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ROLE OF BANKS IN INTERNATIONAL TRADE

Presented by: Muhammad Imran, ACA Region Head Audit & RAR (0332-4188830)

Why Trade?
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Non availability of specific factors of production in some countries. (Land, Labour, Capital and Entrepreneurship) Product differentiation in different countries. Differences in comparative cost between countries e.g. Law of comparative Advantage Scarcity and specialization. (Opportunity Cost)

What is International Trade?

3

International trade is exchange of capital, goods, and services across international borders or territories. In most countries, it represents a significant share of gross domestic product (GDP). While international trade has been present throughout much of history, its economic, social, and political importance has been on the rise in recent centuries. Industrialization, advanced transportation, globalization, multinational corporations, and outsourcing are all having a major impact on the international trade system. Increasing international trade is crucial to the continuance of globalization. Without international trade, nations would be limited to the goods and services produced within their own borders.

Domestic V/S International Trade

International trade is in principle not different from domestic trade as the motivation and the behavior of parties involved in a trade do not change fundamentally regardless of whether trade is across a border or not. The main difference is that international trade is typically more costly than domestic trade. The reason is that a border typically imposes additional costs such as tariffs, time costs due to border delays and costs associated with country differences such as language, the legal system or culture. Another difference between domestic and international trade is that factors of production such as capital and labour are typically more mobile within a country than across countries. Thus international trade is mostly restricted to trade in goods and services, and only to a lesser extent to trade in capital, labor or other factors of production. Then trade in goods and services can serve as a substitute for trade in factors of production. Continued

Domestic V/S International Trade

Instead of importing a factor of production, a country can import goods that make intensive use of the factor of production and are thus embodying the respective factor. An example is the import of labor-intensive goods by the United States from China. Instead of importing Chinese labor the United States is importing goods from China that were produced with Chinese labor. Nutshell, differentiating factor are; A. Foreign Exchange Risk B. Political Risk C. Market Imperfection (MNCs are gift of this) D. Expanded opportunity set

Gains From International Trade

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International trade leads to mutual gain because it allows each country to specialize in the production of those things that it does best. Trade permits each country to use more of its resources to produce those goods that it can produce at a relatively low cost. With trade, it is made possible for the trading partners to consume a bundle of goods that it would be impossible for them to produce domestically. Trade encourages competition & efficiency.

Top 20 Trading Nations (2009 Data)

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Top Traded Commodities-Export

(2009 Data)
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Regulations Of International Trade

Traditionally trade was regulated through bilateral treaties between two nations. For centuries under the belief in mercantilism most nations had high tariffs and many restrictions on international trade. Liberalization (Free Trade) at global level; (2
nd

World War)

A. General Agreement on Tariffs and Trade (GATT) and B. World Trade Organization (1994)

Liberalization (Free Trade) at regional level;

A. MERCOSUR in South America. B. North American Free Trade Agreement (NAFTA) between the United States, Canada and Mexico.

Risks in International Trade

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Buyer insolvency (purchaser cannot pay); Non-acceptance (buyer rejects goods as different from the agreed upon specifications); Credit risk (allowing the buyer to take possession of goods prior to payment); Regulatory risk (e.g., a change in rules that prevents the transaction); Intervention (governmental action to prevent a transaction being completed); Political risk (change in leadership interfering with transactions or prices); War and other uncontrollable events; and Unfavorable exchange rate movements (and, the potential benefit of favorable movements) Hedging (Direct/indirect hedging through Banking Channels)

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Role of Banks (Commercial / Central)

It is impossible to be in international trade without involving your bank for all the services they provide such as advice on financial issues and the potential risks involved. It is true that one critical hurdle is the lack of information on international trade processes, documentation and banking procedures necessary to carry on with business abroad. For result oriented and cost effective international trade, you will very definitely need access to accurate and timely information and a sound knowledge of banking. Continue

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Role of Banks (Commercial / Central)

Attractions for banks in international trade; A. Profitability Overview of International Trade A. Flow of goods from seller to buyer B. Low Risk Nature-The Six Ss B. Flow of Payment from buyer to seller i. Short-Term C. In accordance with a contract of sale ii. Small iii. Secured Documentary requirements iv. Self-Liquidating Buyer - What documents does he needs? Seller - With what documents will he be v. Specific able to supply? vi. Selective Country of export - what documents are C. A large growing Market required under the regulations of the D. Well spread over market exporting country? E. Easy to Monitor Country of import - what documents are F. Cross Selling information required under the regulations of the importing country? G. Capital efficient
Continue

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Role of Banks (Commercial / Central)

Wants / needs and problem of trading partners

Wants / Needs 1. Contract fulfillment. 2. Convenience. 3. Credit. 4. Advice and assistance Problems 1. Am I going to get the goods? (in good condition / in time) 2. Does the settlement method safeguard these risks? 3. Before we payhow to check the goods are exactly those ordered? 4. Any credit terms available Prefers to delay paying for the goods until they are sold. 5. From where can I get information on the exporters creditability 1. 2. 3. 4. Will I be paid? When will I be paid? How to minimize risk of non-payment? How to maintain secrecy of our supplier?

Partner Buyer Wants

Seller Needs

1. Contract fulfillment. 2. Convenience. 3. Prompt payment. 4. Advice and assistance

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Role of Banks (Commercial / Central)

Basic agreement (International Trade Sale Contract)

1.

2. 3.

4.

5.

6.
7.

8.

Preliminary Quotation & Commitment (Invoicing / order etc) The Merchandise (goods to be imported / exported) Packing (instructions regarding packing of imported / exported merchandise) Method of Settlement (Immediate or Credit / Advance / LC Collection???) Shipping Instructions (trans shipment partial shipment etc) Price and its components (INCOTERMS 2000) Delivery Mode ,Period, Place (Sea, Air, Road place of shipment and last date of shipment) Documents (Invoice, packing list, inspection report, certificate of origin, BL/AWB etc)

Methods of Settlement
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Considerations of trading partners;

Partner Buyer Consideration 1. 2. 3. 4. 1. 2. 3. 4. Goods in advance. Payment at the time of receipt of goods. Payment after receipt of shipping documents. Need bank finance. Payment in advance. Payment at the time of shipment of goods. Payment after delivery of shipping documents. Need bank finance.

Seller

Methods of settlement (Payments)

Direct between buyer and seller (trading partners) / Clean Payments 1. Open Account / Extended Terms 2. Advance Payments Indirect through involvement of banks 1. Documentary Collections 2. Documentary Credits

Clean Payments
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Clean Payments are characterized by trust. Either the Exporter sends the goods and TRUSTS the Importer to pay once the goods have been received (Open Account / Extended Terms), or the Importer TRUSTS the Exporter to send the goods after payment is affected (Advance Payments).

Documentary Collection
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A method of payment used in international trade whereby the Exporter entrusts the handling of commercial and financial documents to banks and gives the banks instructions concerning the release of these documents to the Importer. Banks involved do not provide any guarantee of payment. Collections are subject to the Uniform Rules for Collections published by the International Chamber of Commerce. The last revision of these rules came into effect on January 1, 1996 and is referred to as the URC522. Documentary collection may be carried out in two following ways; A. Documents against Payment (DAP) / Sight Collection (SC) / Cash Against Documents (CAD) Documents are released to the Importer only against payment. B. Documents against Acceptance (DAA) / Term Collection (TC) Documents are released to the Importer only against acceptance of a draft/promissory note. Also known as a Term Collection. Due date can be from any document date (BL/AWB etc) or from acceptance of promissory note date.

Documentary Collection
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Parties to a Collection General 1. 2. 3. 4. Importer Importers bank Bank in exporters country Exporter

International Terminologies (URC 522)

1. Drawee (Importer) 2. Collecting bank of proceeds (Importers bank) 3. Remitting bank of documents (Bank in exporters country) Mechanism of Documentary Flow 4. Drawee (Exporter)
The mechanics of a Documentary Collection are easily understood when separated into the following three steps: A. Flow of Goods After the Importer and the Exporter have established a sales contract and agree on a Documentary Collection as the method of payment, the Exporter ships the goods. B. Flow of Documents After the goods are shipped, documents originating with the Exporter (e.g. commercial invoice) and the transport company (e.g. bill of lading) are delivered to a bank (Remitting Bank). The role of the Remitting Bank is to send these documents accompanied by a Collection Instruction giving complete and precise instructions to a bank in the Importers country (Collecting/ Presenting Bank). The Collecting/ Presenting Bank acts in accordance with the instructions given in the Collection Order and releases the documents to the Importer against payment (DAP/SC/CAD) or acceptance (DAA/TC), according to the Remitting Banks Collection instructions. C. Flow of Payment Payment is forwarded by Collecting / Presenting Bank to the Remitting Bank for the Exporters account and the Importer can now present the transport/title document to the carrier in exchange for the goods.

Documentary Collection
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Documentary Collection Governing

Rules
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1.

2.

1. 2. 3.

International URC-522 (Uniform Rules for Collections-ICC Publication no. 522) INCOTERMS-2000(International Commercial Terms) Local Foreign Exchange Manual-2002 SBP Prudential Regulations M-Series Others i.e. (CBR Directives, Trade Policy, Contract Act, Sale of Goods Act, Negotiable Instruments/Bill of Exchange Act, Carriage of Goods by Sea Act, Marine Insurance Act, Bills of

Documentary Credits / L.Cs

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The LC in its modern shape appeared for the 1st time in 1840s in London for the settlement of trade transactions.
A Documentary Credit (DC) is a written undertaking by a bank (Issuing Bank) given to the exporter (Beneficiary) at the request of the importer (Applicant) to effect payment (Reimbursement) up to a stated amount (Credit Amount) within a stated time period (Expiry date) against presentation of compliant documents (LC terms). In other words DC is a conditional payment undertaking from a bank. Parties to a DC/LC General International Terminologies (URC 522) 1. 2. 3. 4. 5. Importer Importers bank Bank in exporters country Exporters other bank (optional) Exporter 1. L.C applicant (Importer) 2. L.C Issuing bank (Importers bank) 3. Advising / Nominated / Negotiating / Presenting bank (Bank in exporters country) 4. Confirming Bank (Exporters other bank optional) 5. Beneficiary (Exporter)

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Documentary Credits Mechanism

The mechanics of a Documentary Credit / Letter of Credit are easily understood when separated into the following three steps;

A. Issuance of Documentary Credit / Letter of Credit

After the trading parties agree on a sale of goods where payment is made by Letter of Credit, the Importer requests that its bank (the Issuing Bank) issue a Letter of Credit in favour of the Exporter (Beneficiary). The Issuing Bank then sends the Letter of Credit to the Advising Bank. A request may be included for the Advising Bank to add its confirmation. The Advising Bank is usually located in the country where the Exporter does business and may be the Exporters bank, but does not have to be. Next, the Advising/ Confirming Bank verify the Letter of Credit for authenticity and sends it to the Exporter. B. Flow of Goods Upon receipt of the Letter of Credit, the Exporter reviews the Letter of Credit to ensure that it corresponds to the terms and conditions in the purchase and sales agreement; that the documents stipulated in the Letter of Credit can be produced; and that the terms and conditions of the Letter of Credit can be fulfilled. Assuming the Exporter is in agreement with the above, it arranges for shipment of the goods.

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Documentary Credits Mechanism

C. Flow of Documents & Payments After the goods are shipped, the Exporter presents the documents specified in the Letter of Credit to the Advising/ Confirming /Negotiating Bank. Once the documents are checked and found to comply with the Letter of Credit (i.e. without discrepancies), the Advising/ Confirming Bank forward these documents to the Issuing Bank. The drawing is negotiated, paid or accepted as the case may be. In turn, the Issuing Bank examines the documents to ensure they comply with the Letter of Credit. If the documents are in order, the Issuing Bank will obtain payment from the Importer for payment already made to the Confirming Bank. Documents are delivered to the Importer to allow him to take possession of the goods

Documentary Credits - Cycle

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Documentary Credits Governing Rules

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1.

2. 3. 4. 5. 1. 2.

3.

International UCP-600 (Uniform Customs and Practice for Documentary Credits -ICC Publication no. 600) URR-525(Uniform Rules for Reimbursements, ICC-525) International Standby Practices ICC-ISP 98 International Standard Banking Practices INCOTERMS-2000(International Commercial Terms) Local Foreign Exchange Manual-2002 SBP Prudential Regulations M-Series Others i.e. (CBR Directives, Trade Policy, Contract Act, Sale of Goods Act, Negotiable Instruments/Bill of Exchange Act, Carriage of Goods by Sea Act, Marine Insurance Act, Bills of Lading Act etc)

SWIFT Operations
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It (Society for Worldwide Interbank Financial Telecommunications) is Cooperative Society under Belgium Law and owned and controlled by its members-share holders. It has a board of 25 Independent directors appointed by the shareholders who are responsible for overseeing and governing the company. The National Bank of Belgium, the central bank of the country in which SWIFT head quarters are located and which is under arrangement with central Banks of G-10 countries i.e. Belgium, Canada, France, Germany, Italy, Japan, The Netherlands, United Kingdom, Unites States, Switzerland, Sweden, and the European Central Bank. A new SWIFT member will pay a onetime entry fee and recurring service fees to SWIFT.

SWIFT Operations - Benefits

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1.
2.

3. 4. 5. 6.

Benefits of joining SWIFT; Cost is much lower than telex message Use of standard formats for messages results in consistency. Improved accuracy. Timely delivery. Confidentiality and security. Reduced risk.

SWIFT Operations Series

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Series Series 1 ** Series 2 ** Series 3 **

Description Deals in direct customer related messages. Deals in Financial Institution Transfers. Deals in Buying and Selling of Two Currencies.

Examples Single customer transfer i.e.MT103 (TT) General Financial Institutions Transfer i.e. MT202 (Imports) Forward Rate Agreement Confirmation i.e. MT340 (Treasury)

Series 4 **
Series 5 ** Series 6 ** Series 7 ** Series 8 ** Series 9 **

Deals in Collections.
Deals in sale /purchase of Securities. Deals in Precious Metal Trade. Deals in Documentary Credit Operations. Deals in Travelers Cheques. Deals in Miscellaneous Purpose Messages

Advice of payment i.e. MT400 (Collection Payment)

Order to Buy i.e. MT500 (Treasury) Precious metal Trade Confirmation i.e. MT600 Issue of Documentary Credit i.e. MT700 T/C Settlement Advice i.e. MT802 Miscellaneous MT-999

Pakistans Perspective
29 Pakistan s Perspect ive Export Open Account / Extended Terms Advance Payments Documen tary Collectio n D/A and D/P Both Allowed (Para 26 F.E.M2002 Chapter XII) Documentary Credit / LC

Not allowed till date.

Chapter-12 Para 24 of F.E.M -8th Edition-2002 and EPD Circular Letter # 03/EPP1(51) Misc-2006 dated Jan.20,2006; Due diligence is required? Ordering customer name & address. Remittance information. Bonafide / genuine trading parties. BPRD Circular Letter No. 07 of 2009 dated March 09, 2009 & M-2 (Anti Money Laundering Measures) Chapter-13 Amended Para 17(i) & 30(i) of F.E.M -8th Edition-2002. F.E. Circular no. 4 dated April 25, 2005 (Manufacturing / Industrial Sector). EPD Circular Letter no.13/Policy2004 dated Nov.10, 2004 50% Advance Payment (against LC for capital good excluding spare parts and other than capital goods SBP approval required).

All types of following LCs are allowed; 1. Sight 2. Usance 3. Transferable 4. Revolving 5. Packing Credit 6. Clean Non-documentary 7. Conversion of usance to sight 8. Mix Payment Following types of LCs are allowed; 1. Sight 2. Usance 3. Mix Payment Following types of LCs are not allowed (Chapter 13 para-14 & 18, F.E.M 2002); 1. Transferable 2. Revolving

Import

Chapter-13 Para 17(i) of F.E.M 8th Edition 2002 Amended vide F.E. Circular # 15 of Aug.15 2003) Documentary Requirements for effecting settlement by the

D/A and D/P Both Allowed (Para 23,21,18, 17(i) F.E.M2002 ChapterXIII)

INCOTERMS 2000
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To provide a set of international rules for the interpretation of trade terms set forth by the International Chamber of Commerce in 1936. Since then, this set of international commercial terms has undergone revision in 1953, 1967, 1976, 1980, 1990 & the new revision was brought out in 2000. The revised incoterms devote a more focused attention to the use of multimodal transport, above all what concerns the delivery of the goods from the exporter to the importer at whatever point in the transport chain, instead of focusing on the point when the goods cross the means of transport. To clarify rights & obligation of the parties (Buyer & Seller) to the contract of sale with respect to the delivery of goods sold. Incoterms allow us to establish some parameters to our international pricing strategies. A company choice of Incoterms in its policy will then have a direct influence on every other aspect of its export activity (distribution, shipping customs etc). For this reason it is of the utmost importance to know in detail these terms & what exactly they will imply.

INCOTERMS 2000 - Groups

31 Grou p E Description The sellers obligation is at its minimum: the seller has to do no more than place the goods at the disposal of the buyer at the agreed place - usually at the sellers own premises. The seller to deliver the goods to a nominated carrier as instructed by the buyer. F stands for Free. Abb. Terms EXW Detail Terms EX Work (Named Place)

FAS FOB FCA

Free Alongside Ship (Name port of loading/shipment) Free On Board (Named port of shipment) Free Carrier (Named Place) Cost of Freight (Named port of destination) Carriage Paid To (Named place of destination) Cost, Insurance destination) & Freight (Named place of

The seller to contract for carriage on usual terms at his own expense. Therefore, a point up to which he would have to pay transport costs must necessarily be indicated after the respective C term CFR Karachi. C stands for Cost/Carriage. The seller bears all related to the delivery the agreed place destination. D Delivered. costs & risks of the goods at or point of stands for

CFR CPT CIF CIP DAF DES DEQ DDU

Carriage & Insurance Paid to (Named place of destination) Delivered at Frontier (Named place) Delivered Ex Ship (Named port of destination) Delivered Ex Quay (Named port of destination) Delivered Duty Unpaid (Named place of destination)

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INCOTERMS 2000 Risk Snapshot

INCOTERMS 2000 Price Determination

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Sellers Expense

FOB

CFR

CIF

FCA

CPT

CIP

Cost of merchandise to be exported

$10,000

$10,000

$10,000

$10,000

$10,000

$10,000

Export License / Custom formalities

Packaging cost

$500
$1,000

$500
$1,000

$500
$1,000

$500
$1,000

$500
$1,000

$500
$1,000

Loading cost
Carriage / freight cost Insurance cost Price to be quoted

$150
Nil Nil $11,650

$150
$3,000 Nil $14,650

$150
$3,000 $1,000 $15,650

$150
Nil Nil $11,650

$150
$3,000 Nil $14,650

$150
$3,000 $1,000 $15,650

Financing Facilities
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Fund Based (Actual banks funds are involved / utilised by the borrower) Non Fund Based (Actual funds of the bank are not utilised by the borrower / commitment) Financing in PKR (Commercial Banks) Financing in FCY (Commercial Banks) Re-finance Scheme (SBP) Facilities.xlsx

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