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Commodity Finance And Its Benefits

Jul 08, 2022 - 09:12 AM Author - Axios Credit Bank


What is commodity finance?

Commodity finance refers to the financing/funding of the commodities being traded between importers & exporters in an international trade transaction. In simple words, the concept of commodity trade finance revolves around funding everything involved in a commodity value chain. 

Why is commodity finance required?

Firstly, commodities that often get traded in a global transaction generally have low margins. Secondly, they are transferred between the global parties who don’t know each other, varying in terms of regional rules & legal guidelines. Hence, trust isn’t generated between importers-exporters. Third, there are other associated risks in commodity trading such as changes in foreign law, shipment issues, inflation, delayed delivery, quality issues, or counterparty's inability to pay for the delivered goods, etc. 

To remedy the situation and avoid all the risks associated with commodity trading, commodity trade finance comes into the picture. Here is how these trade finance services Malaysia helps both the buyers & sellers in a global trade transaction. But first know, what commodities are:

What do you mean by commodities?

Commodities can be defined as a group of goods that are traded, sold, or delivered between transactional parties. They mainly include raw materials, and agricultural products while usually can be categorized into three parts such as:

1. Agricultural commodities - These commodities simply include crops, and animals produced or raised on farms or plantations. The most common agricultural commodities are grains, livestock, dairy, etc. Commodities that can’t be traded under the agricultural category are cotton and tobacco. 

2. Metals And Minerals commodities - It includes: 

1. Mineral resources like ores, and alumina, extracted from mines
2. Industrial & base metals such as steel, copper, aluminum, zinc, nickel, etc.

3. Energy commodities - It includes crude oil, heating oil, natural gas, gasoline, etc.

All the commodities should be:

1. Natural resources/raw materials needed in every economy 
2. Fairly uniform 
3. Supplies are dependent on geographical locations
4. Price volatility 
5. Delivered/shipped in bulk quantities 

Benefits of commodity trade finance 

1. Producers can source more material 

Financing of commodities enables producers of the goods to purchase more raw materials to complete the transaction. It accelerates their production level and results in faster delivery of ordered goods to the buyers. A loan granted to the producers/suppliers of the goods allows them to source more material, whether it is raw, semi-processed, or fully processed. This funding by the bank simply increases their purchasing power to ensure the on-time completion of a trade transaction.

2. Works As A Prepayment To Finance Working Capital Needs

Suppliers in a trade transaction are often compelled to wait for the payment for the delivered goods until the buyers sell them forward. This generally happens in cross-border trade transactions due to the lack of trust between the parties. It creates a lack of finance for them, disrupting their further business activities & working capital requirements. But with the use of commodity trade finance, the suppliers get prepaid, solving their working capital needs and providing them an advance payment on behalf of the buyer to continue their managerial tasks. 

Apart from this, import trade transactions are generally riskier, involving a variety of risks such as loss of products, quality not up to the mark, calamities, and many more. This also calls for the need for trade finance solutions Malaysia.

3. They are typically short-term loans

A good thing about commodity trade finance is that they are generally offered for a short duration. Long-term loans aren’t very common here. Let’s understand it this way. The main purpose of commodity trade finance is to enable both importers & exporters to complete the trading on time. That too without facing risks of failure of payment or delivery of goods. Though many companies require buyers to pay for their goods in advance, this prepaid amount is not enough sometimes. 

The short-term nature of the commodity loans allows them to manage their tasks efficiently. They don’t have to worry about paying off their debts. It can improve their working capital flow and gear up their production process. 

4. Acts as a one-stop solution

One of the benefits of commodity trade finance is that the banks or financial institutions who provide these kinds of services can also guide suppliers or producers about the favorable & emerging markets for the products they have. Whether it is the mining industry, energy, or any other sector. This will give them an idea of which markets they should target so that the assigned loan can be perfectly used. 

5. It offers a range of trade finance solutions 

Any bank or financial institution engaged in commodity trade finance is different from each other and offers a set of various trade finance solutions. For example, a Letter of credit, Standby LC, Bank guarantee, Documentary collection, and many more. They deeply understand the clients’ requirements, evaluate their financial goals, and provide them with suitable trade finance solutions.

Now you know how much commodity finance is important for global traders. It enables companies to increase their purchasing power to buy raw materials, and export them on time. It ensures that things are available in the market and this stability decreases their prices, helping consumers also.