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What Is Commodity Finance?

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  • Written By: Mary McMahon
  • Edited By: Shereen Skola
  • Last Modified Date: 06 December 2016
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Commodity finance is a form of transactional financing for commodities trading, particularly across international borders. Numerous financial institutions offer a variety of products to assist clients with international trading activities. Some focus on particular commodities like grain or oil, while others may handle a wide array, depending on the needs of their clients. The opportunities available depend on the client, the institution, and the commodity. Financial institutions involved in this aspect of the business work primarily with commercial, rather than individual, customers, and may be private in nature or publicly traded.

This financing is intended for the short term, to help clients import or export commodities for trade purposes. Some options are intended to be self-liquidating. As soon as the client has successfully sold a load, the bank expects repayment of a loan or line of credit. Clients remain in good standing by repaying their loans promptly, which allows the bank to issue more financing to that and other companies through its commodity finance wing.

Some commodity finance products, like letters of credit and guarantees, are relatively straightforward and may be readily available. The financial institution typically wants to review the client's financial history and the details of the transaction to determine the level of risk. This information allows a bank to set appropriate terms and conditions. These may include higher interest for more risky transactions, or minimums to make the account worth its while.

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Structured commodity finance products are slightly more complex. These also provide short term financing opportunities, with some changes to reduce risks to the lender. This, in turn, can create savings for the customer. An example is invoice discounting, where banks loan money on the basis of accounts receivable. The bank treats the invoices as collateral assets, discounting their face value to determine how much money to loan, and collects payment when the customer receives the money from a buyer.

Financing is critical for a wide variety of commodities trades. Secondary markets can allow institutions to buy and sell loans and other financial instruments backed by commodities trade agreements. This allows banks to unload liability on the common market. They can issue loans to new customers and make other investments with the profits they receive from these trades, which allows them to keep growing as they serve customers. In commodity finance, banks develop risk ratings for clients to determine how much to loan and how to classify financial products backed by client loans and other activities.

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