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International Trade Finance (Methods of Payment (Open Account (The…
International Trade Finance
Benefits of Trade Finance
As country cannot produce everything its citizens want, trade finance allows specialisation, more efficient production and exploit economies of scale as a result
Risks of Trade Finance
From
IMPORTER'S
perspective
Delivery risk
Risk of non-delivery of goods after payment is made
Goods do not conform to specifications
From
EXPORTER
&
IMPORTER
perspective
Foreign Exchange Risk
Faced with by exporter/importer depending on invoice currency
From
EXPORTER'S
perspective
Credit Risks
Risk of non-payment after goods are delivered
Buyer/goods located abroad, recovery more difficult
Political Risks
Changes in policy/regulations
Political instability
Payment Issue
Risk for exporters
Goods end up in different country
Difficult to get goods back again
Risk for importers
Paying in advance is risky as goods may not comply with contract specifications/not delivered
Methods of Payment
Documentary Collection
Collection Order
A standardised form (provided by exporter's bank) which allows the exporter to give specific instructions regarding documentary collection
Specifies the terms of payment, whether documents are to be released to importer (i) against payment (D/P) or (ii) against acceptance (D/A)
Acceptance: an unconditional obligation on the apart of the accepting party to pay the draft at maturity
Drafts
Sight draft
: demands payment at sight
Time draft
: demands payment at a specified future date
Protection for importer and exporter
Seller/exporter retains control over the goods until either payment is made or a legally binding undertaking to pay is given by buyer
This protects the exporter against credit risk while allowing importer to protect against delivery risk
Limitations
Doesn't guarantee payment by importer (in settlement by D/A); exporter takes risk
For importer, the condition and specifications of the goods received are not guaranteed; importer takes the risk
Document Credit
Characteristics
The exporter s thus relying on the bank's promise and ability to pay in country of importer
If he does not have confidence in importer's bank/country, the exporter may request for Letter of Credit to be confirmed by a bank in his own country
An arrangement whereby the importer's bank guarantees the importer's payment to exporter through letter of credit, provided the exporter presents specified deocuments within a stipulated period and conforms to the terms of the letter of credit
The confirming bank adds its promise (guarantee) to pay to that of the importer's bank
Parties
Issuing bank
: Issues credit on the request of its customer, gives conditional guarantee in favour for exporter
Advising Bank
: Located in exporter's country requested by issuing bank to advise export on the terms and conditions of Letter of Credit
Applicant:
Buyer/Importer
asks his bank (issuing bank) to issue Letter of Credit
Purpose
Guarantees payment to exporter provided he presents the documents according to the credit
Designed to protect the trading partners in the transaction by ensuring that
buyer is assured of receiving all the necessary shipping documents giving title to goods and evidencing their presence
the seller can be assured of payment for his goods
To facilitate payment as well as finance for overseas trade
Ways of settling document credits
Payment
Exporter presents the sight draft to advising bank, together with terms and conditions of the credit
The bank checks the documents to ensure due compliance with the credit and makes payment to the exporter, normally within 2 days
Acceptance of time drafts
Trade Acceptance
: A draft accepted by a company (acceptance made by finance company)
Unconditional obligation on the part of the accepting party to pay the draft at some future date
Banker's Acceptance
: A draft accepted by bank. The exporter sends the documents, evidencing the shipment of goods, to the bank where the credit is available (accepting bank), together with a draft drawn on the bank for specific tenor. After checking that the docs meet the credit requirements, the bank accepts the draft and returns to exporter
Banker's Acceptance represents an undertaking by bank to honour payment of the draft on due date. On maturity, exporter presents the accepted draft for payment. If he requires financing before maturity, he may discount the accepted draft with the bank
Open Account
The documents of title to the goods are sent directly to the importer
If the buyer refuses to pay, the seller would be in difficult position because the goods would already be in buyer's possession
The seller gives up control of the goods at the point of despatch
Least secure method of payment from the exporter's POV
Seller despatches goods to buyer and then invoices him for payment
Payment in Advance
advance payment may be 100% or some lesser % of contract price
Most secured method from exporter's POV but least secure from importer's POV
importer will pay exporter at an agreed time prior to the despatch of goods
Depends on the relative bargaining strength of exporter and importer & on the usual business practice.
Discounting trade bills
Only accepted time drafts can be discounted
Banker's Acceptance accepted or drawn on reputable banks are very saleable and can be discounted at attractive rates
Bank buys up (discount) the bill and exporter receives sales proceeds (Face value - discount)
In large and active market, investors buy and sell banker's acceptance at rates similar or often below LIBOR due to low risk of default
Trade bills under DCollection and DCredit may be discounted with any bank