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Methods of Payment

Dr. Anupam Varma


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

The Risks
Risks involved may be more serious than
those in domestic trade
Complete elimination of the risks
associated with international trade is
Consider your preferred option with
Hedge the risks along with appropriate
credit checks on your customers.

Determination of Method of
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.

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?

To Select Payment Terms


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?

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
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

Documentary Letters of Credit


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.


Parties to a Letter of Credit

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


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


The Process


The negotiating bank checks the documents

and if in conformity with the credit terms,
negotiates the bill and releases payment to the
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

Types of Letters of Credit

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

Types of Letters of Credit


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


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.

New Features in UCP600 vis--vis

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)

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

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.

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).

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
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.

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

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


Risk Situations in a L/C Transaction


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


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

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


Types of Bills for Collection


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.

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
Exporter has little or no control over
the process


International Methods of Payment: Collection vs. L/C



Commercial L/C

Importer must have

Bank Line of Credit



Risk to Seller

Relies on Buyers financial

strength and willingness to

Relies on Issuing/Confirming
Banks financial strength and
legal obligation


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

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


Less expensive, but does

not offer same protection as
a letter of credit

More expensive but offers

greater degree of protection

Payment Risk Ladder












Bills for