UNIT 6

FINANCING INTERNATIONAL TRADE

What are some of the risks involved in trading
internationally?

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Suggested answer

 Risk of not being paid (for the exporter)

 Risk of not receiving goods (for the
importer)
 Risk of receiving goods which are
different from those ordered or of lower
quality or in a damaged condition
 Risk of force majeure (Eg: storms,
disasters etc.)

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What payment methods do you know that are used
when exporting or importing goods?

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Suggested answer

 Open account
 Document credit
 Bills for collection
 Advance payment

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What is the role of the banks in
international trade?

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Suggested answer

 Active role: When the Banks get involved

in the payment process, supporting both
the exporter and the importer to
complete their obligations so that the
contract is carried out as agreed. For
example, in the documentary credit
method of payment.

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Suggested
answers
 Passive role: When the banks only do
things as requested. For example, just
transferring money to the account of the
seller/exporter.

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 Open account
 Documentary letter of credit
 Bills for collection
 Advance payment

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• Seller desires to get the payment before making delivery
• Buyer desires to get the goods before making payment
Open account
Open account means the exporter ships the goods to the buyer and just
waits till a fixed date as agreed in their contract for payment from the
buyer. Normally, the exporter only accepts open account method of
payment if he has known the buyer quite well and they have
established a long-term and trustworthy business relationship.

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Open account

 Is only used for transactions

between exporters and importers
which have already established a
trust-worthy and long-term
business relation.
 Saving time for both exporter and
importer as they deal directly with
each other – not much
involvement of banks.

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Open account
• Open account with bank guarantee
• Open account with export credit insurance

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Open account with security

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 Documentary Letter of
credit
• A document issued by a bank, whereby the bank
replaces the buyer as the paying party. The exporter is
basing his risk of getting paid on the bank rather than on
the importer. The bank will have to be reimbursed by the
importer.
LETTER OF CREDIT (cont.)
• Parties in the letter of credit:
• Applicant: The buyer – open the letter of credit;
• Beneficiary: The seller – present documents and receive payment;
• Issuing/Opening bank: The bank that the buyer asks to open a
letter of credit (open/issue L/C as the buyer’s request);
• Advising bank: The bank notifying the exporter that the letter of
credit has been opened (advice L/C to the beneficiary);
• Confirming bank: Commit to pay beneficiary and bear the risk of
issuing bank;

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• Sight draft: A draft that has been drawn to be payable at the time of
presenting the document
• Usance draft (Time draft / Term draft): A draft that has been drawn to
be payable after a specific number of days.
• Banker’s acceptance: A usance draft drawn on a bank that stamp
ACCEPTED across the face, thereby making it a prime obligation of
that bank to pay. It is used to finance specified short-term, self-
liquidating transaction, including foreign trade.

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 LETTER OF CREDIT
Documents required under a typical letter of credit:
• Commercial Invoice: Must be made out to the applicant for the letter of credit. The
amount shown on the invoice should not be more than the amount permitted by the
letter of credit; if it is, the bank may refuse to accept the invoice.
• Transport documents:
• Sea transport – full set marine bill of lading;
• Air transport – air waybill;
• Rail transport – railway consignment note;
• Road transport – road consignment note;
• Combined transport – combined transport bill of lading.
• Insurance document: If shipment is made on CIF or CIP terms, the letter of credit will
call for an insurance Policy/certificate.
• Other documents: Certificate of origin, Certificate of Inspection, Packing list, Weight
list. 20
LETTER OF CREDIT (cont.)
• The principles of letter of credit: Autonomy and Strict Compliance.
• Autonomy means that the L/C entirely separates from the contract
for the sale of goods. This means the bank is obliged to pay –
whatever the dispute between the buyer and the exporter.
• Strict Compliance means that the exporter must present to the
bank shipping documents that comply in all respects with the
terms of the credit. Small deviations will result in refusal by the
bank to pay.
• If the credit requires documents that the exporter cannot furnish or if
compliance is impossible for some other reason, then the letter of
credit must be amended – a process that requires the cooperation of
the buyer. 21
Irrevocable LC
• A letter of credit that cannot be canceled nor
amended without agreement of all parties
Revocable LC
• A letter of credit that may be canceled at any
moment without prior notice to the beneficiary
Sight Letter of Credit

• If payment is to be made at the time of presenting the document then

it is referred as the Sight Letter of Credit. In this case banks are
allowed to take the necessary time required to check the documents.

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Usance Letter of Credit

• If payment is to be made after the lapse of a particular time period as

stated in the usance draft then it is referred as the Time Letter of
Credit.

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Deferred payment LC
• A letter of credit under which the documents are
forwarded to the importer’s bank, while sight draft is
presented at a latter future date
Usance LC vs Deferred payment LC

Usance LC Deferred payment LC

• Usance draft
• Sight draft
• “ACCEPTED” - Banker’s
acceptance: liquidity/ negotiable • - maturity
document

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• Draw an usance draft on the bank

• Draw an usance draft on the bank at the same time the seller
presents the shipping doc. to the bank --- the bank accepts to pay
an usance draft at maturity (stamp ACCEPTED across the face of an
usance draft) -- Banker’s acceptance---- liquidity

• Draw a sight draft on the bank at the late payment time period
elapsed -- get payment
Red clause LC

• A letter of credit permitting the beneficiary to receive

a sum prior to shipment
Transferable LC
• A letter of credit that can be utilized by someone
designated by the original beneficiary
Revolving LC
• A letter of credit calling for renewed credit to be
made available when the issuing bank informs the
beneficiary that the buyer has reimbursed the issuing
bank for the drafts already drawn
Back to back LC
• Two letter of credits with identical documentary
requirements, except for the difference in the price
as shown by the invoice and draft
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Traveler LC
• A letter of credit issued by a bank, addressed to all its
correspondents, permitting the bearer to draw drafts
up to the total amount named in the letter
Standby LC
• A letter of credit that can be drawn against, but only
if another business transaction is not performed
Bid or performance bond
• A financial guarantee, given by a contracting
company, which states that it has the capability to
start and satisfactorily complete the project
Advised LC
• A letter of credit issued by a bank and forwarded to
the beneficiary by a second bank in his area. The
second bank validates the signatures and attests to
the legitimacy of the first bank
Confirmed LC
• A letter of credit issued by one bank to which a
second bank adds its commitment to pay
Documentary
credit
 Being used worldwide
 Safer for exporter as it makes sure
he will get his money for the goods
sold provided that he presents the
correct documents
 Ensure the importer that he will get
the goods bought as long as he pays
for them or agreed to pay in a fixed
date in the future.
 Greatly supportive involvement of
banks in the transaction process.
 Taking more time than other
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methods of payment
Look at the 2 diagrams below to
explain how a letter of credit works

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1. The applicant (the buyer) completes a contract with the seller.
2. The buyer fills in a letter of credit application form and sends it to his
or her bank for approval.
3. The issuing bank (the buyer’s bank) approves the application and
sends the letter of credit details to the seller’s bank (the advising
bank).
4. The advising bank authenticates the letter of credit and sends the
beneficiary (the seller) the details. The seller examines the details of
the letter of credit to make sure that he or she can meet all the
conditions. If necessary, he or she contacts the buyer and asks for
amendments to be made.

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5. When the seller (beneficiary) is satisfied with the conditions of
the letter of credit, he or she ships the goods.
6. The seller presents the documents to his or her bankers (the
advising bank). The advising bank examines these documents
against the details of the letter of credit and the International
Chamber of Commerce rules.
7. If the documents are in order, the advising bank
sends them to the issuing bank for payment or acceptance. If
the details are not correct, the advising bank tells the seller and
waits for corrected documents or further instructions.

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8. The issuing bank (the buyer’s bank) examines the documents from
the advising bank. If they are in order, the bank releases the
documents to the buyer, pays the money promised or agrees to
pay it in the future, and advises the buyer about the payment. (If
the details are not correct, the issuing bank contacts the buyer for
authorization to pay or accept the documents.) The buyer collects
the goods.
9. The issuing bank advises the advising (or confirming) bank that the
payment has been made.
10. The advising/confirming bank pays the seller and notifies him or
her that the payment has been made.

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Bills for collection
 Clean collection: more risky as the
importer can use the documents of
the title to receive the goods only
by agreeing to pay in a fixed date
in the future
 Documentary collection: safer as
the importer has to pay in return
of the documents of title to receive
the goods after all.
 More passive roles of the banks.
They only do what is required.
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• Documents Against Payment D/P
• In this case documents are released to the importer only when the
payment has been done.
• Documents Against Acceptance D/A
• In this case documents are released to the importer only against
acceptance of a draft.

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The procedure for
documentary collection
• [Link] first step the exporter takes is to ask his bank to ………….. a bill
of exchange on the overseas buyer.
• 2. The exporter’s bank ………………. the bill of exchange, together with
the commercial documents, to the importer’s bank.
• 3. At the same time, the exporter…………………. the goods.
• 4. The exporter must take care to ………………….the correct documents
to the bank.
• 5. When the importer……the bill of exchange, the bank
will………….the documents of title to the goods.
• 6. If the importer…………………..the bill, the exporter may have to find
an alternative buyer or ship the goods back again.
• 7. In some parts of the world, banks may be slow to ……………..
payment to the exporter’s bank.

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Advance payment
 Safest for the exporter if the
importer has to fully pay for the
good bought in advance
 Still safe if the importer pays in
part in advance
 Time saving
 Being used if there is more
demand than supply for that kind
of commodity.

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Losing Prepayment=>Prepayment guarantee
This guarantee promises the buyer that the bank will return advance payments if
the exporter fails to make delivery. The guarantee is often for 100% of the
prepayment.
Conclusions about each
method of payment
mentioned above.

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Importer
• The most secured method of payment – the least secured method of
payment
- Open account
- Bill for collection
- LC
- Advanced payment

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Exporter
• The most least secured method of payment – the most secured
method of payment
- Open account
- Bill for collection
- LC
- Advanced payment

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