Financing Guarantee
Exporters often use letters of credit, bills of exchange or bank guarantees to facilitate their export transaction. The New Zealand Export Credit Office (NZECO)’s financing guarantee can apply to each of these financial instruments.
Under a financing guarantee facility, a NZ bank grants a credit to the international buyer or the buyer's bank in the form of a letter of credit, a bank guarantee or bills of exchange. The NZECO then provides the lending bank with a guarantee, which covers the risk of default on repayment of the credit.
As with all export credit arrangements, the NZECO shares a degree of the risk with the insured (in this case, the lending bank). The lending bank may then seek recourse back to the exporter. The NZECO can insure up to 90% for commercial risk cover and up to 95% for political risk cover.
A description of the financial instruments and use of a financing guarantee are provided below.
Bills of Exchange
In international trade, a bill of exchange is typically a written order drawn up by the exporter and accepted by the importer, who is then responsible for paying a specific amount on presentation of the bill at a specified time in the future. The total term of credit is represented in a schedule of bills of exchange, often with consecutive six-monthly repayment dates.
Once the bills of exchange have been accepted by the importer, the exporter often sells the bills to a bank at a discounted rate (it’s called forfaiting). In this way, the exporter is paid in advance and is freed from the credit risk that their buyer may not be able to pay a bill of exchange when it falls due. In turn, the bank can insure against this risk of non-payment, pursuant to an NZECO financing guarantee.
This is summarised in the diagram below:
Letters of Credit
Letters of credit are a means of payment between an exporter and importer via their banks. A letter of credit is a document issued by the buyer’s bank guaranteeing payment once all the conditions stated in the letter have been met.
Essentially, the process is that the buyer requests its bank to open a letter of credit in favour of the exporter. The exporter then asks its bank to confirm the letter of credit. The exporter is able to receive the payment specified on the letter of credit by presenting its bank with the set of documents required by the letter of credit (generally shipping and delivery documentation).
The NZECO’s financing guarantee covers the exporter’s bank’s subsequent credit risk that the buyer's bank will not be able to repay this amount the bank has already disbursed to the exporter.
This process is summarised in the diagram below:
Bank Guarantees
In cases where the buyer’s creditworthiness is considered inadequate or the political and/or economic situation in the buyer's country indicates instability, the lending bank may demand a guarantee from a creditworthy bank in the buyer’s country to cover the buyer's payments under the terms of the loan.
Under this scenario, the risk of the buyer’s bank defaulting is covered by the financing guarantee.
This guarantee is summarised in the diagram below:
