Trade Finance

Definition of 'Trade Finance'


The financing of international trade. Trade finance includes such activities as lending, issuing letters of credit, factoring, export credit and insurance. Companies involved with trade finance include importers and exporters, banks and financiers, insurers and export credit agencies, as well as other service providers. Trade finance is of vital importance to the global economy, with the World Trade Organization estimating that 80 to 90% of global trade is reliant on this method of financing.

Investopedia explains 'Trade Finance'


Although international trade has been in existence for centuries, trade finance developed as a means of facilitating it further. The widespread use of trade finance is one of the factors that have contributed to the enormous growth of international trade in recent decades.

In its simplest form, trade form works by reconciling the divergent needs of an exporter and importer. While an exporter would prefer to be paid upfront by the importer for an export shipment, the risk to the importer is that the exporter may simply pocket the payment and refuse shipment. Conversely, if the exporter extends credit to the importer, the latter may refuse to make payment or delay it inordinately. The most common solution to this problem is through a letter of credit, which is opened in the exporter's name by the importer through a bank in his or her home country. The letter of credit essentially guarantees payment to the exporter by the bank issuing the letter of credit upon receipt of documentary proof that the goods have been shipped. Although this is a somewhat cumbersome process, the letter of credit system is one of the most popular trade finance mechanisms.



comments powered by Disqus
Hot Definitions
  1. Market Capitalization

    The total dollar market value of all of a company's outstanding shares. Market capitalization is calculated by multiplying a company's shares outstanding by the current market price of one share. The investment community uses this figure to determine a company's size, as opposed to sales or total asset figures.
  2. Oil Reserves

    An estimate of the amount of crude oil located in a particular economic region. Oil reserves must have the potential of being extracted under current technological constraints. For example, if oil pools are located at unattainable depths, they would not be considered part of the nation's reserves.
  3. Joint Venture - JV

    A business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task. This task can be a new project or any other business activity. In a joint venture (JV), each of the participants is responsible for profits, losses and costs associated with it.
  4. Aggregate Risk

    The exposure of a bank, financial institution, or any type of major investor to foreign exchange contracts - both spot and forward - from a single counterparty or client. Aggregate risk in forex may also be defined as the total exposure of an entity to changes or fluctuations in currency rates.
  5. Organic Growth

    The growth rate that a company can achieve by increasing output and enhancing sales. This excludes any profits or growth acquired from takeovers, acquisitions or mergers. Takeovers, acquisitions and mergers do not bring about profits generated within the company, and are therefore not considered organic.
  6. Family Limited Partnership - FLP

    A type of partnership designed to centralize family business or investment accounts. FLPs pool together a family's assets into one single family-owned business partnership that family members own shares of. FLPs are frequently used as an estate tax minimization strategy, as shares in the FLP can be transferred between generations, at lower taxation rates than would be applied to the partnership's holdings.
Trading Center