What is Buyer’s Credit?
When a buyer wants to import goods or services from abroad, an overseas bank or financial institution extends a short-term loan facility to finance this purchase.
Buyer’s Credit involves multiple parties. First is the buyer or the importer who seeks to make the purchase; the second party is the overseas lender; then it is the seller or the exporter; and lastly, an export finance agency – in the exporter’s country – that guarantees the loan. Due to its complicated nature and involvement of multiple parties, Buyer’s Credit is issued only for purchases of a sizeable cost, usually upwards of a million dollars.
Importance of Buyer’s Credit
Larger export orders come with a significantly higher risk. Buyer’s Credit enables importers to carry out such high-risk, high-value orders with peace of mind. Additionally, since the payment norms are spread out over a stipulated time, it gives the importer a substantial amount of time and the flexibility to pay for such purchases and provide the exporter with the surety of receiving the money within the time frame.
Another factor to consider is the currency difference across the globe. When importing from overseas, especially to a second- or third-world country, Buyer’s Credit is a prudent way to transact. It allows the importer to get funding in a primary global currency, which is more stable. This becomes particularly important if the importer’s currency is subject to higher devaluation risks. And Buyer’s Credit may give the importers access to cheaper funds closer to the London Inter-bank Offered Rate (LIBOR) rates compared to local financing options.
What are the steps involved in obtaining Buyer’s Credit?
The inclusion of multiple players makes obtaining Buyer’s Credit a multi-layered process.
Step 1: A binding contract is set in place between the exporter and the importer.
Step 2: The buyer then approaches a financial institution to fund the purchase.
Step 3: The exporter’s local credit agency extends the guarantee to the institution to avoid the risk of default.
Step 4: Once the shipment is completed, the exporter receives the money from the lending bank as per the contract. At the importer’s end, he will then start repaying the loan along with interest within a pre-decided time frame.
Besides the risk of non-payment by the buyer, the export finance agency also safeguards the lending bank from the repercussions of economic and political risks. Hence, their involvement is crucial, especially in cases of big-ticket purchases. In return for their guarantee, the importer pays them an arrangement fee, as well as interest.
Buyer’s Credit v/s Letter of Credit
Buyer’s Credit is often confused with a Letter of Credit (LC). Besides the same suffix, these are two completely different products. While both facilitate international trade, Buyer’s Credit is a loan facility with interest and a fee attached. In contrast, LC is a payment mechanism wherein, for a fee (no interest), the bank provides the guarantee of covering the purchase amount if the buyer defaults on payment. Additionally, Buyer’s Credit is available for high-volume, high-cost transactions, while LC can be availed for any purchase size.
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