Forfaiting

Forfaiting

            A form of financing of receivables arising from international trade is known as forfaiting. Within this arrangement, a bank/financial institution undertakes the purchase of trade bills/promissory notes without recourse to the seller. Purchase is through discounting of the documents covering the entire risk of non-payment at the time of collection. All risks become the full responsibility of the purchaser (forfaiter). Forfaiter pays cash to the seller after discounting the bills/notes.

Modus Operandi

  Following are the salient steps involved in forfaiting:

1. Commercial Contract

            Exporter and importer enter into a commercial contract. The contract provides the basic terms of the arrangement, such as cost of forfaiting, margin to cover risk, commitment charges, days of grace, fee to compensate the forfaiter for loss of interest due to transfer and payment delays, period of forfaiting contract, repayment installment (usually bi-annual), rate of interest and so on. The factoring charges depends upon such factors as terms of the note/bill, the currency in which it is denominated, the credit rating of the availing bank, the country, risk of importer etc.

2. Transaction

            The exporter sells and delivers the goods to the importer on a deferred payment basis.

3.  Notes acceptance

            The importer accepts a series of promissory notes in favor of the exporter for payment, including interest charges. Such notes are then sent to the exporter. Bank guarantee in respect of promissory notes/bills is also obtained.      

4. Factoring contract

            The exporter and the forfaiting agent enter into a forfaiting contract, with the forfaiter usually being a reputed bank, including the exporter’s bank.

5. Sale of notes

            The exporter sells the notes/bills to the bank (forfaiter) at a discount without recourse.

6. Payment

            The exporter makes payment to the forfaiter for the face value of the bill/note, less discount. The forfaiter either holds these notes/bills till maturity for payment by the importer’s bank, or securitizes them in order to sell them high-yielding unsecured paper in the secondary market.

Differences between Factoring and Forfaiting

Sl. No	Characteristics	Factoring	Forfaiting
1 2 3 4 5 6 7 8 9 10	Suitability Recourse Risk Cost Coverage Extent of Financing Basis of Financing Services Exchange Fluctuation Contract	For transaction with short-term maturity period Can be either with or without recourse Risk can be transferred to seller Cost of factoring is usually borne by the seller Covers a whole set of jobs at a predetermined price Only a certain percent of receivables factored is advanced Financing depends on the credit standing of the exporter Besides financing, a factor also provides other services such as ledger administration  etc. No security against exchange rate fluctuations Between seller and factor	For transaction with medium-term maturity period Can be without recourse only All risks are assumed by the forfaiter Cost of forfaiting is borne by the overseas buyer (importer) Structuring and costing is done on a case-to-case basis Hundred percent finance is available. Financing depends on the financial standing of the availing bank It is a pure financing arrangement A forfaiter guards against exchange rate fluctuations for a premium charge Between exporter and forfeiter