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What Are the Different Types of Trade Finance Programs?

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  • Written By: Naomi Smith
  • Edited By: A. Joseph
  • Last Modified Date: 05 September 2016
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Trade finance programs are sponsored by government or international financial organizations to encourage banks to fund private sector trade transactions in areas where the financial markets break down. Typical programs include credit guarantees, revolving credit facilities and risk mitigation programs, particularly in regions that have currency restrictions and in which foreign trade provides liquidity in foreign exchange. Sponsoring international organizations as of 2011 included the Asian Development Bank, the World Bank's International Finance Corporation and the European Bank for Reconstruction and Development.

Credit guarantee programs ensure that an exporter's bank will receive payment on a letter of credit, even if the importer or the importer's bank does not pay as expected. This encourages banks to take on clients with whom they might not normally work, and it allows smaller companies to participate in import and export transactions. Credit guarantees are made on an individual transaction basis after the importer and exporter have negotiated terms. The importer's bank and exporter's bank generally must be approved before the trade finance programs sponsor will offer a credit guarantee.

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Risk mitigation is one of the key goals of trade finance programs. Sponsoring organizations reduce or eliminate risk to the individual banks by guaranteeing full or partial repayment in the face of commercial or political risk. For companies in more developed countries, this risk generally is covered by private trade credit insurance, but in less-developed regions, the cost of such a policy would be prohibitive, thus requiring public sector or regional international organizations to step in. For example, the Asian Development Bank might guarantee the transaction from a Chinese company to a Thai company, promising payment if political instability in one country or the other prevents the transaction from being completed.

Trade finance programs also offer revolving credit facilities to help banks fund loans for pre- and post-transaction expenses. Many trade finance organizations offer programs to lend additional money to banks that lend the funds to client companies to pay for expenses that are not necessarily part of the individual export/import contract. In this case, the organization takes on the bank's risk, rather than guaranteeing the performance of the private-sector importer or exporter. An example of such a loan might be one for an Indonesian clothing manufacturer to purchase fabric and other supplies to fill a large order for export.

Regional trade finance programs such as those by the Asian Development Bank or the African Development Bank are designed to promote trade within the region as well as support member country banks and companies in import/export activity outside of the region. Banks from third or even fourth countries might be involved in transactions, further adding to the risk of any trade undertaking. For example, a Vietnamese company might import French capital equipment, with a German bank financing the export. The Asian Development Bank might then offer a credit guarantee to the German bank that the importer's bank would pay.

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