Pre-export financing takes place when a financial institution advances funds to a borrower based on proven orders from buyers. The borrower usually requires the funding in order to produce and supply the goods.
An export-import bank or development bank often provides financing but commercial banks also lend.
In most cases the exporter will arrange for the buyer to send payment directly to the lender. The lender will then send the money to the exporter having deducted and charges and interest associated with the loan; this is known as prepayment finance. Prepayment finance allows the producer to ensure that they will be paid for the goods they are sending to the buyer. It also allows the buyer to enter into long-term contracts, something it might not have been able to do without the finance.
One of the key reasons for pre-export financing is so that the borrower has sufficient liquidity to maximise production. Commodity firms are some of the largest users of pre-export financing, using the loans to finance large, capital-intensive production operations.
When providing financing, lenders will have to consider factors including production and delivery risk. The repayment of the loan is contingent on the production and sale of goods. Payment risk is also an issue in the event that the seller distributes the goods in time but the buyer fails to pay in full.
Other risk structures are also put in place. In many countries a borrower will be required to purchase political risk insurance. This would cover the event of expropriation, sanctions, law changes and war and would provide coverage for both the borrower and lender.
Image source: IIG Trade Finance LLC, www.iigtradefinance.com
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