July 26, 2018

Forfaiting as a method of crediting foreign economic activity

The emergence of the forfaiting market is determined by changes in the structure of the world economy that occurred in the late 50’s and early 60’s, when the seller’s market for production goods gradually transformed into a buyer’s market for these goods. Significant development of international trade was accompanied by an increase in the tendency of growth of importers’ requirements to extend the term of the traditional 90-180-day commercial loan. This time is characterized by a decrease in the level of customs confrontation, which was the result of post-war depression. The revival of new relations between the countries of Western and Eastern Europe and the growing importance in world trade of the countries of Asia, Africa and Latin America have created many difficulties, primarily among Western European exporters. Moreover, the emergence of these new markets was at a time when existing banks were not able to offer the services expected by exporters. Thus, in response to the unsatisfied and constantly growing demand for international loans, forfeited funds appeared. Forfaiting is a similar operation with factoring. The difference between the first is the one-time operation involving the collection of cash through the resale of the acquired rights to goods and services.

The pioneer among the largest banks operating in the forfaiting market was Credit Suise, the first major forfaiting banking center in Switzerland.

Forfaiting is a rapidly growing industry requiring the creation of a special unit within the traditionally functional structure of the bank. In addition to the growing volume of transactions, there was a need to expand activities in other areas and offer financing services outside the bank. Since 1965, a specialized organization dedicated exclusively to forfeiting has started operations – the company “Finance AG” in Zurich – a branch of the largest Swiss bank. Switzerland’s championship in forfeiting has not been surpassed so far, although operations on forfeiting have spread to other financial centers in Western Europe. Forfeiting is a term commonly used to describe the purchase of obligations arising in the process of the supply of goods and services (for the most part export operations) without turnover to any previous debtor whose repayment occurs at any time in the future.

Thus, forfeiting (from a forfait, the whole, the total amount) is the granting of certain exchange rights to a cash payment. In foreign trade, it means the purchase (without recourse to the exporter) of bills of exchange or other claims arising from commodity deliveries by a special credit institution (forfeiter) when providing sufficient security, i.e. forfaiter has no right to make any claims to the forfeit (exporter) in the event of default of the importer, taking on, in fact, all kinds of risks. The term of the importer’s purchase requirements depends on its creditworthiness and is limited to 2-5 years, sometimes up to 7 years. The minimum size accepted for forfeiting requirements is from 100 thousand to 5 million Swiss francs. The rate of forfaiting is based on market demand and supply and significantly exceeds the normal rates on loans, as forfaiter, as noted above, assumes almost all the risks. Bills accepted for forfeit must be disbursed, and other requirements – have a bank guarantee. Forfeiting is usually used when delivering equipment for large amounts with a long installment payment (from 6 months to 5-7 years). In this case, forfaiter acquires debt claims after deducting interest for the whole period, thus turning the export credit transaction into cash, which is beneficial for the exporter. The scheme of the forfaiting operation can be represented as follows. After invoicing the exporter, the importer pays an avalized bill. Having received from the importer a bill, the exporter transfers it to the forfeiter in exchange for a cash payment.

The costs of forfeiting include the following: the cost of obtaining an aval, which is usually borne by the importer. If he refuses, then the exporter must take care of these expenses, because without a bank guarantee forfaiter will not buy the requirements; costs associated with the risk of the buyer’s country are proposed by forfaiter in the form of a risk premium, ranging from 0.5 to 6% per annum; the cost of mobilizing money depends on the rates in the euro market; administrative expenses amounting to 0.5% per annum.

The total costs of forfeiting are calculated by discounting the amount of the claim. Despite the relatively high costs of transferring risks to forfeiters, the forfeist, based on strategic considerations, covers them due to a number of advantages: increase in liquidity, since the requirements are immediately paid in cash; exemption from a number of financial and commercial risks: credit, exchange rate risk, non-payment risk etc.; simplification of the balance due to its partial exemption from receivables; credit enhancement; lack of control over repayment of a loan, etc.

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