What Is Buyer's Credit?
Buyer's credit is a short-term loan facility extended to an importer by an overseas lender such as a bank or financial institution to finance the purchase of capital goods, services, and other big-ticket items. The importer, to whom the loan is issued, is the buyer of goods, while the exporter is the seller. Buyer’s credit is a very useful financing method in international trade as it gives importers access to cheaper funds compared to what may be available locally.
- Buyer's credit is a short-term loan to an importer by an overseas lender for the purchase of goods or services.
- An export finance agency guarantees the loan, mitigating the risk for the exporter.
- Buyer's credit allows the buyer, or the importer, to borrow at rates lower than what would be available domestically.
- With buyer's credit, exporters are guaranteed payment(s) on the due date.
- Buyer's credit allows an exporter to execute large orders and allows the importer to obtain financing and flexibility to pay for large orders.
- Because of the complexity involved, buyer's credit is only made available for large orders with minimum monetary thresholds.
Understanding Buyer's Credit
A buyer’s credit facility involves a bank that extends credit to an importer of goods, as well as an export finance agency based in the exporter's country that guarantees the loan. Since buyer’s credit involves multiple parties and cross-border legalities, it is generally only available for large export orders with a minimum threshold of a few million dollars.
The availability of buyer’s credit also makes it possible for the seller to pursue and execute large export orders. The importer obtains the flexibility to pay for the purchase over a period of time as stipulated in the terms of the credit facility. The importer can also request funding in a major currency that is more stable than the domestic currency, especially if the latter has a significant risk of devaluation.
The export finance agency's involvement is critical to the success of the buyer’s credit mechanism. That's because its guarantee protects the financial institution making the loan from the risk of non-payment by the buyer.
The export finance agency also provides coverage to the lending bank from other political, economic, and commercial risks. In return for this guarantee and risk coverage, the export agency charges a fee that is paid for by the importer. Costs associated with buyer's credit include interest and arrangement fees on the loan.
Buyer's credits are often confused with letters of credit; however, they are different products. A buyer's credit is a loan facility whereas a letter of credit is a promise by a bank to a seller that payment will be received on time, and if the buyer cannot pay, the bank will be responsible for the entire amount of the purchase.
Buyer's Credit Process
There are several steps involved in the buyer's credit process. The exporter first enters into a commercial contract with a foreign buyer or importer. The contract specifies the goods or services supplied along with prices, payment terms, etc.
The buyer then obtains credit from a financial institution for the purchase. An export credit agency based in the exporter’s country provides a guarantee to the lending bank to cover the risk of default by the buyer.
Once the exporter ships the goods, the lending bank pays the exporter according to the contract terms. The buyer makes principal and interest payments to the lending bank according to the loan agreement until the loan is repaid in full.
Advantages of Buyer's Credit
Buyer’s credit benefits both the seller and the buyer in a trade transaction. As mentioned above, borrowing rates are generally cheaper than what an importer may find with domestic lenders. The rates are typically based on London Interbank Offered Rate (LIBOR); the point of reference for most short-term interest rates. The importer also gets an extended amount of time for repayments, rather than having to pay upfront at once directly to the exporter.
Another benefit extends to the exporter. Payment is made on time on the due date or according to the terms of the sales contract with the importer without any undue delays. The certainty of the time of payment helps to manage loan receivables, which in turn allows a financial institution to manage its deposits and regulatory requirements.