Forfaiting: Meaning and Characteristics

Generally, there is a delay in getting paid by the exporter from the importer. This makes it difficult for the exporter to expand his export business. However, for getting immediate payment, the concept of forfeiting shall come to the help of exporters. The concept of forfeiting was originally developed to help finance German exports to Eastern block countries.

Meaning of Forfaiting

The term ‘forfait’ is a French world. It means ‘to surrender something’ or ‘give up one’s right’. Thus forfaiting means giving up the right of an exporter to the forfaitor to receive payment in future from the importer. It is a method of trade financing that allows exporters to get immediate cash and relieve from all risks by selling their receivables (amount due from the importer) on a ‘without recource’ basis. This means that in case the importer makes default the forfaitor cannot go back to the exporter to recover the money.

Under forfaiting the exporter surrenders his right to a receivable due at a future date in exchange for immediate cash payment, at an agreed discount. Here the exporter passes to the forfaitor all risks and responsibilities in collecting the debt. The exporter is able to get 100% of the amount of the bill immediately. Thus he gets the benefit of cash sale. However, the forfaitor deducts the discount charges and he gives the balance amount to the exporter. The entire responsibility of recovering the amount from the importer is entrusted with the forfaitor. The forfaitor may be a bank or any other financial institution. In short, the non-recourse purchase of receivables arising from an export of goods and services by a forfaitor is known as forfaiting.

Characteristics of Forfaiting

The main characteristics of forfaiting are:

  1. It is 100% financing without recourse to the exporter.
  2. The importer’s obligation is normally supported by a local bank guarantee (i.e.,‘aval’).
  3. Receivables are usually evidenced by bills of exchange, promissory notes or letters of credit.
  4. Finance can be arranged on a fixed or floating rate basis.
  5. Forfaiting is suitable for high-value exports such as capital goods, consumer durables, vehicles, construction contracts, project exports etc.
  6. Exporter receives cash upon presentation of necessary documents, shortly after shipment.