What Exactly Is Forfaiting?
Forfaiting allows exporters to get quick cash by selling their medium- and long-term receivables at a discount through an intermediary. The exporter removes risk by selling without recourse. It is not responsible for the importer’s potential default on receivables.
The receivables buyer is the forfeiture. The importer pays the forfeiture for the receivables. Forfaiters are banks or financial firms that specialize in export finance.
How Forfaiting Works
Purchasing receivables by forfeiture expedites payment and cash flow for the exporter. Importer banks usually guarantee the amount.
Additionally, the purchase reduces credit risk from credit sales to importers. Forfaiting helps importers who cannot pay in full upon delivery.
The importer’s receivables become a debt instrument that may be traded freely on the secondary market. The receivables are usually legally enforceable bills of exchange or promissory notes, providing security for the forfeiture or debt buyer.
These debt instruments vary from one month to 10 years in maturity. Most maturity occurs within one to three years after the sale.
Forfaiting is typically utilized for overseas transactions of commodities or capital items above $100,000.
Pros and Cons of Forfaiting
Advantages
Forfaiting removes the exporter’s payment risk. The approach mitigates credit, transfer, and foreign exchange/interest rate risks. Forfaiting streamlines credit-based sales by turning them into cash. This credit-to-cash procedure saves collection fees and gives sellers rapid cash flow. Additionally, the exporter can eliminate accounts receivable, a liability, from its balance sheet.
Flexible forfeiting. Forfaiters can adjust their services to meet exporters’ demands and international transactions. Exporters can sell without credit or insurance via forfeiture. Forfaiting is useful when a nation or bank lacks access to an export credit agency (ECA). Exporters can conduct business with buyers in nations with significant political risks using this approach.
Disadvantages
Forfaiting reduces exporter risks but costs more than commercial lender funding, raising export costs. Standard pricing passes on these additional costs to importers. Forfaiting is only available for transactions exceeding $100,000 with longer maturities, but not for delayed payments.
Some prejudice occurs between developing and developed countries. Certain currencies are chosen for forfeiture due to their worldwide liquidity. An international credit agency cannot guarantee financing for firms. This uncertainty impacts long-term faith.
Real-World Example
BSTDB includes forfeiting among its unique products, along with underwriting, hedging instruments, financial leasing, and discounting. 11 founding countries—Albania, Armenia, Azerbaijan, Bulgaria, Georgia, Greece, Moldova, Romania, Russia, Turkey, and Ukraine—founded BSTDB to finance development initiatives.
According to the bank, “Accepted bills of exchange or promissory notes that a bank accepts or guarantees are evidence of the importer’s obligations.” BSTDB will finance a €5 million operation over one to five years. The bank may charge option, commitment, termination, or discount rate fees.
Conclusion
- Forfaiting allows exporters to sell their receivables at a discount to a third party for quick payment.
- The forfeiture, usually by a bank, guarantees the payment.
- Forfaiting mitigates credit, transfer, foreign currency, and interest rate risks.
- Debt instruments like unconditional bills of exchange or promissory notes become receivables that can be sold on a secondary market.
- Debt securities typically mature within one to three years after sale.
