Factoring essentially involves purchase of inland receivables. In international trade transactions, forfeiting is much a more common form of financing export-related receivables.
Forfaiting is purchasing of export bills where payment is expected to be received over a longer period in installments (deferred payment exports). It is done without recourse to the exporter if the bills are accepted by the importer’s bank – also known as Avalling Bank. An Aval is an endorsement on the importer’s promissory note by the importer bank, guaranteeing the payment.
How does Forfaiting work?
The below diagram shows the basic function of the Forfaiting Process.
Exporter sells the goods to importer on deferred payment basis. Importer issues series of promissory notes undertaking to pay the exporter in installments with interest. Importer approaches its banker (Avalling bank) (1) for adding the bank guarantee on the promissory note that that payment will be made on each maturity date. The promissory notes are now ‘avalised’ (2).
Avalled notes are sent to the exporter (3). Avalled notes are sold at a discount to a forfeiter, usually exporters bank (4) and exporter obtains finance (5). Forfaiter may hold till maturity date and obtain payment from the importer/avalling bank, or sell it in the secondary market or sell it, to a group of investors (securitization).
Benefits of Forfaiting