International trade has a fundamental trust problem: the buyer and seller are in different countries, may not know each other, and certainly can't sue each other in any practical court. Trade finance solves this with a stack of instruments that substitute bank promises for buyer/seller promises. Without it, global trade as we know it doesn't exist.
Letters of credit (LCs) — the workhorse
An LC is a promise by the buyer's bank to pay the seller once the seller presents documents proving shipment per agreed terms (bill of lading, certificate of origin, insurance, quality inspection). The seller no longer relies on the buyer's promise to pay — they rely on the bank's. If the bank is reputable (typically rated A or above), this is a vastly stronger promise than the buyer's.
Buyer (importer in Kenya) Seller (exporter in China)│ ││ 1. Apply for LC │▼ │Issuing bank (in Kenya) ││ ││ 2. Issue LC, send to advising bank ││ ────────────────────────────────────────► ││ ││ │ 3. Ship goods│ │ to buyer│ ││ 4. Seller presents ││ documents (BL, etc.) ││ ◄────────────────────────────────────── ││ ││ 5. Bank checks documents against LC ││ 6. Bank pays seller ││ │ 6. Receive payment│ ││ 7. Bank releases documents to buyer ││ 8. Buyer pays bank, takes possession │▼ │Goods cleared at port │
Documentary collections — cheaper, weaker
An alternative to LCs: the seller's bank forwards shipping documents to the buyer's bank with collection instructions. The buyer must pay (or accept a bill of exchange) to receive the documents. The bank's role is administrative, not as guarantor. Cheaper than an LC (no bank credit risk to charge for) but weaker — if the buyer refuses to pay, the seller has goods in transit they can't easily redirect.
Factoring — selling receivables for cash
A seller with $1m of receivables 90 days out can sell them to a factor for, say, $900k cash today. The factor collects the $1m from the buyer and pockets the $100k discount. Two flavours: recourse (seller liable if buyer doesn't pay) and non-recourse (factor absorbs the default risk). Factoring is a working-capital tool — converts receivables into cash to fund the next production cycle. Common in textile, manufacturing, distribution.
Supply-chain finance
A more recent innovation. A large buyer (think Walmart, Unilever) extends 60-90 day payment terms to its suppliers. Many suppliers can't bear the cash gap. The buyer establishes a financing programme: suppliers can opt to be paid early by a financier (typically at the buyer's interest rate, much lower than the supplier's own borrowing rate would be). The financier collects from the buyer at the original due date. Everyone benefits — supplier gets cash faster; buyer maintains long payment terms; financier earns a spread. Greensill Capital famously collapsed in 2021 partly due to over-extended supply-chain finance; the model itself is sound, the execution there wasn't.
Trade finance in Africa
Africa has a structural trade-finance gap. African importers often pay premium fees for LCs because correspondent banking relationships have thinned (KYC compliance pressure on Western banks). African Export-Import Bank (Afreximbank), African Trade Insurance Agency (ATI), and AfDB provide insurance and re-insurance to keep trade flowing. The African Continental Free Trade Area (AfCFTA) is supposed to grow intra-African trade — currently only ~15% of African trade is intra-African vs ~60% in Europe — and that growth will need a deeper trade-finance ecosystem to enable it.
Cost of trade finance
An LC for a Kenyan importer typically costs 1.5-3% of the LC amount as a one-time fee + funding cost (the importer's bank may extend an LC line that converts to a loan if needed). For a $1m import, expect $20-40k in trade-finance costs + the FX cost. This is why import volumes in African trade are often less competitive — the financing cost adds 2-3% to landed cost vs zero in fully-trusted markets.
Exercise
A Kenyan agricultural exporter sells $5m of avocados monthly to a European buyer on 45-day terms. They want $5m of working capital to bridge the period between paying farmers (immediate) and being paid by the buyer (45 days). Compare three options: (1) bank overdraft at 16%; (2) factoring at 3% per 45 days; (3) supply-chain finance program with the European buyer at 8% annual.