Basics of Foreign Exchange

Contents

 Basics Of foreign Exchange

 Pre Shipment Credit

 Post Shipment Credit

 Forfaiting

 Factoring
Basic concepts of foreign exchange

 Foreign Currency means any currency

other than Indian currency.

 Forex, or Foreign Exchange, is the

simultaneous exchange of one
country’s currency for that of another.
Forex Market

 The market where the commodity

traded is Currencies.

 Price of each currency is determined in

term of other currencies.
Exchange Rate

 Exchange Rate is the price of one country’s currency expressed in

another country’s currency. In other words, the rate at which one
currency can be exchanged for another.
e.g. Rs. 48.50 per one USD

 Major currencies of the World

 US $

 EURO

 Japanese Yen

 POUND STERLING
What is a Forex Transaction ?

 Any financial transaction that involves

more than one currency is a foreign
exchange transaction.

 Most important characteristic of a

foreign exchange transaction is that it
involves Foreign Exchange Risk.
What is a Forex Transaction ?

 Money or currency is the ultimate

commodity.

 Every time a company or government buys

or sells products and services in a foreign
country, they are subject to a foreign
currency trade; the exchanging of one
currency for another.
Factors Affecting the Market

 Currency prices are affected by a variety of economic and

political conditions, most importantly interest rates, inflation
and political stability.

 Governments sometimes participate in the Forex market to

influence the value of their currencies, either by flooding the
market with their domestic currency in an attempt to lower
the price, or conversely buying in order to raise the price. This
is known as Central Bank intervention.

 Any of these factors, as well as large market orders, can

cause high volatility in currency prices.
FOREIGN EXCHANGE
MARKET

 Foreign Exchange Market is an Over the

Counter Market. It means that there is no
fixed market place. Market players are
differently and distantly located.

 It has no borders and barriers. All the

transactions are put through over
telecommunications followed up by written
confirmations.
PARTICIPANTS IN THE
FOREIGN EXCHANGE MARKET

 All Scheduled Commercial Banks (Authorized Dealers only).

 Reserve Bank of India (RBI).

 Corporate Treasuries.

 Exchange Companies

 Money Changers
Who is an Authorized
Dealer?
 Reserve Bank of India under the provisions of FEMA , has
delegated the authority of handling Foreign Exchange to State
Bank of India (and its subsidiaries), Public Sector Banks,
Private Sector Banks and Foreign Banks.

 RBI has delegated the authority of handling Foreign

Exchange and they are explained through various Chapters of
Exchange Control Manual, a book released by Reserve bank
of India.

 Under ECM, designated Authorized Dealers (of Foreign

Exchange) will be dealing in various Foreign Exchange
transactions, to comply with all terms and conditions.
PARTICIPANTS IN THE
FOREIGN EXCHANGE MARKET
 Foreign Exchange Market is a three tier market viz.:

 Merchant Market : Between Authorized Dealers and the

public.

 Inter Bank Market : Between Authorized Dealers in India

including Reserve Bank.

 INTERNATIONAL MARKET : Comprising all Banks who deal in

Foreign Exchange at select international Foreign Exchange
Centers like Singapore, Hong Kong, Tokyo, London, New York
etc. When an Authorized Dealer is unable to cover a deal in
the local market, he will approach the other Bankers in the
International Market for covering his deal.
Why Exchange Control?

INFLOWS OUTFLOWS
Inward Remittances  Outward Remittances

Remittances to  all bank accounts  Export related payments like

commission, legal fees, etc. 
Foreign Assistance /Loans  Loan repayments / servicing of
/Borrowings by Corporates etc.  loans 

Export Receivables Payments relating imports

Tourists’ income  Tour/Travel related expenses

TYPES OF FOREIGN
EXCHANGE TRANSACTIONS
 Authorized Dealers can handle two types of transactions viz.
Purchase and Sale of Foreign Exchange.

 When customers tender export bills denominated in Foreign

Currency, ADs shall purchase the Foreign Currency Bill.
Likewise, when customers request for a remittance in Foreign
Currency towards payment of Import bills, then ADs have to
sell Foreign Currency to him.

 This represents selling and purchasing transactions from the

bank’s angle.
SETTLEMENT OF FOREIGN
EXCHANGE TRANSACTIONS
NOSTRO Account: Our Account with you;

 The account maintained by an Authorized Dealer with a

foreign bank is called "NOSTRO" Account or "Our Account
with You".

 When an instrument like a cheque or an export bill is

purchased the same is sent to the overseas bank
(correspondent) for realization, the amount is collected and
credited to Authorized Dealer’s account with them.

 Similarly, when a draft is issued on a banks foreign

correspondent it will be paid at the overseas centre by
debiting the NOSTRO Account of the issuing bank.
SETTLEMENT OF FOREIGN
EXCHANGE TRANSACTIONS
VOSTRO Account: Your Account with us

 Foreign banks (Correspondents) also

maintain accounts with any bank in India in
Indian Rupees for the purpose of settling
their rupee transactions and these accounts
are called "VOSTRO" Accounts meaning
"Your Account with us".
SETTLEMENT OF FOREIGN
EXCHANGE TRANSACTIONS
LORO Account: Their account with them

 It is like State bank Of India maintaining an

account with foreign correspondent say Bankers
Trust Co (BTC) New York, Canara Bank may also
maintain a Nostro Account with them.

 When SBI advises BTC New York for transfer of

funds to Canara Bank Account with them, Canara
Bank Account is titled as LORO Account "i.e. their
account with you".
SETTLEMENT OF FOREIGN
EXCHANGE TRANSACTIONS

 When the bank deals in an export credit bill on

collection basis/on realization of export bills
negotiated /purchased/discounted, the foreign
currency funds is to be credited to the banks
account.

 For this purpose, banks maintain Foreign Currency

accounts with various correspondents abroad. The
account is called NOSTRO account.
SETTLEMENT OF FOREIGN
EXCHANGE TRANSACTIONS

 Once the proceeds are credited in the NOSTRO

account, banks receive a statement, based on
which, the concerned branch, who have handled
the transaction, will be informed.

 Likewise, when remittances are to be made on

behalf of our customers towards import payments,
miscellaneous remittances etc., banks give
instructions to their correspondents, to debit their
NOSTRO account and effect payment.
SETTLEMENT OF FOREIGN
EXCHANGE TRANSACTIONS
 Sometimes correspondent bankers maintain
VOSTRO accounts (Rupee accounts of Non-
resident banks) with the bank and payment
or receipts are made through this account.

 For exports, they will authorize banks to

debit their VOSTRO account and for
imports, they will give instructions to credit
their account.
Pre Shipment credit
Pre Shipment Finance is extended by a financial
institution when the seller wants financing before
the goods are shipped. The main objectives
behind pre shipment finance or pre export finance
is to enable exporter to:

 Procure raw materials.

 Carry out manufacturing process.
 Process and pack the goods.
 Ship the goods to the buyers.
 Meet other financial cost of the business
Types of Pre Shipment Finance

Pre shipment finance is extended in

the following forms :

 Packing Credit in Indian Rupee

 Advance against Cheques/Draft etc.
representing Advance Payments.
 Packing Credit in Foreign Currency
(PCFC)
Requirement for Getting Packing Credit

This facility is provided to an exporter who

satisfies the following criteria
 A ten digit Importer Exporter code number
allotted by DGFT.
 Exporter should not be in the caution list of
RBI.
 If the goods to be exported are not under OGL
(Open General License), the exporter should
have the required license /quota permit to
export the goods.
Requirement for Getting Packing Credit

Packing credit facility can be provided to an exporter on production of the

following evidences to the bank:

 Formal application for release the packing credit with undertaking to the
effect that the exporter would be ship the goods within stipulated due date
and submit the relevant shipping documents to the banks within prescribed
time limit.

 Firm order or irrevocable L/C or original cable / fax / telex message exchange
between the exporter and the buyer.

 License issued by DGFT if the goods to be exported fall under the restricted or
canalized category. If the item falls under quota system, proper quota
allotment proof needs to be submitted.

 The confirmed order received from the overseas buyer should reveal the
information about the full name and address of the overseas buyer,
description quantity and value of goods (FOB or CIF), destination port and the
last date of payment.
Quantum of Finance

The quantum of finance is granted to an exporter against

the LC or an expected order.  The only guideline or
principle is the concept of Need based Finance. Banks
determine the percentage of margin, depending on
factors such as:

 The nature of Order.

 The nature of the commodity.
 The capability of exporter to bring in the requisite
contribution.
Different Stages of Pre Shipment
Finance

Appraisal and Sanction of Limits

 Before making any an allowance for Credit facilities banks

need to check the different aspects like product profile,
political and economic details about country.

 Apart from these things, the bank also looks in to the status
report of the prospective buyer, with whom the exporter
proposes to do the business. To check all these information,
banks seek the help of institution like ECGC or International
consulting agencies like Dun and Brad street etc.
Different Stages of Pre Shipment
Finance

The Bank extends the packing credit facilities after ensuring the
following

 The exporter is a regular customer, a bona fide exporter and has a

goods standing in the market.

 The exporter has the necessary license and quota permit (as
mentioned earlier)

 Whether the country with which the exporter wants to deal is under
the list of Restricted Cover Countries (RCC).

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Disbursement of Packing Credit
Advance

Before disbursing the bank specifically checks for the following

particulars

 Name of buyer
 Commodity to be exported
 Quantity
 Value (either CIF or FOB)
 Last date of shipment / negotiation.
 Any other terms to be complied with
Disbursement of Packing Credit
Advance

 The quantum of finance is fixed depending on the FOB value

of contract /LC or the domestic values of goods, whichever is
found to be lower. Normally insurance and freight charged are
considered at a later stage, when the goods are ready to be
shipped.

 Sometimes an exporter is not able to produce the export

order at time of availing packing credit. So, in these cases,
the bank provide a special packing credit facility and is known
as Running Packing credit Account
Liquidation of Packing Credit
Advance

 Packing Credit Advance needs be liquidated out of

as the export proceeds of the relevant shipment,
thereby converting pre shipment credit into post
shipment credit.

 This liquidation can also be done by the payment

receivable from the Government of India which
may be the duty drawback, payment from the
Market Development Fund (MDF) etc.
Overdue Packing Credit
advance

 Bank considers a packing credit as an

overdue, if the borrower fails to
liquidate the packing credit on the due
date. And, if the condition persists
then the bank takes the necessary
step to recover its dues as per normal
recovery procedure.
Running Account facility
 It is a special facility under which a bank
grants pre shipment advance for export to
the exporter.
 Sometimes banks extend these facilities
depending upon the good track record of
the exporter.
 In return the exporter needs to produce the
letter of credit / firms export order within a
given period of time.
Pre shipment Credit in
Foreign Currency (PCFC)
 Authorized dealers are permitted to extend Pre shipment Credit in
Foreign Currency (PCFC) with an objective of making the credit
available to the exporters at internationally competitive price. This is
considered as an added advantage under which credit is provided in
foreign currency in order to facilitate the purchase of raw materials.

 The rate of interest on PCFC is linked to London Interbank Offered

Rate (LIBOR). According to guidelines, the final cost of exporter must
not exceed 0.75% over 6 month LIBOR, excluding the tax.

 The exporter has freedom to avail PCFC in convertible currencies like

USD, Pound, Sterling, Euro, Yen etc. However, the risk associated
with the cross currency truncation is that of the exporter.
Post Shipment Finance

 Post Shipment Finance is a kind of loan provided by

a financial institution to an exporter or seller
against a shipment that has already been made.

 This type of export finance is granted from the date

of extending the credit after shipment of the goods
to the realization date of the exporter proceeds.
Exporters don’t wait for the importer to deposit the
funds.
Financing For Various
Types of Exports
 Physical exports: Finance is provided to the
actual exporter or to the exporter in whose name
the trade documents are transferred.
 Deemed export: Finance is provided to the
supplier of the goods which are supplied to the
designated agencies.
 Capital goods and project exports: Finance is
sometimes extended in the name of overseas buyer
(Also known as buyers Credit). The disbursal of
money is directly made to the domestic exporter.
Purpose of Finance

 Post shipment finance is meant to

finance export sales receivable after the
date of shipment of goods to the date of
realization of exports proceeds. In cases
of deemed exports, it is extended to
finance receivable against supplies made
to designated agencies.
Types of Finance

 Post shipment finance can be secured or unsecured.

Since the finance is extended against evidence of export
shipment and bank obtains the documents of title of
goods, the finance is normally self liquidating. In that
case it involves advance against undrawn balance, and
is usually unsecured in nature.

 Further, the finance is mostly a funded advance. In few

cases, such as financing of project exports, the issue of
guarantee (retention money guarantees) is involved and
the financing is not funded in nature.
Period of Finance
 Post shipment finance can be off short terms or
long term, depending on the payment terms
offered by the exporter to the overseas importer. In
case of cash exports, the maximum period allowed
for realization of exports proceeds is six months
from the date of shipment.

 Concessionary rate of interest is available for a

highest period of 180 days, from the date of
surrender of documents. Usually, the documents
need to be submitted within 21days from the date
of shipment.
Receivables of Export Credit

 There are 3 standard ways of payment

methods in the export import trade
international trade market:

– Clean Payment
– Collection of Bills
– Letters of Credit L/c
Clean Payments

 In clean payment method, all shipping documents,

including title documents are handled directly
between the trading partners. The role of banks is
limited to clearing amounts as required.

 Clean payment method offers a relatively cheap

and uncomplicated method of payment for both
importers and exporters.
Clean Payments
 There are basically two type of clean payments:

Advance Payment

 In advance payment method the exporter is trusted to ship

the goods after receiving payment from the importer.

Open Account

 In open account method the importer is trusted to pay the

exporter after receipt of goods.
The main drawback of open account method is that exporter
assumes all the risks while the importer get the advantage
over the delay use of company's cash resources and is also
not responsible for the risk associated with goods.
Payment Collection of Bills in
International Trade

 The Payment Collection of Bills also called “Uniform Rules for

Collections” is published by International Chamber of
Commerce (ICC) under the document number 522 (URC522)
and is followed by more than 90% of the world's banks.

 In this method of payment in international trade the exporter

entrusts the handling of commercial and often financial
documents to banks and gives the banks necessary
instructions concerning the release of these documents to the
Importer. It is considered to be one of the cost effective
methods of evidencing a transaction for buyers, where
documents are routed thro’ the banking system.
Payment Collection of Bills in
International Trade

 There are two methods of collections of bill

Documents Against Payment  D/P

 In this case documents are released to the
importer only when the payment has been
done.

Documents Against Acceptance  D/A

 In this case documents are released to the
importer only against acceptance of a draft.
Letter of Credit  L/c

 Letter of Credit also known as Documentary

Credit is a written undertaking by the
importers bank known as the issuing bank
on behalf of its customer, the importer
(applicant), promising to effect payment in
favor of the exporter (beneficiary) up to a
stated sum of money, within a prescribed
time limit and against stipulated documents.
Forfaiting
 The terms Forfaiting is originated from a old
French word ‘Forfait’, which means to
surrender ones right on something to
someone else. In international trade,
forfaiting may be defined as the purchasing
of an exporter’s receivables at a discount
price by paying cash. By buying these
receivables, the Forfaiter frees the exporter
from credit and the risk of not receiving the
payment from the importer.
Benefits to Exporter

 100 per cent financing : Without recourse and not

occupying exporter's credit line that is to say once the
exporter obtains the financed fund, he will be exempted from
the responsibility to repay the debt.

 Improved cash flow : Receivables become current cash in

flow and its is beneficial to the exporters to improve financial
status and liquidation ability so as to heighten further the
funds raising capability.

 Reduced administration cost : By using forfaiting , the

exporter will spare from the management of the receivables.
The relative costs, as a result, are reduced greatly.
Benefits to Exporter
 Risk reduction : forfaiting business
enables the exporter to transfer various risk
resulted from deferred payments, such as
interest rate risk, currency risk, credit risk,
and political risk to the forfeiting bank.
 Increased trade opportunity : With
forfaiting, the export is able to grant credit
to his buyers freely, and thus, be more
competitive in the market
Benefits to Banks

 Forfaiting provides the banks following

benefits:
 Banks can offer a novel product range to
clients, which enable the client to gain
100% finance, as against 80-85% in case of
other discounting products.
 Bank gain fee based income.
 Lower credit administration and credit follow
up.
Factoring

 Definition of factoring is very simple and can be

defined as the conversion of credit sales into cash.
Here, a financial institution which is usually a bank
buys the accounts receivable of a company usually
a client and then pays up to 80% of the amount
immediately on agreement. The remaining amount
is paid to the client when the customer pays the
debt. Examples includes factoring against goods
purchased, factoring for construction services etc.
Characteristics of Factoring
 The normal period of factoring is 90-150 days and rarely
exceeds more than 150 days.

 It is costly.

 Factoring is not possible in case of bad debts.

 Credit rating is not mandatory.

 It is a method of off balance sheet financing.

 Cost of factoring is always equal to finance cost plus

operating cost.
Different Types of Factoring

 Disclosed

 Undisclosed

 Disclosed Factoring
In disclosed factoring, client’s customers are
aware of the factoring agreement.
Disclosed factoring is of two types:
Different Types of Factoring

 Recourse factoring: The client collects the money from the

customer but in case customer don’t pay the amount on
maturity then the client is responsible to pay the amount to
the factor. It is offered at a low rate of interest and is in very
common use.

 Nonrecourse factoring: In nonrecourse factoring, factor

undertakes to collect the debts from the customer. Balance
amount is paid to client at the end of the credit period or
when the customer pays the factor whichever comes first.
The advantage of nonrecourse factoring is that continuous
factoring will eliminate the need for credit and collection
departments in the organization.
Different Types of Factoring

 Undisclosed

In undisclosed factoring, client's customers

are not notified of the factoring
arrangement. In this case, Client has to pay
the amount to the factor irrespective of
whether customer has paid or not.

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