International Payment Methods

Advantages and Disadvantages of Letters of Credit

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Advantages and Disadvantages of Letters of Credit

Letter of credit is one of the payment methods in international trade. Just like other payment methods it has certain advantages and disadvantages.

Advantages of letter of credit:

  • It simply works: In some situations, letter of credit works when other payment options not.
  • It is a balanced payment option: Importers and exporters could reach reasonable payment terms via letter of credit.

Disadvantages of a letter of credit:

  • It is expensive: Both exporters and importers have to pay high fees when choosing the letter of credit as a payment option.
  • It is difficult: Letters of credit requires experienced stuff who possess certain amount of trade finance knowledge.

After explaining the advantages and disadvantages of a letter of credit briefly, we can now proceed for further descriptions.

advantages of a letter of credit for exporters and importers

Advantages of a Letter of Credit:

For Exporters:

  1. Reach out New Customers: Establishing a new business connection is not easy. It is difficult to find a new buyer who is ready to make an advance payment to an untested exporter. By offering a letter of credit, the exporter can increase the chance of securing the order.
  2. Increasing Export Coverage: Exporters can increase their export coverage by regional means if they can effectively use letters of credit. For example, letter of credit is the main payment option for majority of the Middle East countries.
  3. Mitigates Default Risk of the Importer: By using a letter of credit, the exporter can replace default risk from the importer to the importer’s bank, because the letter of credit is a conditional payment undertaking of the issuing bank.
  4. Eliminates Importing Country’s Political Risks via Confirmation: By adding confirmation, the exporter can eliminate importing country’s political risks, at least in theory. For further information please read our post “Confirmation and Confirmed Letter of Credit“.
  5. Discounting Possibilities: It is possible to discount letters of credit that do not payable at sight. Once the issuing bank or confirming banks determines that the letter of credit documents are complying, the respected bank can discount the credit.

For Importers:

  1. Proof of Creditworthiness: By issuing a letter of credit from a reputable bank, the importer proves that he is a financially reputable company.
  2. More Favorable Payment Terms: The importer may be able to convince the exporter to work with a deferred payment terms instead of an at sight payment via a letter of credit. As the exporter can discount the credit any time after the complying presentation, deferred payment should not a big issue for him. Most frequently used deferred payment options under the letters of credit are 30 days, 60 days or 90 days after the bill of lading date.
  3. Timely Shipments: Importers can determine the shipment period by using a letter of credit. If the exporter can not shipped the goods on time, he may face a late shipment discrepancy.

disadvantages of a letter of credit for exporters and importers

Disadvantages of a Letter of Credit:

For Exporters:

  • Higher Learning Costs: Letter of credit is one of the most complex fields of the international trade. Exporters acting with lack of letter of credit expertise and experience may face unpleasant consequences.
  • Higher Bank Fees: Exporters may have to pay high letter of credit fees to the banks under different names comparing to other payment methods.
  • Time Consuming Procedures: Letter of credit is a conditional payment undertaking of the issuing bank. The condition is known as complying presentation. Making a complying presentation is not easy and a very time consuming process.

For Importers:

  • Fraud Risks: While not common, it is possible that exporters can reach to the funds under letters of credit by submitting fraudulent documents.
  • Higher Bank Fees: Just like exporters, importers have to pay high letter of credit fees to the banks under letters of credit transactions.
  • Risks Associated with Shipment of Low Quality Goods: It is not easy to stop payment under the letter of credit once the issuing or confirming bank determines complying presentation. The importer may have to pay for the goods not consistent with the sales contract.

BCG and SWIFT Published Global Payments Report 2014

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BCG and SWIFT Published Global Payments Report 2014

The Boston Consulting Group (BCG) published in cooperation with Swift a new report on consumer payments-exploring key trends in Europe, North America, and rapidly developing economies.

Report also examines the wholesale transaction-banking business, with a focus on the implications of regulatory challenges.

The report discusses the steps that all types of payments players must take in order to succeed.

Global Payments Report 2014:

Published on 28 Nov 2014 – The aim of the report is to provide payments and transaction-banking institutions with a comprehensive overview of major business drivers shaping the industry.

It also provides the reader with recommendations on which specific actions should be taken by various types of players in order to achieve or maintain market-leading positions.

In today’s competitive environment, financial institutions must differentiate themselves and bring value to continue to grow.

Global Payments 2014 Report

The report in numbers:

  • In 2013, payments businesses generated $425 billion in transaction revenues, $336 billion in account-related revenues, and $248 billion in net interest income and penalty fees related to credit cards.
  • Banks handled $410 trillion in non-cash transactions in 2013, more than five times the amount of global GDP.
  • The value of non-cash transactions will reach an estimated $780 trillion by 2023, a compound annual growth rate of 7 percent. Payments revenues will reach an estimated $2.1 trillion, a CAGR of 8 percent

Stefan Dab, Senior Partner and Managing Director, BCG, says: “The growth in payments and transaction banking, moreover, is driving stiff competition among not only traditional players but new entrants as well. Consequently, financial institutions must differentiate themselves, refine their strategies, and raise their execution skills if they want to remain competitive.”

Wim Raymaekers, Head of Banking and Treasury Markets, SWIFT, adds: “We are pleased to work with BCG to provide our customers with insights as to how the payments transaction landscape and revenues will evolve over the next 10 years. Banks can use these insights as input to their payment business strategy and execution, since growth will differ widely by region.”

Here is the interactive version of the Global Payments Report 2014.

Revolving Letter of Credit

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Revolving Letter of Credit

Revolving letter of credit is a special type of letter of credit, which is not covered under the UCP 600 rules.

Contrary to popular belief, revolving letters of credit are not used frequently.

They may be utilized in limited occasions in international trade, especially when exporters and importers sign a long term commercial sales contract, which covers shipments of the same commodity on a regular basis such as;

  • Shipments of 10.000 mtons of iron ore from Australia to China monthly basis for a 6 months period of time
  • Shipments of textile products monthly basis from China to USA for a 12 months period of time.

An exporter and importer, who have concluded a contract as indicated above and wish to have a letter of credit issued to satisfy their contractual payment obligations, may apply for a revolving letter of credit.

Definition:

A revolving letter of credit is a special letter of credit type, which is structured in a way so that it revolves either in value or in time covering multiple-shipments over a long period of time under a single letter of credit.

Types of Revolving Letters of Credit:

i. Revolvement Based on Time: A fix amount could be drawn under letter of credit within each specific period of time as indicated in the documentary credit until letter of credit expires.

Example: Letter of credit stipulates that 100.000,00 USD can be drawn on monthly basis for a 12 months validity period.

  • Type 1 – Non-Cumulative Revolving Letter of Credit: For a non-cumulative revolving letter of credit, the beneficiary can draw each revolving amount for any given period, and any unused portions cannot be drawn on the subsequent periods.

Example: Using the above example, the shipper could still ship USD 100.000,00 each month and be fully paid. If the shipper shipped USD 90.000,00 in a given month, they would still be paid provided that partial shipment is allowed for each shipments, but they could not get the additional USD 10.000,00 by shipping excessive amount on the upcoming months.

Type 2 – Cumulative Revolving Letter of Credit: Cumulative revolving letter of credit means that the unused sums in the L/C can be added to the upcoming shipments.

Example: Using the above example, the shipper could still ship USD 100.000,00 each month and be fully paid. If the shipper shipped USD 90.000,000 in a given month, they would still be paid, and they could get the additional USD 10.000,00 by shipping extra in the next months until letter of credit reaches to expiry.

ii. Revolvement Based on Value: A fixed amount is replenished every time just after it is utilized by the beneficiary within the overall validity of the revolving letter of credit.

Revolvement dependent upon value could be very risky for the issuing banks as beneficiaries can make excessive presentations if issuing banks fail to specify maximum letter of credit limit.

Confirmed L/C at Sight

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Understanding the benefits of confirmed lc at sight.

Confirmed L/C at sight covers two definitions: Confirmed letter of credit which is payable at sight.

Letters of credit can permit the beneficiary to be paid immediately upon presentation of specified documents (at sight letter of credit), or at a future date as established in the sales contract (term/usance letter of credit). (1)

Confirmation means “a definite undertaking of the confirming bank , in addition to that of the issuing bank, to honour or negotiate a complying presentation” according to latest UCP rules.

By reading this post, you should understand the responsibilities of confirming banks, benefits of confirmed at sight letters of credit and why in some situations at sight confirmed letters of credit mechanism does not work.

Definition of at Sight Letter of Credit:

Latest letter of credit rules, UCP 600, defines four availability options;

A credit must state whether it is available by sight payment, deferred payment, acceptance or negotiation (UCP 600 – Article 6- b).

At sight payment is one of the payment terms in a letter of credit transaction.

At sight letter of credit can be defined as a letter of credit that is payable as soon as the complying documents have been presented to the issuing bank or the confirming bank.

Definition of the Confirmation:

According to latest UCP rules confirmation means,

“a definite undertaking of the confirming bank , in addition to that of the issuing bank, to honour or negotiate a complying presentation”

Confirming Banks’ Responsibilities:

UCP 600 define confirming banks’ responsibilities as follows,

Article 8 – Confirming Bank Undertaking

a. Provided that the stipulated documents are presented to the confirming bank or to any other nominated bank and that they constitute a complying presentation, the confirming bank must:

i. honour, if the credit is available by

a. sight payment, deferred payment or acceptance with the confirming bank;
b. sight payment with another nominated bank and that nominated bank does not pay;
c. deferred payment with another nominated bank and that nominated bank does not incur its deferred payment undertaking or, having incurred its deferred payment undertaking, does not pay at maturity;
d. acceptance with another nominated bank and that nominated bank does not accept a draft drawn on it or, having accepted a draft drawn on it, does not pay at maturity;
e. negotiation with another nominated bank and that nominated bank does not negotiate.

ii. negotiate, without recourse, if the credit is available by negotiation with the confirming bank.

b. A confirming bank is irrevocably bound to honour or negotiate as of the time it adds its confirmation to the credit.

c. A confirming bank undertakes to reimburse another nominated bank that has honoured or negotiated a complying presentation and forwarded the documents to the confirming bank. Reimbursement for the amount of a complying presentation under a credit available by acceptance or deferred payment is due at maturity, whether or not another nominated bank prepaid or purchased before maturity. A confirming bank’s undertaking to reimburse
another nominated bank is independent of the confirming bank’s undertaking to the beneficiary.

d. If a bank is authorized or requested by the issuing bank to confirm a credit but is not prepared to do so, it must inform the issuing bank without delay and may advise the credit without confirmation.

Benefits of At Sight Confirmed Letter of Credit?

Why exporters pay additional fees to have their L/Cs confirmed?

  • First reason is that the exporters would like to eliminate default risk of the issuing bank.
  • Second reason is that they would like to receive their payment sooner by removing the issuing bank out of the equation.

Why in some Situations At Sight Confirmed Letter of Credit Mechanism Does not Work?

The nominated banks, whom added their confirmations and became the confirming banks, keep sending documents to the issuing banks and wait for reimbursement even under confirmed at sight letters of credit.

Unfortunately even the confirmation couldn’t eliminate typical nominated bank action: wait for reimbursement, then pay to the beneficiary!

Confirming banks should pay the credit amount against confirming documents to the beneficiaries under at sight letters of credit as letter of credit rules dictate.

But in practice they are ready to act in this way only if they have determined that the issuing bank is defaulted.

Sources:

  1. Documentary Letters of Credit: A Practical Guide, Scotiabank International Trade Services, Page:2

URBPO – ICC Uniform Rules for Bank Payment Obligations – ICC Publication No. 750

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URBPO - ICC Uniform Rules for Bank Payment Obligations

What Does URBPO Mean?

The URBPO are the Uniform Rules for Bank Payment Obligations ICC publication No. 750.

URBPO were approved by the ICC national committees and entered into force on 1 July 2013.

Bank Payment Obligations (BPO) is a new payment option for international trade finance. It will be located somewhere between an open account and letter of credit.

Banks play a key role on the Bank Payment Obligation transactions.

The ICC has set itself an ambitious goal to introduce an innovative way for trading counterparties to secure and finance their open account trade transactions via their banking partners.

The new instrument called “Uniform Rules for Bank Payment Obligations” (URBPO; also referred to as ICC URBPO or ICC BPO rules) will enable importers and exporters to involve their preferred banking partners in their trade transactions and get flexible risk and financing services.

Based on standardized messaging and advanced transaction matching operated by SWIFT, this new instrument will accelerate the financial supply chain in support of ever accelerating physical supply chains.

URBPO - ICC Uniform Rules for Bank Payment Obligations

What are the Headings of URBPO?

URBPO consists of total 17 articles.

  • URBPO – Article 1 Scope
  • URBPO – Article 2 Application
  • URBPO – Article 3 General Definitions
  • URBPO – Article 4 Message Definitions
  • URBPO – Article 5 Interpretations
  • URBPO – Article 6 Bank Payment Obligations (BPO) vs. Contracts
  • URBPO – Article 7 Data vs. Documents, Goods, Services or Performance
  • URBPO – Article 8 Expiry Date and Submission
  • URBPO – Article 9 Role of an Involved Bank
  • URBPO – Article 10 Undertaking of an Obligor Bank
  • URBPO – Article 11 Amendments
  • URBPO – Article 12 Charges
  • URBPO – Article 13 Disclaimer on Effectiveness of Data
  • URBPO – Article 14 Force Majeure
  • URBPO – Article 15 Unavailability of a Transaction Matching Application
  • URBPO – Article 16 Applicable
  • URBPO – Article 17 Assignment and Transfer

How URBPO 750 Can be Applied to the Bank Payment Obligations ?

The BPO is an irrevocable undertaking given by a bank to another bank that payment will be made on a specified date after successful electronic matching of data according to an industry-wide set of ICC rules known as Uniform Rules for Bank Payment Obligations (URBPO 750).

Match report will be generated by SWIFT’s Trade Services Utility (TSU) or any equivalent transaction matching application.

One of the key features of the BPO is that it supports interoperability between participating banks, because it makes use of a standard set of ISO 20022 messages.

Some important definitions from URBPO 750:

  • “Obligor bank” means buyer’s bank under Bank Payment Obligations. Obligor bank issues the legally binding, valid, irrevocable but conditional and enforceable payment undertaking to Recipient Bank. Obligor bank is an equivalent term of issuing bank under letters of credit definitions.
  • “Recipient Bank” means seller’s bank under Bank Payment Obligations.
  • “Trade Services Utility” (TSU) means a centralized matching and workflow engine providing timely and accurate comparison of data taken from underlying corporate purchase agreements and related documents, such as commercial invoices, transport and insurance.

Bank Payment Obligation – BPO

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BANK PAYMENT OBLIGATION

Each payment method in international trade has strengths and weaknesses.

For example, open account and cash in advance payments are elementary payment options. They are not only simple, but also inexpensive. However, they inherit high volumes of risks either for the importers or the exporters.

Documentary credits, on the other hand, are relatively secure payment methods, but they are complicated and expensive.

Does international trade finance need another payment method? Can bank payment obligation be the right answer?

Definition of Bank Payment Obligation:

Bank payment obligation (BPO) is an irrevocable undertaking given by an Obligor Bank (typically buyer’s bank) to a Recipient Bank (usually seller’s bank) to pay a specified amount on a agreed date under the condition of successful electronic matching of data according to an industry-wide set of rules adopted by ICC.

Some Important Definitions under Bank Payment Obligation (BPO):

  • “Obligor bank” means buyer’s bank under Bank Payment Obligations. Obligor bank issues the legally binding, valid, irrevocable but conditional and enforceable payment undertaking to Recipient Bank. Obligor bank is an equivalent term of issuing bank under letters of credit definitions.
  • “Recipient Bank” means seller’s bank under Bank Payment Obligations.
  • “Trade Services Utility” (TSU) means a centralized matching and workflow engine providing timely and accurate comparison of data taken from underlying corporate purchase agreements and related documents, such as commercial invoices, transport and insurance.
  • The URBPO, the Uniform Rules for Bank Payment Obligations ICC publication No. 750, are the rules of Bank Payment Obligation adopted by ICC banking commission.

How Does Bank Payment Obligation Work?

Bank payment obligation and letter of credit have some characteristics in common.

Firstly banks play a key role on both payment methods. Secondly banks are giving the irrevocable payment undertaking.

Figure 1 : Basic Bank Payment Obligation Transaction

Figure 1 : Basic Bank Payment Obligation Transaction

Bank Payment Obligation (BPO) has been established on two main expectations,

  • The use of minimum fields, the buyer, the seller and respective banks agree on the payment terms and conditions and on the minimum trade information required to assess the credit risk;
  • The dispatch of documents, such as the bill of lading, certificate of origin and certificate of quality, from the seller directly to the buyer.

Given the limited information required by the banks and the accelerated document exchange, companies should expect a lower rate of discrepancies and an acceleration of the settlement process.

Figure 2 : Bank Payment Obligation Transaction Flow in Detail

Figure 2 : Bank payment obligation transaction flow

Step-by Step Bank Payment Obligation Transaction

Baseline Establishment

  • Step 1 : Buyer and seller agreed on BPO (bank payment obligation) as a payment term on the sales contract. Buyer send its purchase order to the seller.
  • Step 2 : Buyer provides the minimum data from the purchase order and conditions of the bank payment obligation to the obligor bank.
  • Step 3 : Seller confirms the data from the PO and send its acceptance of the BPO conditions to the recipient bank. If both buyer’s and seller’s data are matched on the Transaction Matching Application than the baseline is established. Both buyer and seller will be receiving a matching reports from their banks.

BPO is irrevocable but conditional payment method. (payment is subject to the electronic matching of agreed data-sets)

Matching

  • Step 4 : Seller ships the goods as agreed on the sales contract.
  • Step 5 :Seller presents the shipment data and invoice data to its bank, which submits it to Transaction Matching Application for matching.
  • Step 6 : Buyer receives a match report from its bank. Buyer is invited to accept any mismatches if any.
  • Step 7 : Seller’s bank inform seller about the successful data-set match.

BPO becomes operative and due according to the agreed payment terms.

Settlement

  • Step 8 : Seller sends the trade documents directly to the buyer. Buyer will clear goods from the customs with these documents.
  • Step 9 : On the due date, the obligor bank debits the proceeds from buyer’s account

Bank Payment Obligation Video Presentation

Bank payment obligation (BPO) is the newest payment method in international trade.

Exporters , importers and bank professionals need learning material to understand its usage.

On this page you can find bank payment obligation video presentation. It is prepared by Commerzbank, one of the world’s leading banks in international trade services solutions sector.

What are the Advantages of the BPO (Bank payment Obligation) for the Exporters?

  • Bank payment obligation is a secure payment method in international trade for the exporters. BPO can be more secure than the letter of credit, because the documents will not be checked by human beings, by which process eliminating alleged discrepancy risks.
  • The bank payment obligation is cheaper than letter of credit.
  • Exporters could get their money very fast from the banks under the BPO transactions as documents are checked by an automatic system instantly.
  • Exporters have more control over the goods until they have been paid by the banks under the BPO transactions as shipment documents will be held by the exporters during the BPO process. Exporters do not send paper documents to the banks. Once exporters receive their money from the banks, they dispatch the documents to the importers separately.
  • Exporters could reach pre-shipment and post-shipment finance in BPO transactions.
  • Once the bank payment obligation is opened, it is almost impossible for the importer to cancel the order without the consent of the exporter.
  • Non-payment risk shifts from importer to importer’s bank, which is called obligor bank in the BPO transaction.

What are the Advantages of the BPO (Bank payment Obligation) for the Importers?

  • As a payment method the bank payment obligation is more secure than the advance payment, because the BPO is a conditional payment method. Under the BPO transactions, banks send payment amounts to the exporters only after the shipment of the goods, not before.
  • Issuing a bank payment obligation may prove that the importer is a financially secure and strong company.
  • The Bank payment obligation is an irrevocable payment method like the letter of credit. As a result importers can convince exporters to make shipments with the BPO much more easily comparing to open account or documentary collections.
  • The BPO facilitates financing of the shipment for the importers.
  • It is possible for the importers to pay the transaction amount after receiving the shipment, if a deferred payment has been agreed upon such as “60 days after match”, “90 days after match” etc.
  • The BPO may protect the buyers, at least in theory, against non-shipments, late shipments and inferior quality of goods shipments.

Bank Payment Obligation – Comparison to Letter of Credit and Open Account

Bank Payment Obligation Comparison to Letter of Credit:

  • Both bank payment obligation and letter of credit have an irrevocable structure.
  • Bank payment obligation and letter of credit are governed by ICC rules. BPO rules are URBPO, letters of credit rules are UCPDC.
  • The conditional payment guarantee is given by a bank to another bank in BPO transactions. BPO is a bank-to-bank payment obligation. The conditional payment guarantee is given by a bank to a commercial company in L/C transactions. (Letters of credit can be issued bank-to-bank transactions as well.)
  • Letter of credit is paper intensive. BPO is an electronic payment method.
  • Documents have been checked by banks’ staff manually under letter of credit transactions. Data match completed by online means under BPO transactions.
  • Under BPO transactions shipment documents would not be sent to the banks.
  • Letter of credit is slow and expensive. BPO is fast and not as expensive as L/Cs.

Bank Payment Obligation Comparison to Open Account:

  • Both bank payment obligation and open account are fast and easy to handle.
  • Open account is the riskiest payment method for the exporters. Nonpayment risk is stemmed from the importer and must be covered by the exporter in full under open account payments. On the contrary, under the BPO the obligor bank is the entity that is giving the payment guarantee to the exporter through the recipient bank. As a result non-payment risk mitigates from the importer to the importer’s bank under BPO transactions.
  • There are no rules exist for open account payments. On the other hand bank payment obligations can be issued subject to the URBPO 750.
  • Under open account transactions exporters must finance importers, whereas they can be benefited pre-shipment finance and post-shipment finance under the BPO.

Sources:

  1. Bank Payment Obligation A new payment method, July 2016, SWIFT’s Corporate and Supply Chain Market Management team,
  2. Bank Payment Obligation – Comparison To Letter Of Credit And Open Account, J.P. Morgan,

Cash in Advance Payment

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. Cash in advance payment in international trade Cash in advance payment in international trade

Cash in advance (CIA) is a payment method in international trade. Cash in advance is also known as cash with order or advance payment by most exporters and importers.

Key Characteristics:

  • One of the main characteristics of a cash in advance payment is that the full order amount will be paid by the importer to the exporter prior to the transfer of ownership of the goods.
  • In most cases, exporters demand significant advance payments on order confirmation in order to protect themselves against order cancellations. Some common phrases stipulated in sales contracts to this effect are as follows:
    • %50 of proforma invoice total will be paid on order confirmation, remaining %50 will be paid 1 week before shipment.
    • %30 of proforma invoice total will be paid 1 week after order confirmation, remaining %70 will be paid against copy of shipment documents send via e-mail or fax.
  • Cash in advance payment is the most secure payment method in international trade for exporters, because it eliminates non payment risk especially when money transfer is done via wire transfer.
  • By paying total value of the goods before shipment, importers have to bear some risks such as;
    • non shipment risks
    • low quality goods
    • non compliance risks
    • custom clearance risks

Cash in Advance Payment Rules:

There is no set of rules exists that governs cash in advance payment used in international trade.

UCP 600 is the set of rules for letters of credit (LOC) transactions and URC 522 is the set of rules for cash against documents (CAD) payments.

Both UCP 600 and URC 522 is published by ICC (International Chamber of Commerce). On the other hand ICC has not published any rules for the cash in advance payments.

For this reason, exporters and importers have to identify cash in advance payment details on the proforma invoice in order to prevent misunderstandings and possible mistakes.

Payment Settlement Methods for Cash in Advance Payment:

Wire Transfer: Wire transfer is the most secure and preferred cash-in-advance payment settlement method used in international trade transactions.

A wire transfer is an electronic payment service for transferring funds by wire for example, through the Federal Reserve Wire Network or the Clearing House Interbank Payments System (CHIPS). (1)

Wire transfer can either be sent via online banking or traditional banking applications.

In order to complete an international wire transfer correctly you need to specify below details;

  1. Currency of the wire transfer and wire transfer total
  2. Name of the account holder:
  3. Full Name and address of the bank:
  4. Bank Branch:
  5. Account number:
  6. Swift Code: SWIFT is the short form of “Society for Worldwide Interbank Financial Telecommunication”. SWIFT is an industry-owned co-operative supplying secure, standardized messaging services and interface software to nearly 8,100 financial institutions in 207 countries and territories. SWIFT members include banks, broker-dealers and investment managers. While not always required, a SWIFT Code (also known as BIC Code) may be required by some banks for the completion of wire transfers.
  7. IBAN Number: (if applicable) The International Bank Account Number (IBAN) is the international standard for identifying international bank accounts across national borders. The IBAN is comprised of a maximum of 27 alphanumeric characters within Europe and a maximum of 34 outside of Europe (German IBAN: 22 characters). At present, the United States does not participate in IBAN. Therefore, US banks do not have an IBAN number.

Credit Card: For small scale orders credit cards could be used as a viable cash-in-advance payment method in international trade.

As international credit card transactions are typically placed via online, telephone, or fax methods that facilitate fraudulent transactions, proper precautions should be taken to determine the validity of transactions before the goods are shipped.

Although exporters must endure the fees charged by credit card companies, this option may help the business grow because of its convenience.

Payment by Check: Advance payment using an international check may result in a lengthy collection delay of several weeks to months.

Therefore, this method may diminish the original intention of receiving the payment before the shipment.

Moreover, there is always a risk that a check may be returned due to insufficient funds in the buyer’s account.

As a result payment by check is a less-attractive cash-in-advance settlement method in international trade finance.

Sources: 

  1. Wire Transfers FAQs, Bank of America, https://www.bankofamerica.com/deposits/wire-transfers-faqs/

Documentary Collections – Cash Against Documents (CAD)

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Documentary Collections – Cash Against Documents (CAD)

Documentary collection (D/C) is a payment method in international trade.

Documentary collection is also known as Cash Against Documents (CAD) by most exporters and importers.

Documentary collection is more like formal name usually used by bank professionals, whereas cash against documents is a daily life name usually used by importers and exporters.

Key Characteristics:

  • Importers normally pay for the goods after the shipment in whole. But it is also possible to make an partial advance payment under the documentary collections. For example, it is possible to pay %25 of the transaction amount in advance and %75 is payable via cash against documents (CAD).
  • Generally, there are two payment options available under the documentary collections: Documents Against Payment (D/P) and Documents Against Acceptance (D/A).
  • The title of goods belongs to the exporter until the exporter is paid by the importer. But exporter must be very careful about land, rail and air shipments. The transport documents issued under these shipments do not represent the title to the goods.
  • Although banks play an essential role in documentary collections, they neither check or verify the documents, nor take any risks.
  • Documentary collections are less complicated than letters of credit. Also documentary collections are less expensive comparing to the letters of credit.

Rules:

Documentary collections are governed by the Uniform Rules for Collections, 1995 Revision, ICC Publication No. 522, shortly known as URC 522.

Documentary collection rules, URC 522, published by International Chamber of Commerce, ICC.

URC 522 will only be effective if it is incorporated into the text of the “collection instruction“.

Collection Instruction and its Scope:

Collection Instruction is a separate document, which the exporter should supply to his bank along with other commercial and financial documents under a documentary collection.

Collection instructions are written in a cover letter format and normally should contain below points.

  • Governing Rules for the Collection: As an example “This collection is subject to The Uniform Rules for Collections, 1995 Revision, ICC Publication No. 522.”.
  • Details of the bank from which the collection was received including full name, postal and SWIFT addresses, telex, facsimile numbers and reference.
  • Details of the principal including full name, postal address, and if applicable telex, telephone and facsimile numbers.
  • Details of the drawee including full name, postal address, or the domicile at which presentation is to be made and if applicable telex, telephone and facsimile numbers.
  • Details of the presenting bank, if any, including full name, postal address, and if applicable telex, telephone and facsimile numbers.
  • Total amount and currency of the documentary collection.
  • Documents to be supplied: URC 522, the rules of the documentary collections, define two types of documents; financial documents and commercial documents.
    • Financial Documents : Financial documents means bills of exchange, promissory notes, cheques, or other similar instruments used for obtaining the payment of money.
    • Commercial Documents: Commercial documents means invoices, transport documents, documents of title or other similar documents, or any other documents whatsoever, not being financial documents
  • How many number of originals and copies of each document supplied
  • Conditions for release of documents
    • Documents Against Payment (D/P): Documents may be released only if the importer makes immediate payment according to the contracted agreement between the exporter and the importer. Also known as sight collection.
    • Documents Against Acceptance (D/A): Documents may be released only if the importer accepts the accompanying draft, thereby incurring an obligation to pay at a specified future date. In this arrangement the exporter is exposed to the credit risk of the importer and the political risk of the country. Also known as a term collection.

Note: It should be noted that the party preparing the collection instruction should have to clearly define how documents should be handed over to the drawee. If instructing party fails to do so they will be liable for any consequences arising therefrom.

  • Charges: Charges to be collected, indicating whether they may be waived or not and who is going to pay for charges in detail.
  • Interest: Collection of interest is a very rare case in documentary collections but if applicable, collection instruction should be indicating whether it may be waived or not, with following information:
    • a. rate of interest
    • b. interest period
    • c. basis of calculation (for example 360 or 365 days in a year) as applicable
  • Method of payment and form of payment advice.
  • Instructions in case of non-payment, non-acceptance and/or non-compliance.

Sample Collection Instructions:

Almost every bank has its own collection instructions format available to its clients either in electronic format or hard-copy.

These collection instructions follow the requirements indicated in URC 522, the Uniform Rules for Collections.

Their structure is almost identical. Please click to reach corresponding collection instructions examples provided below.

Parties in a Documentary Collection:

Main parties in a documentary collection and their roles and responsibilities are summarized below:

  • the “principal” who is the party entrusting the handling of a collection to a bank;
  • the “remitting bank” which is the bank to which the principal has entrusted the handling of a collection;
  • the “collecting bank” which is any bank, other than the remitting bank, involved in processing the collection;
  • the “presenting bank” which is the collecting bank making presentation to the drawee.
  • the “drawee” is the one to whom presentation is to be made according to the collection instruction.

Documentary Collection Process (Cash Against Document Transaction Flow)

Figure 1 : Cash Against Document Payment Transaction Diagram

  1. Exporter and importer sign a sales contract indicating the payment method and shipment terms in addition to other details.
  2. The exporter makes the shipment.
  3. The exporter submits the documents and collection instructions to it’s bank with instructions for delivery.
  4. The exporter’s bank sends the documents to the importer’s bank together with the exporter’s instructions.
  5. The importer’s bank reaches out the the importer and informing about the documentary collection.
  6. The importer fulfills his collection obligations and gets the documents from his bank. The importer’s bank hands the documents to the importer on payment or acceptance of a bill of exchange.
  7. The exporter receives payment.

What are the Advantages of a Documentary Collection?

Advantages of a documentary collection can be examined in exporters or importers perspective.

Below figure shows the advantages of a documentary collection for both exporters and importers.

Figure 1 : Advantages of a documentary collection for exporters and importers

Advantages of a Documentary Collection for Exporters:

  1. Under documentary collections, the documents will not be handed over to the importers unless payment or acceptance of a time draft has been obtained. As importers could not clear goods from the customs without the documents, at least in theory, documentary collections give considerable payment warranty to the exporters.
  2. Documentary collections are less complicated than its alternatives such as letters of credit.
  3. Documentary collections are less expensive than its alternatives such as letters of credit.
  4. Exporters remain the title of goods (only with sea shipments under negotiable b/l) until payment has been received.

Advantages of a Documentary Collection for Importers:

  1. Documentary collections are less expensive than its alternatives such as letters of credit.
  2. Documentary collections are less complicated than its alternatives such as letters of credit.
  3. Under documentary collections, generally, importers make the payment after the shipment of goods.
  4. Importers may be able to review copies of the shipment documents before payment.
  5. Importers may be able to make the payment after they received the documents from their banks by accepting usance bills of exchange (time drafts).

Risks for the Exporters:

Non-Acceptance of Documents Risk: This is one of the major risk factor in a documentary collection for exporters.

Under current documentary collection rules, which are called URC 522, importers are not obligated to collect documents from their banks.

As a result exporters have to understand that upon arrival of the cargo to the importing country, buyers may decide not to pay for the documents and simply left goods unclear at the customs.

Under such a scenario exporters have couple options.

  • Option 1: Exporters can find another customer to the goods within the country that cargo has arrived. For example if you shipped one container of textile products to Algiers and your buyer do not clear goods from the customs by not having the documents from the bank, then you may try to find another buyer to your goods from Algiers. You may have to give additional discount to make the container attractive to the new buyer.
  • Option 2: Exporters may try to bring back the container to its home country.
  • Option 3: Exporters may try to sell the container to the same buyer under more favorable terms.

Non-Payment Risk: Nonpayment risk is the second most frequently seen risk factor in documentary collections.

In most cases we would expect to see a nonpayment risk in a documentary collection which is available by Documents Against Acceptance (D/A).

Nonpayment risk would be happened if the importer accepts a time draft but not be paying on maturity.

“Exporters may seek to have importer’s banks aval to the time draft or bill of exchange in order to eliminate non-payment risk.”

Risk of Delivery of Goods to the Importer without Original Shipment Documents: Importers may clear goods from the customs without having original shipment documents on road, air and rail transportation.

It is also possible for buyers to receive goods from transport companies under sea shipments if express bills of lading (non-negotiable bills of lading) has been utilized.

Under all these conditions as explained above, the importers will be able to receive the goods without the need of original shipment documents, which may lead to a non-payment for the exporters under documentary collections.

Risks for the Importers:

Low Quality Goods Shipment Risk: This is one of the major risk factor in a documentary collection for the importers.

Under current documentary collection rules, which are called URC 522, banks do not check or control the documents.

As a result importers pay for the documents without knowing the quality of the goods.

This risk is higher when the documentary collection is utilized with “documents against payment” (D/P).

Even if the documentary collection is utilized with “documents against acceptance” (D/A), importers may be forced to pay low quality goods according to the local law that governs bill of exchange (draft) procedures.

“Importers can limit their Low Quality Goods Shipment Risk by requesting a pre-shipment inspection from the exporters when working with a new supplier under a documentary collection payment.”

What Are the Differences Between Cash Against Documents and Letters of Credit?

Ozgur Eker (CDCS) Cash Against Documents, International Payment Methods, Letters of Credit , ,
Differences Between Cash Against Documents and Letters of Credit

Letters of credit (l/c) and cash against documents (documentary collections, cad) are both payment methods in international trade.

Their combined share is around 50% in all trade finance practices.

Letters of credit and cash against documents have some similarities. We can identify major common points of these two payment methods as follows:

  • Both payment methods are executed by banks,
  • Documents play a key role under both payment options,
  • Both of them are governed by internationally accepted rules.

Despite these similarities they have significant differences as well.

On this article I would like to identify the main differences between Letters of credit (l/c) and cash against documents (documentary collections, cad).

What are the Main Differences Between Cash Against Documents and Letters of Credit?

Let us examine the differences between these two important payment methods of international trade article by article below.

Governing Rules: Letters of credit transactions are governed by UCP 600 and cash against documents are governed by URC 522 rules. You can get detailed information regarding these two sets of rules by reading my related articles.

Transaction Flow: Letters of credit are opened by the issuing banks with the request and authorization which they have received from the applicants.

Applicant is the importer in a commercial letter of credit. As a result letters of credit are initiated by the importers.

On the other hand, cash against documents or documentary collections as we called them in trade finance are initiated by the exporters.

cash against documents transaction flow
Basic cash against documents transaction flow
Basic letter of credit transaction flow
Basic letter of credit transaction flow

 

 

 

 

 

 

Risk Degree: Letters of credit give more assurance to the exporters than cash against documents. For this reason the letter of credit is accepted as a more secure payment method in international trade than the documentary collection.

payment methods in international trade

Responsibilities of Banks : Banks play a key role in letters of credit transactions and they have high levels of responsibilities against the exporters.

On the other hand in documentary collections banks have almost no valid responsibilities against the exporters.

As an example, the banks do not control the documents in documentary collections, but in documentary credit transactions banks check the documents to determine whether the presentation is complying or not.

Complexity : Documentary collections are much more easy in operational perspective than letters of credit.

Cost : The costs of the documentary collections are less than the cost of the documentary credits.

Letters of credit are one of the most expensive payment methods in international trade.

Please read my article for detailed information : How to deal with high banking commissions under letters of credit as an exporter?