit (LC) is a financial instrument that extends repayment assurance from an importer’s lending institution to the exporter’s bank. | Buyer’s credit is a financial tool that allows importers to avail affordable borrowing from foreign lending institutions. The short-term credit facility typically extends between a period of 180 to 360 days. |
| Liability | LCs are used as a payment method in international transactions to cover third party risk.
Where the importer fails to make timely repayment of loan, the importer’s bank will step up to honor payment commitment. |
Generally, the export credit agency (ECA) acts as a guarantor for security of repayment in the event of default by the importer. |
| Purpose | LCs are a guaranteed assurance of repayment by the importer’s bank in the event where the importer fails to make payment. | Buyer’s credit facility enables the importers to fulfill their funds required for import functions. |
| Transaction Value | LCs are used for smaller as well as high value transactions. | Typically used for large amount transactions. |
| Parties Involved | Importer, Importer’s Bank, Exporter as well as his bank are common parties to a Letter of Credit transaction. | Importer/Borrower, International lending institution as well as the exporter/seller of goods are common parties in buyer’s credit arrangement. |
| Repayment terms | The importer needs only to repay a certain security fee to his bank. | The importer has to pay a security fee as well as interest on the borrowed sum. |
| Working mechanism | LCs arrangement entails transfer of goods from exporter to the importer as well as transfer of funds from importer’s financial institution to the exporter’s bank. | Under Buyer’s Credit, there is only movement of funds from lending institution to exporter and later from importer to the lender. |
| Charges Involved | In a LC transaction, banks levy commission and security fee charges. | In case of buyer’s credit transaction, some common charges levied by lender include-
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Buyer Credit Vs Supplier Credit
The parties involved in both the types of credit, buyer credit and supplier credit, are generally the same.
- The difference lies between the agreement – in case of buyer’s credit the main contractual agreement is between the buyer and the bank. Whereas, the contractual agreement in case of supplier credit is between the buyer and the supplier.
- Therefore in the former case the repayment is made by the importer to the foreign bank whereas in the latter case the repayment is done directly to the supplier.
- The duration for supplier credit is generally shorter than the buyer credit period.
- In case of buyer credit the risk is easily mitigated as an Export Credit Agency (ECA) is usually involved. Whereas, in case of a supplier credit, the exporter bears the risk unless insured or guaranteed.
- A buyer’s credit utilises readily convertible foreign currencies, like USD, EURO etc. Whereas the supplier credit can be in any agreed upon currency, local or foreign.
Cost Components in a Buyer’s Credit Arrangement
Interest Cost-
The foreign lending institution charges interest on the borrowed sum (LIBOR + Margin) above the margin levied over the LIBOR (London Interbank Offered Rate) rate. Generally, such interest costs differ depending on the cost of borrowing, lending institution as well as the loan tenure.
Letter of Comfort/Undertaking charges-
The importer’s local bank shall charge a certain fee for issuing a letter of comfort or letter of undertaking.
Currency risk premium-
Usually buyer’s credit usually involves foreign currencies posing a significant risk of currency value fluctuations. Thus, to mitigate risk of currency instabilities, the foreign lending institutions may charge a currency risk premium charge.
Broker Fees-
Importers may need to pay a fee to brokers or agents who assist them to secure Buyer credit.
ECA Fees-
Regardless of whether the borrowed funds are supported by either a guarantee or insurance, the Export Credit Agency levies a guarantee fee for reassurance of payment to the foreign lender.
Withholding Tax-
Importers may be required to make payment of withholding tax on interest payments which may vary on the basis of the lender nation.
Miscellaneous Expenses-
Other expenses may include paperwork costs, fees for intermediate banks, and other service fees, etc.
Documentation Checklist for Buyer’s Credit Facility
- Letter of Customer Request;
- Letter of Offer;
- Loan Agreement (drafted as per the applicable state law);
- Copy of transaction related documents
- Importer Bank’s Standing Letter of Credit;
- Importer Bank’s funding request in prescribed format;
- Importer Bank’s Validation and Approval Certificate;
- Copy of Repayment Plan;
- Details of the Trade Transactions.
Strategic Value of Buyer’s Credit in International Trade
Therefore, buyer’s credit is a mutually advantageous financial instrument for importers and exporters. It promotes business growth, business collaboration and international trade.
Compared to regular loans, it comes with attractive features such as lower cost of borrowing and longer payback schedules making it easier to seek capital for businesses. Although, it involves multiple costs making it an expensive financing alternative the benefits surpass such costs. All of which make it an ideal choice for importers dealing with immediate funding needs or longer delivery cycles. To know how to manage your SME loans, reduce interest costs and avoid overpaying on your business loans to the banks, contact us at BankKeeping.
FAQs
What is Buyers Credit?
It is a lending facility that can be availed by importers from foreign lenders, enabling them to finance their import transactions at competitive interest rates. It is generally available as a short term credit facility to facilitate uninterrupted foreign trade.
Who are the parties involved in buyer’s credit arrangements?
Typically there are four parties involved in a buyer’s credit arrangement – Importer, Exporter, Foreign Lending Institution and Importer’s Bank. In most cases an Export Credit Agency (ECA) is also involved, who guarantees repayment on behalf of the importer.
For what types of goods can buyer’s credit be availed?
Buyer’s Credit can be used to finance capital goods and non-capital goods, like raw materials, depending on the credit agreements.
What is the time period for the buyer’s credit arrangement?
The normal time period for buyer’s credit period ranges anywhere from 180-360 days, though it may vary depending on each country’s lending / banking policies.
Is buyer’s credit available for SMEs and MSMEs as well?
Definitely Yes! An SME can avail buyer’s credit depending on its credit worthiness and size of the transaction. It may also depend on the evaluation made by the international lenders who provide credit to the importers.