Many businesses need to import massive goods and commodities to meet domestic demand.

However, the requisite funds to import large volumes of goods might not always be available to these businesses.

This can lead to either delayed payments to international suppliers or delayed delivery to customers, either of which can affect their relationships and reputation, while also affecting their financial health.

This is where importers can use buyer's credit to avail funds.

What is Buyer's Credit?

Buyer's credit, a form of trade finance, is a short-term loan extended to a buyer by an overseas lender.

These loans are issued to the business by financial institutions to purchase capital goods or to pay for heavy imports.

A buyer’s credit typically involves not only a lender from the exporter’s country, but also the export credit agency in that country.

Since several parties are involved in the transaction, the process for receiving buyer’s credit can be quite complicated. Hence, only large purchases with a minimum of a few million dollars are eligible for buyer's credit, making it preferable for exporters to complete large orders.

With buyer's credit, the importers get the flexibility to pay over a stipulated amount as per the terms of the buyer's credit agreement.

The importer can also ask for a specific currency in which the credit can be extended. They can request a more stable major currency than the domestic one, if it is bound for significant devaluation.

Why Do Importers Opt for Buyer's Credit?

The primary purpose of introducing buyer's credit, a form of import financing was to aid importers in procuring loans overseas through favorable payment terms.

This credit is readily available for the import of primarily capital goods and even non-capital goods, as mentioned in the letter of undertaking.

A major benefit of buyers' credit over a traditional loan is that buyers' credit is cheaper than a conventional loan.

These can be availed at a very low-interest rate compared to LIBOR (London InterBank Offered Rates), which is the standard for all short-term loan interest rates.

Moreover, for big purchases, it can be difficult for smaller businesses to get a loan sanctioned by traditional banks or financial institutions, where buyers' credit can be of great help.

The importer's bank plays a significant role in the process of availing buyer's credit.

The exporter first gets into a contract with the importer.

Then the buyer's bank or the export credit agency located in the importer's country provides a guarantee to the lending bank to cover the risk of default by the buyer.

What’s the Role of Standby Letters of Credit in Buyer's Credit?

A Standby Letter of Credit (SBLC) is an agreement that the importer’s bank issues to the exporter, which states that the bank guarantees the exporter's payment if the buyer defaults on the payment.

An SBLC helps businesses avoid the worst-case scenario.

If the buyer cannot settle the payment within the duration mentioned in the agreement, the seller can present the SBLC to the buyer's bank for the payment.

With buyer's credit, if the buyer cannot pay, the SBLC can always be presented so that the buyer's bank can pay the exporter.

What are the Costs of Buyer's Credit?

As mentioned above, buyers credit involves multiple parties and hence has multiple costs involved, which include:

1. Interest cost Interest cost is any cost above the margin charged over the LIBOR, the international benchmark for interest rates.

Usually, these interest costs can vary with the cost of funds as well as the tenure of the buyer's credit.

2. Cost of letter of credit The local bank charges this cost from the importer. The importer pays for the same since the letter of credit is issued for its benefit.

3. Currency risk premium The risk of fluctuations in the exchange rate of one currency to another is known as currency risk.

This premium's value varies according to the transaction size and the currencies being used.

4. Broker fee This is the fee that is paid to the agent or the broker. It is the amount paid as compensation for the authorized dealer's services in setting up buyer's credit quotes for the importer.

5. Export credit agency (ECA) guarantee charges This is the fee that the ECA charges for providing their services, be it insurance, financial guarantee or loans.

6. Witholding Tax These are the charges that the foreign bank charges for the funds arranged. The importer has to pay the WHT on the interest amount.

7. Other charges These include out-of-pocket charges such as intermediary bank charges, charges for documents, and other similar charges.

What is the Difference between a Letter of Credit and Buyer’s Credit?

The fundamental difference between an LC and buyer’s credit is that buyer’s credit is a loan that an importer avails and an LC is a payment guarantee that an exporter uses.

Table showing the difference between LC and buyer's credit

What are the Alternatives to a Buyer's Credit Facility?

There are several alternatives to buyer's credit for trade financing. The most common of them include-

  • Payment in advance Pre-export trade financing, known as "payment-in-advance," entails an advance payment or even full payment from the buyer before the delivery of the products or services.

  • Working capital loans Working capital loans, often known as company loans, can fund the up-front costs of conducting business, including the price of labor and raw supplies.

  • Overdrafts An overdraft is a simple feature that allows a firm to get "overdrawn" to a specific amount. It is frequently already accessible on commercial bank accounts.

  • SBA Loans The US government's Small Business Administration (SBA) offers financial support to small companies.

The government partially guarantees these. Businesses prefer buyers' credit over SBA loans since buyer credit allows them cheaper financing. Additionally, the repayment period for an SBA loan is generally longer than any other type of loan. SBA 7 (a) loans are among the most commonly used short-term SBA loans.

A buyer's credit has various alternatives, but few features of buyers' credit are uniquely advantageous to importers.

Drip capital has different supply chain finance solutions that can help businesses understand and choose one that fits them perfectly to help them grow.