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METHODS OF PAYMENT IN INTERNATIONAL TRADE/EXPORT AND IMPORT FINANCEInternational Business Management

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WORLD BANK The World Bank is an international financial institution

that provides loans to developing countries for capital programs

The World Bank's official goal is the reduction of poverty. According to the World Bank's Articles of Agreement (as

amended effective 16 February 1989), all of its decisions must be guided by a commitment to promote foreign investment, international trade, and facilitate capital investment

The World Bank comprises two institutions: The

International Bank for Reconstruction and Development (IBRD) lends to governments of middle-income and creditworthy low-income countries.

The International Development Association (IDA) provides interest-free loans—called credits— and grants to governments of the poorest countries.

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EXPORT AND IMPORT FINANCE METHODS Accounts Receivable Financing

An exporter that needs funds immediately may obtain a bank loan that is secured by an assignment of the account receivable

Factoring (Cross-Border Factoring) The accounts receivable are sold to a third party (the factor), that then assumes

all the responsibilities and exposure associated with collecting from the buyer. Letters of Credit (L/C)

These are issued by a bank on behalf of the importer promising to pay the exporter upon presentation of the shipping documents.

The importer pays the issuing bank the amount of the L/C plus associated fees. Commercial or import/export L/Cs are usually irrevocable. The required documents typically include a draft (sight or time), a

commercial invoice, and a bill of lading (receipt for shipment). Sometimes, the exporter may request that a local bank confirm (guarantee) the

L/C. Variations include

standby L/Cs : funded only if the buyer does not pay the seller as agreed upon transferable L/Cs : the first beneficiary can transfer all or part of the original L/C to a third

party assignments of proceeds under an L/C : the original beneficiary assigns the proceeds to

the end supplier

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EXPORT AND IMPORT FINANCE METHODS

Banker’s Acceptance (BA) This is a time draft that is drawn on and accepted by a bank

(the importer’s bank). The accepting bank is obliged to pay the holder of the draft at maturity.

If the exporter does not want to wait for payment, it can request that the BA be sold in the money market. Trade financing is provided by the holder of the BA.

The bank accepting the drafts charges an all-in-rate (interest rate) that consists of the discount rate plus the acceptance commission.

In general, all-in-rates are lower than bank loan rates. They usually fall between the rates of short-term Treasury bills and commercial papers.

Working Capital Financing Banks may provide short-term loans that finance the

working capital cycle, from the purchase of inventory until the eventual conversion to cash.

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EXPORT AND IMPORT FINANCE METHODS

Medium-Term Capital Goods Financing (Forfaiting) The importer issues a promissory note to the exporter

to pay for its imported capital goods over a period that generally ranges from three to seven years.

The exporter then sells the note, without recourse, to a bank (the forfaiting bank).

Countertrade These are foreign trade transactions in which the sale

of goods to one country is linked to the purchase or exchange of goods from that same country.

Common countertrade types include barter, compensation (product buy-back), and counterpurchase.

The primary participants are governments and multinationals.

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METHODS OF PAYMENT IN INTERNATIONAL TRADE To succeed in today’s global marketplace and win sales

against International trade presents a spectrum of risk, which causes uncertainty over the timing of payments between the exporter (seller) and importer (foreign buyer).

For exporters, any sale is a gift until payment is received. Therefore, exporters want to receive payment as soon as

possible, preferably as soon as an order is placed or before the goods are sent to the importer.

For importers, any payment is a donation until the goods are received.

Therefore, importers want to receive the goods as soon as possible but to delay payment as long as possible, preferably until after the goods are resold to generate enough income to pay the exporter.

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METHODS OF PAYMENT IN INTERNATIONAL TRADE : CASH IN ADVANCE / PREPAYMENTS With cash-in-advance payment terms, the exporter

can avoid credit risk because payment is received before the ownership of the goods is transferred.

Wire transfers and credit cards are the most commonly used cash-in-advance options available to exporters.

However, requiring payment in advance is the least attractive option for the buyer, because it creates cash-flow problems. Foreign buyers are also concerned that the goods may not be sent if payment is made in advance.

Thus, exporters who insist on this payment method as their sole manner of doing business may lose to competitors who offer more attractive payment terms.

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METHODS OF PAYMENT IN INTERNATIONAL TRADE:

LETTERS OF CREDIT Letters of credit (LCs) are one of the most secure

instruments available to international traders. An LC is a commitment by a bank on behalf of the

buyer that payment will be made to the exporter, provided that the terms and conditions stated in the LC have been met, as verified through the presentation of all required documents.

The buyer pays his or her bank to render this service. An LC is useful when reliable credit information about a

foreign buyer is difficult to obtain, but the exporter is satisfied with the creditworthiness of the buyer’s foreign bank.

An LC also protects the buyer because no payment obligation arises until the goods have been shipped or delivered as promised.

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f.METHODS OF PAYMENT IN INTERNATIONAL TRADE:

DOCUMENTARY COLLECTIONS/DRAFTS/BILLS OF EXCHANGE)

A documentary collection (D/C) is a transaction whereby the exporter entrusts the collection of a payment to the remitting bank (exporter’s bank), which sends documents to a collecting bank (importer’s bank), along with instructions for payment.

Funds are received from the importer and remitted to the exporter through the banks involved in the collection in exchange for those documents.

D/Cs involve using a draft that requires the importer to pay the face amount either at sight (document against payment) or on a specified date (document against acceptance).

The draft gives instructions that specify the documents required for the transfer of title to the goods. Although banks do act as facilitators for their clients, D/Cs offer no verification process and limited recourse in the event of non-payment.

Drafts are generally less expensive than LCs.

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METHODS OF PAYMENT IN INTERNATIONAL TRADE:

OPEN ACCOUNT An open account transaction is a sale where the goods are

shipped and delivered before payment is due, which is usually in 30 to 90 days.

Obviously, this option is the most advantageous option to the importer in terms of cash flow and cost, but it is consequently the highest risk option for an exporter.

Because of intense competition in export markets, foreign buyers often press exporters for open account terms since the extension of credit by the seller to the buyer is more common abroad. Therefore, exporters who are reluctant to extend credit may lose a sale to their competitors.

However, the exporter can offer competitive open account terms while substantially mitigating the risk of non-payment by using of one or more of the appropriate trade finance techniques, such as export credit insurance.

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COMPARISON

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COMPARISONCash in Advance Letter of Credit DC/BoE Open

Account

Time of Payment

Before Shipment

When shipment is made

On presentation of draft

As agreed upon

Goods available to buyers

After payment After payment After payment Before

payment

Risk to exporter None Very little - None Disposal of

unpaid goods

Relies on buyer to pay as agreed upon

Risk to importer

Relies on exporter to ship goods as ordered

Assured shipment but relies on exporter to ship goods as described in the documents

Relies on exporter to ship goods as described in the documents

None

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LETTER OF CREDIT: PROCEDURE

Buyer (Importer)

Seller (Exporter)

Exporter’s bank (Advising

Bank)

Importer’s bank (Issuing

Bank)

1. Sale Contract

3. Send Credit

4. Deliver Letter of Credit

2. Request for Credit

5. Deliver Goods

7. Present Documents

6. Present Documents

8. Documents and claim for payments

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TYPES OF LETTER OF CREDIT Irrevocable and revocable letters of credit

A revocable letter of credit can be changed or cancelled by the bank that issued it at any time and for any reason.

An irrevocable letter of credit cannot be changed or cancelled unless everyone involved agrees. Irrevocable letters of credit provide more security than revocable ones.

Confirmed and unconfirmed/Advised letters of credit When a buyer arranges a letter of credit they usually do so with their

own bank, known as the issuing bank. The seller will usually want a bank in their country to check that the letter of credit is valid.

For extra security, the seller may require the letter of credit to be 'confirmed' by the bank that checks it. By confirming the letter of credit, the second bank agrees to guarantee payment even if the issuing bank fails to make it. So a confirmed letter of credit provides more security than an unconfirmed one.

In case of unconfirmed LC, the advising bank forwards an unconfirmed letter of credit directly to the exporter without adding its own undertaking to make payment or accept responsibility for payment at a future date, but confirming its authenticity.

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TYPES OF LETTER OF CREDIT Transferable letters of credit

A transferable letter of credit can be passed from one 'beneficiary' (person receiving payment) to others. They're commonly used when intermediaries are involved in a transaction.

Stand-by LC A standby letter of credit is like a guarantee that is

used as support where an alternative, less secure, method of payment has been agreed.

It is an assurance from a bank that a buyer is able to pay a seller. The seller doesn't expect to have to draw on the letter of credit to get paid.

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TYPES OF LETTER OF CREDIT Revolving LC

The revolving credit is used for regular shipments of the same commodity to the same importer. It can revolve in relation to time or value. If the credit is time revolving once utilised it is re-instated for further regular shipments until the credit is fully drawn. If the credit revolves in relation to value once utilised and paid the value can be reinstated for further drawings.

Revolving letters of credit are useful to avoid the need for repetitious arrangements for opening or amending letters of credit.

Back to Back LC A back-to-back letter of credit can be used as an alternative to the

transferable letter of credit. Rather than transferring the original letter of credit to the supplier, once the letter of credit is received by the exporter from the opening bank, that letter of credit is used as security to establish a second letter of credit drawn on the exporter in favour of his importer.

Many banks are reluctant to issue back-to-back letters of credit due to the level of risk to which they are exposed, whereas a transferable credit will not expose them to higher risk than under the original credit.

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POSSIBLE QUESTIONS Explain all the modes of payment used in international

business. Discuss various types of L/Cs. Write short notes on:

Balance of payment vs. balance of trade Asian Development Bank Balance of payment Types of Letter of Credit

Explain the role played by ‘International Monetary Fund’, ‘Asian Development Bank’ and World Bank in promotion of International Trade

Explain the functions of International Monetary Fund. What are various methods of payment in International

Trade? Discuss the role of World Bank in International Financial

Management.

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Thank You