Chapter 7 Methods of International Trade Settlement and Financing Documentary Credit 1 Parties in D/C & How It Works Documents Required Sight & Usance D/C 2 Types of D/C Trade Bloc • A trade bloc is a large free trade area formed by one or more tax, tariff & trade agreements. • Typical trade pacts define such a bloc specify formal adjudication bodies, e.g. NAFTA trade panels. • It may include even a more democratic & participative system, as the EU & its parliament. • Economic blocs, generally regionally based, have been developed to promote trade between member states. • A trade bloc is established thru a trade pact/pacts covering different issues of the economic integration. Documentary letters of Credit • Definition • An undertaking of payment made by a bank(on the buyer’s/importer’s behalf) to the exporter’s bank. • Payment would normally be against presentation of sight bill, maturity of the usance bill 3 Continued • Applied by importer • Importer needs to fill in the form, submit a copy of the insurance policy (if purchase is on CIF terms), and import permit • The bank’s guarantee that they will pay the exporter in the event the importer becoming insolvent • Serves to facilitate smooth transactions in IT Mechanism Of L/C • Parties to LC – Importer – L/C issuing bank – Exporter – Notifying bank Cont’d 1. Sales contract Exporter (Beneficiary Importer (Applicant) 5. Shipping 2.Application for LC 6. Negotiation 4. Advice on For purchase Opening of LC of bill 3. Opening of LC Notifying (advising) Bank (Negotiating Bank) 7. Send BE & shipping Doc. 8. Presentation Of BE,Pmt & surrender bill Issuing (Opening) Bank (Reimbursing bank) 4 Cont’d • Steps in opening L/C 1.When sales contract is made between the exporter & importer, both sides agree to do business on an L/C basis 2.Importer requests the issuing bank to issue an L/C. Issuing bank will determine the importer’s financial standing & if acceptable, the bank will issue the L/C to the exporter. The bank may request the importer to make a deposit in order to guarantee themselves Continued 3.The issuing bank will forward the credit to its correspondent (advising) bank 4. The advising bank advises the exporter that credit has been issued in his favour 5.The exporter executes the shipment according to the conditions of the L/C 6.The exporter presents the Bill of Exchange (Draft) based on the condition of the L/C together with a full set of the shipping doc. & applies for negotiation of the doc. bill at the exporter’s bank (negotiating bank) Continued 7. The advising bank will send the doc. To the issuing bank for reimbursement. 8. The issuing bank will forward the doc. To the importer for payment. On payment the documents will be released to the importer. 5 Classification • Revocable – May be cancelled or amended by the issuing bank at any time & without prior notice to the beneficiary. • Irrevocable – Lc that can only be amended/ cancelled if all parties to the credit agrees to the alteration or cancellation Cont’d • Irrevocable confirmed credit – May be used when an exporter is concerned about the creditworthiness of the issuing bank – The advising bank on instruction of the issuing bank may also confirm the credit – Cant be modified/cancelled w/out agreement of all parties – Provides an added securiy to the exporter since it bears the guarantee of two banks Payment Provision • Sight payment With this type of letter of credit, the beneficiary will draw the draft (bill of exchange) payable at sight on a bank. • Usance payment • The beneficiary will draw the draft payable at some future point in time ( usually a specified number of day after it has been sighted) 6 Cont’d Deferred payment • No bills of exchange will be issued, only the required documents will be sent to the nominated bank for inspection. • If it is good, the documents would be retained & passed on to the issuing bank • The beneficiary would be paid at the time specified in the LC (he is paid on the deferred date) Cont’d • Payments under negotiation • The bank(negotiating) will buy the doc. That relate to a LC. • A bank gives full immediate value to the beneficiary under the credit • The negotiating bank will attend to their presentation on the drawee bank. It would be expected that the bank would pay on sight or on the agreed date, as appropriate. Types of LC • Red-clause-LC – Special type of LC which contain a clause printed in red – The issuing bank (importer bank) authorizes the negotiating bank (the exporter bank) to make advance payment to the beneficiary (exporter) prior to shipment of goods. – This allows the exporter to purchase or prepare the goods that it will export to the importer. – Normally used by parties who have established business relation ship • Standby LC – Does not provide guarantee of payment to the beneficiary – It gives guarantee to the beneficiary against default by the applicant. 7 Cont’d Revolving LC – The LC that provides an element of flexibility to an exporter – The credit can revolve either in relation to amount/ time and the terms & conditions of the LC – The amount is reinstated/renew without specific amendments to the original LC – When the has been utilized & paid either fully or partially, the credit amount in that LC is automatically restored to its original amount. Cont’d • Back-to-back LC – Two or more LC issued – Is issued by by the importer bank (LC1) in favour of a beneficiary (exporter 1) who is normally known as the primary beneficiary – The credits & value is made available to another or second beneficiary (exporter 2) Cont’d – Exporter1 who gets the BBLC will apply for another LC (LC2) and use the first LC as a security – The exporter’s bank will issue the second LC in favour of a second beneficiary (exporter 2) – Smaller value than LC1 8 Back to back LC 11.Doc. Presented & reimbursement Advising/ Issuing Bank Issuing Bank 2. Issue 1st LC (Master credit) 10.Doc. Presented & reimbursement Advising Bank 6.Issue New LC (#2) 4.Apply credit 3. Advise 1.Apply 12.Doc. Presented On LC To buyer & LC Get paid Applicant 5.Substitute BE & inv. & present For nego. Beneficiary 1 (Buyer) 8.Ship goods 7.Credit advised 9.Doc. Presented & nego. To buyer Beneficiary 2 (Supplier) Cont’d • Transferable LC – LC that gives the right to the beneficiary to instruct the advising bank to pay to a second beneficiary who is the real supplier of the goods in the transaction. – Normally used when the original beneficiary is only a middleman Transferable Credit 10.Doc. Presented & reimbursement Issuing Bank Advising/ Issuing Bank 2. Issue LC 9.Doc. Presented & reimbursement Advising Bank 5.Credit transfer 4.Substitute BE & inv. & present For nego. 1.Apply 11.Doc. Presented To buyer & LC Get paid Applicant 7.Ship goods 6.Credit advised 3. Advise On LC & instructio n to transfer Beneficiary 1 (Buyer) 8.Doc. Presented & nego. To buyer Beneficiary 2 (Supplier) 9 The Difference Between Transferable & Back to Back LC The buyer is aware that the seller is only a middleman, not the real supplier Only one LC is issued Not governed by the rules specified in the Uniform Customs & Practice for Documentary Credits The buyer is not aware that the seller is only a middleman, not the real supplier More than one LC is issued It is governed by the rules specified in the Uniform Customs & Practice for Documentary Credits Documents Against Payment D/P Terms & Documents Against Acceptance D/A • Used when traders do business without L/C terms, for instance: • Buyer can’t obtain LC from his bank because of tight regulations • Buyer resides in a country where banks do not issue LC at all • Buyer is a credible leading company • Importer’s good financial standing is very well known to the exporter Continued • Two terms of settlement through documentary collection without using LC: – Doc. Against payment (D/P) terms – Doc. Against acceptance (D/A) terms 10 Documents Against Payment (D/P) Term 6. Remit payment Collecting Bank Remitting Bank 3. Sends B/E 7. Pay exporter 4. Presents B/E for payment 2. Presents B/E for collection 5. Makes payment 1. Ships goods Exporter Importer D/P Terms 1. The exporter ships the goods w/out the documents 2. The documents (sight bill, bill of lading) are presented to the remitting bank (banker of exporter 3. Then the remitting bank will remit the doc. To its corresponding bank (collecting bank) in the importer’s country. Continued 4. The collecting bank will forward the doc. to the importer & will only release the documents once the importer makes payment. 5.The importer pays the BE 6.The collecting bank will remit the payment to the remitting bankbank notifies the negotiating bank in the exporter’s country to confirm payment from the importer 7. The remitting bank pays the exporter & the settlement is finished 11 D/A Terms • The exporter gives a grant of deferred payment to the importer • The process for D/A up to the arrival of the doc. at the reimbursing bank is similar to D/P. • When the reimbursing bank notifies the importer on the arrival of the documents, the importer checks the doc & agrees on payment (promises to pay at a later date), then the bank hands over the doc. to the importer. • Under D/A terms the BE is drawn on “Usance Bill” • Usance means the time limit for the drawee to honour the bill (30 to 180 days later after sight) Documents Against Payment (D/A) Term 6. Holds BE till maturity & remits payment when buyer pays Remitting Bank 7. Pay exporter Collecting Bank 3. Sends B/E & Doc. 2. Forward documents 4. Presents B/E for acceptance & Obtains doc. 5. Makes payment 1. Ships goods Exporter Importer 12
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