What is forfaiting?
Forfaiting is a trade-finance technique that lets an exporter convert medium- and long‑term receivables into immediate cash by selling those receivables—usually in the form of negotiable instruments such as promissory notes or accepted bills of exchange—to a third party (the forfaiter) at a discount. The sale is normally without recourse, so the exporter transfers the credit risk on the importer (and usually certain country/transfer risks) to the forfaiter.
Key takeaways
– Forfaiting converts credit sales into cash sales by selling receivables to a forfaiter (typically a bank or specialist financier).
– The exporter removes the receivable and credit risk from its balance sheet through a non‑recourse sale.
– Receivables are usually evidenced by enforceable, negotiable instruments (bills of exchange, promissory notes) often avalled or guaranteed by the importer’s bank.
– Typical transaction size is large (often > $100,000) and maturities commonly run from 1–3 years (can range from 1 month to ~10 years).
– Forfaiting is flexible and useful for international sales where the buyer needs medium/long payment terms, but it is generally more expensive than standard commercial lending.
How forfaiting works — step‑by‑step (high level)
1. Export contract:
– Exporter sells goods or capital equipment to an importer on deferred payment terms. Parties agree to payment by one or more negotiable instruments (e.g., promissory notes) or accepted bills of exchange.
2. Bank aval/guarantee:
– The importer’s bank often avals (guarantees) the instruments to make them acceptable to a forfaiter. This reduces political/bank credit risk for the forfaiter.
3. Exporter approaches a forfaiter:
– Exporter submits the receivables/instruments and transaction documents to a forfaiter (bank or specialist).
4. Due diligence and offer:
– Forfaiter assesses credit quality of the importer/bank, country risk, currency, legal enforceability, and maturity profile, then quotes a discount rate and any fees.
5. Sale without recourse:
– If terms are accepted, exporter sells the receivables to the forfaiter without recourse. The forfaiter pays the exporter the discounted present value (net of fees).
6. Collection:
– The importer (or its bank) pays the forfaiter as each instrument matures.
Fast fact
Forfaiting typically requires negotiable, enforceable debt instruments and a bank guarantee (aval) is commonly used to make the instruments acceptable to the forfaiter.
Advantages of forfaiting (for exporters)
– Immediate cash flow: exporter receives funds upfront instead of waiting for long-term payments.
– Risk elimination: selling without recourse transfers commercial credit risk and often some political/transfer risk to the forfaiter.
– Simplifies administration: exporter avoids collection effort and foreign receivables management.
– Off‑balance treatment: a bona fide, non‑recourse sale typically removes the receivable from the exporter’s balance sheet.
– Flexibility: forfaiting can be structured for a wide range of international capital‑goods transactions and tailored to deal specifics.
– Useful where ECA cover is absent: can facilitate transactions in markets with limited export credit agency options.
Disadvantages and limitations
– Cost: forfaiting pricing (discount + fees) is typically higher than standard commercial borrowing and may increase the delivered price to the importer.
– Eligibility requirements: usually only sizable transactions (frequently > $100,000) with negotiable instruments are acceptable. Informal deferred payments that are not evidenced by negotiable instruments often cannot be forfaited.
– Currency and market restrictions: forfaiters prefer hard, liquid currencies; limited currency coverage can disadvantage some developing‑country buyers/sellers.
– No supranational guarantee: there is no single international guarantee provider for forfaiters, which can limit appetite for very long-term or high‑risk exposures.
– Potential perceived discrimination: transactions involving some developing countries or weaker banks may be harder or more expensive to forfait.
Real‑world example (illustrative)
– Scenario: Manufacturer sells industrial equipment to an overseas buyer for $2,000,000. Payment is structured as a single promissory note due in 3 years, avalled by the buyer’s bank.
– Forfaiter offer: discount rate and fees imply an effective discount of, say, 18% (this is illustrative and depends on market rates, country risk, and document quality).
– Cash to exporter: $2,000,000 × (1 − 0.18) = $1,640,000. The exporter receives $1.64M now and relinquishes any future claim; the forfaiter will collect $2.0M at maturity from the issuing bank.
– Outcome: exporter gains immediate liquidity and eliminates credit risk; forfaiter assumes risk and expects returns via the discount margin.
Practical steps for exporters who want to forfait receivables
1. Structure receivables as negotiable instruments:
– Use promissory notes or accepted bills of exchange that are legally enforceable in the relevant jurisdictions. Secure a bank aval or guarantee where possible.
2. Assemble documentation:
– Sales contract, invoices, shipping documents, instrument text (notes/bills), and bank confirmations. Clear, complete documentation speeds execution.
3. Select potential forfaiters:
– Contact banks and specialist forfaiting houses experienced in the buyer’s country/currency. Ask about minimum deal size, accepted maturities, and currencies.
4. Request indicative terms:
– Provide transaction details and request quotes for discount rates, fees, and any covenants (e.g., required aval). Compare offers.
5. Negotiate and close:
– Agree discount and fees, execute the sale contract (confirm non‑recourse status), deliver instruments, and receive proceeds.
6. Accounting and tax:
– Work with accountants to ensure correct derecognition of receivables, recognition of proceeds and any loss on sale, and tax implications of the discount/fees.
Practical steps for forfaiters (lenders)
1. Credit analysis:
– Assess importer’s creditworthiness, guarantor bank strength (aval), and country/transfer risk.
2. Legal review:
– Confirm negotiability and enforceability of instruments in relevant jurisdictions; confirm validity of aval/guarantee.
3. Price and structure:
– Set discount rate and fees reflecting time to maturity, credit and country risk, and liquidity. Decide on any additional covenants or collateral.
4. Documentation:
– Draft purchase/sale agreement, transfer documentation, and confirmations with the importer’s bank if needed.
5. Portfolio and secondary market strategy:
– Decide whether to hold the instruments to maturity or package and sell on secondary markets. Forfaiters often rely on secondary trading to manage liquidity.
Due diligence and checklist
– Confirm instrument type (promissory note, bill of exchange) and its legal standing.
– Verify aval/guarantee from a bank with acceptable creditworthiness.
– Check currency convertibility and expected transfer restrictions in the importer’s country.
– Review political risk, sovereign restrictions, and likely time to enforcement if needed.
– Ensure transaction size meets forfaiter minimums and maturities are within acceptable range.
– Clarify tax/withholding treatment and any cross-border withholding that might affect receipts.
Accounting and tax considerations (high level)
– Exporter:
– Non‑recourse sale: derecognize receivable, record cash proceeds, and recognize any loss (discount + fees) in the income statement as cost of financing/sale of receivables, subject to local GAAP/IFRS rules.
– Recourse or partial recourse sales may require recognizing a liability for potential repurchases.
– Forfaiter:
– Recognizes a financial asset (the receivable) and records income as the difference between cash paid and collections (effective interest method).
– Tax:
– Treatment of discount and fees varies by jurisdiction; obtain tax advice for withholding, VAT, or stamp duty implications.
When to use forfaiting (common use cases)
– Large capital‑goods exports where buyer needs medium/long terms but exporter prefers cash.
– Sales to buyers in countries with elevated political risk where a guaranteed instrument is available.
– Transactions where the exporter wants to remove receivables from the balance sheet and avoid collection costs.
– Situations where export credit agency support is unavailable or insufficient.
When forfaiting is not appropriate
– Small-ticket export transactions (often below forfaiter minimums).
– Informal deferred payment arrangements that are not evidenced by negotiable, enforceable instruments.
– When the cost of forfaiting (discount and fees) outweighs the benefits of improved liquidity or risk transfer.
Sources and further reading
– Investopedia, “Forfaiting” (overview of concept, mechanics, pros and cons). https://www.investopedia.com/terms/f/forfaiting.asp
– Black Sea Trade & Development Bank, “Special Products” / “Who We Are” (example of forfaiting product terms and minimums). https://www.bstdb.org
If you’d like, I can:
– Draft a sample checklist and templated documentation list to present to potential forfaiters; or
– Build a simple Excel‑style illustrative calculation that shows the present value/outflow for different discount rates and maturity profiles. Which would help you most?