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Methods of Payment

Dr. Anupam Varma


BIMTECH

The Importance
In international trade today,
the competition is no longer
confined to price, quality or
delivery schedule but extends
to terms of payment
The terms of payment often
decide obtaining of the order
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The Risks
Risks involved may be more serious than
those in domestic trade
Complete elimination of the risks
associated with international trade is
difficult
Consider your preferred option with
care
Hedge the risks along with appropriate
credit checks on your customers.
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Determination of Method of
Payment
Host of factors determine the payment terms,
such as
export control regulations,
trade practices,
buyers credibility,
economic and political stability of the
buyers country
competition faced by the seller bargaining strength
size and type of sale, etc.
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To Select Payment Terms


Questions to Ask:
Can your business afford the loss if it is
not paid?
Will extending credit and the possibility
of waiting several months for payment
still make the sale profitable?
Can the sale be made only by
extending credit?
(contd)
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To Select Payment Terms

(contd)

How long have the buyers been operating,


and what is their credit history?
Has your business sold successfully to the
buyer before?
Are there reasonable alternatives for
collecting if the buyer does not pay? (Does
the buyers country have the legal and
business infrastructure for settling disputes
fairly and swiftly?)
If shipment is made but not accepted, can
alternative buyers be found?
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Methods of Payments
Cash in advance
Letter of credit
Bill of exchange
Open account

Cash in Advance
Typically used where transactions
are small or you have a unique
product
Advantage to exporter:
No risk
Immediate use of funds

Letters of Credit
Most commonly used mechanism in
international trade.
Affords greatest degree of protection to
the seller after advance payment. Acts
like an insurance contract for
buyer/seller, eliminating credit risk
Issued by importers bank in favour of
the exporter giving him authority to
draw bills up to a particular amount
covering a specified shipments of goods
(contd.)

Documentary Letters of Credit


(contd.)

Bills are accompanied by the shipping


documents covering the goods contracted to be
purchased by the importer

Assures payment against delivery of


documents. At the same time reduces
payment delays
Governed by Uniform Customs & Practice
for Documentary Credits latest edition
UCP 600.

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Parties to a Letter of Credit


Rights and Responsibilities
Applicant/Importer
Applicants/Importers Bank (Issuing
Bank)
Confirming Bank
Intermediary Bank (Advising Bank)
Exporter

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The Process
The importer (opener) asks his bank to open a LC in
favour of the exporter
The LC is opened by the opening bank
The advising bank (an intermediary bank in exporters
country) receives credit from the opening bank. If all
okay, it is forwarded to beneficiary (exporter)
Exporter satisfies itself about the provisions in the LC
as in conformity with the contract and seeks any
amendment, if needed
The shipment is effected by the exporter. He prepares
the documents and draws his bill under the LC and
sends these to advising/negotiating bank
contd

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The Process

(contd)

The negotiating bank checks the documents


and if in conformity with the credit terms,
negotiates the bill and releases payment to the
exporter.
The documents are sent to the opening bank
which reimburses the negotiating bank. The
opening bank forwards the bills to the importer
The importer receives the bill. Checks the
documents. If found in order the payment is
made to the opening bank
On acceptance/payment, the shipping
documents are given to the importer for
receiving the goods
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Types of Letters of Credit

Sight LC
Usance/Deferred payment
LC
Revocable & Irrevocable LC
Confirmed LC
With recourse & without recourse LC
Transferable LC contd.
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Types of Letters of Credit

contd.

Divisible
Back to back LC
Red Clause and Green Clause LC
Revolving LC
Restricted & unrestricted LC
Standby LCBoth ISP98 (International
Standby Practices) & UCP 600 apply

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UCP 600
The stated aim of the new revision is:
To address developments in the banking,
transport and insurance industries.
To improve the drafting of the UCP in order
to facilitate consistent application and
interpretation of the Rules.
In practice there are many changes, the
overall effect is one of clarification and
consolidation not radical rethought.
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New Features in UCP600 vis--vis


UCP500
Article 1 of the UCP 600 states that the Rules will only
apply when the text of the credit expressly indicates
that it is subject to these rules.
The default type L/C is now irrevocable L/C. The UCP
600 have moved firmly away from revocable credits.
There is no equivalent of the old Article 6 which
expressly gave buyers the choice of applying for a
revocable credit.
Article 2 now defines a credit as any arrangement,
however named or described, that is irrevocable and
thereby constitutes a definite undertaking of the issuing
bank to honor a complying presentation. (contd)
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New Features in UCP600 vis--vis


UCP500 (contd)
As no presumption relating to the status of confirmation
exists, this important choice needs to be expressly
made in the payment clause of the sale & purchase
agreement and the L/C
It is made clear that the banks will disregard all nondocumentary requirements. The consequence is that
parties will need to exercise greater care in formulating
their documentary requirements.
For examination of documents the banks now have a
maximum of five banking days following the day of
presentation, and no longer the reasonable time not
exceeding 7 banking days
(contd)
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New Features in UCP600 vis--vis


UCP500 (contd)
Commercial Invoice must be made out in the
same currency as the L/C
The data in a document when read in context
with the credit, the document itself and
international banking practice, need not be
identical to, but must not conflict with data in
that document, any other stipulated document
or the L/C.
At least one original of each stipulated
document must be tendered unless excepted in
the L/C. Original document has been defined in
UCP 600.
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New Features in UCP600 vis--vis


UCP500 (contd)
B/L may now allow trans-shipment provided
that the entire carriage is covered by one and
same B/L. When trans-shipment is not to be
allowed, it must be expressly mentioned in the
sale/purchase contract and L/C
In case charter party BL is to be produced, it
should be mentioned in the LC
A bank will only accept clean transport
documents. (A clean document does not need
the word clean but must not have any clause
or notation expressly declaring a defective
condition of the goods or packaging).
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New Features in UCP600 vis--vis


UCP500 (contd)
A new addition is express acceptance of insurance
documents with a deductible, excess or franchise. It
remains a requirement that the insurance cover by
110% of the CIF or CIP value.
The date of the insurance must be prior to shipment or
expressly cover from a date not later than the date of
shipment.
The early payment of deferred payment undertakings
(discounting) by a nominated bank is now expressly
recognised and permitted. The Issuing bank must
reimburse the nominated bank on maturity whether or
not the nominated bank has paid. The overall effect is to
move risks of something going wrong (e.g. fraud) from
the discounting bank back to the applicant for the credit
during the deferred payment period early.
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Common Defects in Documentation


About half of all drawings contain discrepancies, like:
The L/C expires prior to presentation of documents
B/L evidences delivery prior to or after the date range
stated in L/C
Changes included in invoice not authorized in L/C
Inconsistent description of goods
Insurance document errors. A document required may
be missing
Invoice amount not equal to draft amount
Name of documents not exact as described in the
credit. Beneficiary information not exact
Invoice/statement not signed as stipulated in L/C
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Risk Situations in a L/C Transaction


General- If goods being offered for sale at a price
that is too good to be true, then it is a risky situation
Fraud- Payment may be obtained for non-existent or
worthless goods against presentation of by the
beneficiary of forged or falsified documents or credit
itself may be forged
Risks to applicant non delivery of goods, short
shipment, inferior quality, early/late shipment,
damages in transit, Failure of bank viz. issuing
bank/collecting bank
Risks to beneficiary- failure to comply with credit
conditions, failure of, or delays in payment from the
issuing bank
contd

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Risk Situations in a L/C Transaction


(contd)

Sovereign & Regulatory Risks- possibility that L/C


may be prevented by the government action out side
the control of parties
Risks to issuing bank- Insolvency of the applicant,
fraud risk, sovereign, regulatory & legal risks
Risks to advising bank- if it is a paying bank
failure to check apparent authenticity of L/C and
advising it to beneficiary
Risks to confirming bank- Once having paid the
beneficiary, it may not be able to obtain
reimbursement from the issuing bank because of
insolvency of issuing bank

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Bills for Collection (Drafts)


Drawn by exporters on importers
No letter of credit is established
The exporter draws the bill of exchange
(draft) for collection which is sent to
buyers bank via the exporters bank along
with the shipping documents
The buyers bank acts on the instructions
provided by the exporter (through their
bank) for giving these to buyers depending
the type of payment agreement
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Types of Bills for Collection


Documents against payment (DP), also
called Cash against documents (CAD)
The shipping documents are delivered to the
importer only after the payment is released
by him
In case of air freight the goods can be
consigned to the bank with their prior
approval. They will then hand over to the
importer only after receipt of payment
(contd.)

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Types of Bills for Collection


(contd.)

Documents Against Acceptance/DA


Used where a credit period (e.g.
30/60/90 days sight of documents from
the date of shipment) is agreed between
the exporter and the importer
Until the point of acceptance, exporter
retains control of goods. After
acceptance, the exporter is financially
exposed until the buyer actually initiates
payment through their bank.
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Open Account
Least secure for exporter, most
attractive to buyer. Goods are shipped
and documents are sent for payment
at the appropriate time as may be
agreed.
Exporter has little or no control over
the process

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International Methods of Payment: Collection vs. L/C


Differences

Collection

Commercial L/C

Importer must have


Bank Line of Credit

Recommended

Required

Risk to Seller

Relies on Buyers financial


strength and willingness to
pay

Relies on Issuing/Confirming
Banks financial strength and
legal obligation

Documentation

Not checked by the bank,


only counted. Buyer must
review himself or herself

Compared to letter of credit


requirements provided by
the importer and
international guidelines

Role of Banks

Acts as collection agent only

Bank substitutes its credit for


that of buyer. Pays against
conforming documents
regardless of whether Buyer
can pay

Receipt of
Merchandise

After time draft is accepted


or after payment of sight
draft by the Buyer

After time draft is accepted


or after payment of sight
draft by the Bank

Cost

Less expensive, but does


not offer same protection as
a letter of credit

More expensive but offers


greater degree of protection
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Payment Risk Ladder


Exporter:

Least
Secure

Importer:

Most
Secure

Open
Account

Less
Secure

More
Secure

Most
Secure

More
Secure

Less
Secure

Least
Secure

Bills for
Collection

Documentary
Credits

Advance
Payment

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Thank
You

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