Buyer’s Credit

Article byNanditha Saravanakumar
Edited byRaisa Ali
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Buyer’s Credit?

Buyer’s credit refers to a loan offered by an overseas lender to an importer to finance the purchase of goods they are importing. The importer is the buyer, and choosing an overseas bank helps them to borrow at a lower rate than domestic financial institutions. 

Buyer's Credit

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Buyer’s credit plays an important role in international trade since its usage ensures timely payment to the exporter or seller and motivates sellers to participate in export activities. It also helps importers to access foreign funds to finance purchasing from exporters easily and pays off the loan from their sales proceeds.

Key Takeaways

  • Buyer’s credit is a funding mechanism where the buyer of goods borrows from an overseas bank to finance the purchase due to its obvious advantages.
  • The seller is paid immediately in this arrangement, thereby eliminating risk. Furthermore, the importer can pay off the loan from their sales. 
  • Supplier’s credit is another financing method where the letter of credit is used to mitigate the risk for the seller. The seller is assured of the payment at a later date.
  • Any person engaging in a cross-border transaction must know the numerous laws that apply to such transactions.

Buyer’s Credit Process Explained

Buyer’s credit is one of the many ways an importer can choose to finance their international purchase. Other alternatives include opening letter of credit, documentary credits, supplier credit, etc. The buyer’s or importer’s credit might be a good option due to the following:

  • If the seller demands payment on or before delivery and doesn’t want to bear any risk.
  • If the transaction amount is significant (millions of dollars).
  • A foreign bank is ready to lend at a lower interest rate than a domestic bank.

So how much can an importer borrow as credit from an overseas bank? Banks can pay up to twenty million as credit for a maturity period of one year. While for capital goods, the maximum period is three years.

Now, let’s analyze the process. First, the buyer and seller, or the importer and exporter, respectively, enter into a contract. Terms of payment, delivery, etc., are specified. The importer then approaches a foreign bank for credit. The bank lends the requisite amount at a certain interest rate, and the importer pays off the exporter. The buyer can later pay the principal amount and interest to the bank.

However, it is important to remember that multiple laws bind all cross-border transactions, and any party entering such transactions must be aware of these.

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Example

Here’s the recent news regarding the credit constraints faced by Vietnam’s fuel importers. As the Vietnamese dong hit record lows against the USD, the credit conditions for the importers tightened. Since January 2022, the dong had slid by 10% on October 25. Essentially, it has made it difficult for fuel importers to access foreign currencies.

Though many countries are facing energy issues, Vietnam’s situation is worse because the local refineries have halved, and thus, gross domestic production has fallen. In addition, with the currency concerns, many banks have tightened their lending policies. Fuel buyers are now required to open letters of credit to open dong-denominated loans

Difference between Buyer’s Credit and Supplier’s Credit 

The buyer’s and supplier’s credit are methods of financing imports or purchases in international trade. So, let’s look at how they differ:

  • Supplier’s credit, as the name suggests, is the credit or loan extended by the supplier or the seller to the buyer. The supplier, here, is the exporter of goods. 
  • A foreign financial institution extends a loan to the importer in the buyer’s credit process.
  • A letter of credit (LC) is an important instrument in a supplier’s credit method. First, the supplier and buyer agree on certain contracts and payment terms. Then, the supplier is paid by their bank based on the LC opened. On the other hand, LC is considered an alternative to buyer’s credit and, therefore, is not used in the latter.
  • Though the parties to both the buyer’s credit and supplier’s credit are the same, in the former, the main agreement is between the bank and the buyer, whereas, in the supplier’s credit, the contract is between the buyer and the supplier.
  • The exporter enjoys immediate payment in the importer’s credit arrangement. Thus, the risk associated with export is eliminated. On the contrary, in the supplier’s credit, the risk is mitigated to a great extent but not fully. Further, the seller is not assured of immediate payment.

Buyer’s Credit vs Letter of Credit (LC)

The buyer’s credit and the letter of credit are financing methods that aim to mitigate the exporter’s risk. Now, let’s differentiate between the two modes.

Buyer’s CreditLetter of Credit
Parties to the contract include the buyer and the foreign bank.Parties involved are the importer, exporter, and their respective banks.
The seller receives immediate or advance payment.The seller is protected to an extent but does not receive immediate payment.
Focuses on the movement of money. Focuses on the movement of money, goods, and documents.
Method of financing purchase.Method of risk coverage.

Frequently Asked Questions (FAQs)

What is the limit for buyer’s credit?

Banks are allowed to lend up to USD 20 million per import transaction. The buyer’s credit maximum maturity period is one year from the date of shipment, whereas, for capital goods, it is three years.

Why buyer’s credit is important?

Buyer’s credit is just one of the many alternatives to finance an international purchase. But, of course, it has its advantages and disadvantages too. Nevertheless, it might be a good option, especially if the exporter demands immediate payment or payment before delivery.

Is the buyer’s credit a fund-based limit?

It is not a limit based on fundsToto get a buyer’s credit, it is necessary to have a non-fund-based limit with an existing bank. Letter of credit (LC) limitations, bank guarantee (BG) restrictions, etc., are other examples of non-fund-based limits in the banking industry. Depending on the amount, maturity timeframe, and available security, the bank may charge a commission for the service in non-fund-based facilities.

This has been a guide to what is Buyer’s Credit. We explain it with examples and comparison with the supplier’s credit and letter of credit. You can learn more about finance from the following articles –

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Comments

  1. Tariku Tadesse says

    Very helpfull

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