LETTER OF CREDIT

Methods Of Payment

LETTER OF CREDIT A document from a bank guaranteeing that a seller will receive payment in full as certain delivery conditions are met.

It comes into effect when:- 1. buyer and seller dont know each other. 2. operating in different countries.

It is an important aspect of international trade.

Types of risks exposed to seller

Credit risk 1. credit default risk 2. concentration risk 3. country risk Legal risk Advantages to the Exporter:-It eliminates the credit risk.Reduces the risk of payment to be delayedReduces uncertainty Also guard against pre-shipment risksIt facilitates financing

Advantages to the Importer:-Able to ascertain that merchandise shipped It is as good as cash in advanceSome only sell a letter of creditCheaper than other alternatives

Types of letter of credit:-Revocable letter of credit

Irrevocable letter of credit 1. confirmed 2. unconfirmed

Open AccountDefinitionAn open account transaction in international trade is a sale where the goods are shipped and delivered before payment is due, which is typically in 30, 60 or 90 days.Advantageous to the importer in terms of cash flow and cost, but it is consequently a risky option for an exporterOften exporters who are reluctant to extend credit may lose a sale to their competitors. However, though open account terms will definitely enhance export competitiveness, exporters should thoroughly examine the political, economic, and commercial risks as well as cultural influences to ensure that payment will be received in full and on time.CharacteristicsApplicabilityRecommended for use (a) in low-risk trading relationships or markets and (b) in competitive markets to win customers with the use of one or more appropriate trade finance techniquesRiskSubstantial risk to the exporter because the buyer could default on payment obligation after shipment of the goodsProsBoost competitiveness in the global market andhelp establish and maintain a successful trade relationship

ConsSignificant exposure to the risk of non-payment andAdditional costs associated with risk mitigation measures

Mitigation Of riskExport Working Capital FinancingGovernment-Guaranteed Export Working Capital ProgramsExport Credit InsuranceExport Factoring

Cash-In-Advance

DefinitionWith the cash-in-advance payment method, the exporter can eliminate credit risk or the risk of non-payment since payment is received prior to the transfer of ownership of the goods.Wire transfers and credit cards are the most commonly used cash-in-advance options available to exporters.It is the least attractive option for the buyer, because it tends to create cash-flow problems, and it often is not a competitive option for the exporter especially when the buyer has other vendors to choose from.Characteristics ApplicabilityRecommended for use in high-risk trade relationships or export markets, and appropriate for small export transactionsRiskExporter is exposed to virtually no risk as the burden of risk is placed almost completely on the importerProsPayment before shipment and eliminates risk of non-payment

ConsMay lose customers to competitors over payment terms and no additional earnings through financing operations

Types of Cash in AdvanceWire Transfer: Most Secure and Preferred Cash-in-Advance MethodCredit Card: A Viable Cash-in-Advance MethodEscrow Service: A Mutually Beneficial Cash-in-Advance MethodPayment by Check: A Less-Attractive Cash-in-Advance Method

Bank Guarantee

Standby Letters of Credit (SBLCs) or Bank Guarantees

SBLCs are similar to Bank Guarantees, in that they sit behind a transaction and are only called upon if the buyer fails to pay in the normal course of business (which is often Open Account).They can be particularly useful to cover an underlying financial risk where multiple payments are to be made, possibly as part of an agreed schedule. However, they do not offer the documentary control of Letters of Credit to buyers and, as such they are an unconditional guarantee.

More secure for an exporter than Open Account trading, as the exporters documentation is sent from a Canadian bank to the buyers bank. This invariably occurs after shipment and contains specific instructions that must be obeyed. Should the buyer fail to comply, the exporter does, in certain circumstances, retain title to the goods, which may be recoverable. The buyers bank will act on instructions provided by the exporter, via their own bank, and often provides a useful communication route through which disputes are resolved.There are two types of Bill for Collection, which are usually determined by the payment terms agreed within a commercial contract. Different benefits are afforded by each and they are covered separately:

17Bills of Exchange

Bills for Collection Collection is one of the conventional methods of payment in international tradewhereby the seller forwards financial and/or commercial documents to the buyer against cash payment or acceptance of a bill of exchange. The Bills for Collection process is governed by a set of rules, published by the International Chamber of Commerce (ICC) called Uniform Rules for Collections document number 522 (URC522). Over 90% of the worlds banks adhere to this document Bills for Collection are used in certain markets (particularly Asian) to fulfill Exchange Control Regulations. They are a cost-effective method of evidencing a transaction for buyers, where documents are handled (and reported) via the banking system.

More secure for an exporter than Open Account trading, as the exporters documentation is sent from a Canadian bank to the buyers bank. This invariably occurs after shipment and contains specific instructions that must be obeyed. Should the buyer fail to comply, the exporter does, in certain circumstances, retain title to the goods, which may be recoverable. The buyers bank will act on instructions provided by the exporter, via their own bank, and often provides a useful communication route through which disputes are resolved.There are two types of Bill for Collection, which are usually determined by the payment terms agreed within a commercial contract. Different benefits are afforded by each and they are covered separately:

19Documents against Payment (D/P)

Usually used where payment is expected from the buyer immediately, otherwise known as at sight. This process is often referred to as Cash against Documents.

The buyers bank is instructed to release the exporters goods only when payment has been made. Where goods have been shipped by sea freight, covered by a full set of Bills of Lading, title is retained by the exporter until these documents are properly released to the buyer. Unfortunately, for airfreight items, unless the goods are consigned to the buyers bank* no such control is available under an Air Waybill or Air Consignment Note, as these documents are merely movement certificates rather than documents of title. Similarly there is no such control available for road or rail transport.

Under URC522, goods should not be consigned to a bank without prior approval.

20Documents against Acceptance (D/A) Used where a credit period (e.g. 30/60/90 days - 'sight of document' or from 'date of shipment') has been agreed between the exporter and buyer. The buyer is able to collect the documents against their undertaking to pay on an agreed date in the future, rather than immediate payment. The exporter's documents are usually accompanied by a "Draft" or "Bill of Exchange" which looks something like a cheque, but is payable by (drawn on) the buyer. When a buyer (drawee) agrees to pay on a certain date, they sign (accept) the draft. It is against this acceptance that documents are released to the buyer. Up until the point of acceptance, the exporter may retain control of the goods, as in the D/P scenario above. However, after acceptance, the exporter is financially exposed until the buyer actually initiates payment through their bank.Process

Promissory Note

Promissory Notes Apromissory noteis alegal instrument(more particularly, afinancial instrument), in which one party (themakerorissuer) promises in writing to pay a determinate sum ofmoneyto the other (thepayee), either at a fixed or determinable future time or on demand of the payee, under specific terms. If the promissory note is unconditional and readily salable, it is called a negotiable instrument. Referred to as anote payableinaccounting(as distinguished fromaccounts payable), or commonly as just a "note", it is internationally defined by theConvention providing a uniform law for bills of exchange and promissory notes, although regional variations exist.Bank noteis frequently referred to as a promissory note: a promissory note made by a bank and payable to bearer on demand.Mortgage notes are another prominent example

Buyers and Sellers CREDITBuyers credit is a loan facility extended to an importer by a bank or financial institution to finance the purchase of capital goods or services. This facility involves a bank that can extend credit to the importer, as well as an export finance agency based in the exporter's country that guarantees the loan. Since buyers credit involves multiple parties and cross-border legalities, it is generally only available for large export orders.Seller financing is a loan provided by the seller of a property or business to the purchaser. Usually, the purchaser will make some sort of down payment to the seller, and then make installment payments over a specified time, at an agreed-upon interest rate, until the loan is fully repaid. In layman's terms, this is when the seller in a transaction offers the buyer a loan rather than the buyer obtaining one from a bank. To a seller, this is an investment in which the return is guaranteed only by the buyer's credit-worthiness or ability and motivation to pay the mortgage. For a buyer it is often beneficial, because he/she may not be able to obtain a loan from a bank. In general, the loan is secured by the property being sold. In the event that the buyer defaults, the property is repossessed or foreclosed on exactly as it would be by a bank.There are no universal requirements mandated for seller financing. In order to protect both the buyer's and seller's interests, a legally binding purchase agreement should be drawn up with the assistance of an attorney and then signed by both parties.

Benefits

The exporter gets paid on due date; whereas importer gets extended date for making an import payment as per the cash flowsThe importer can use this financing for any form of trade; open account, collections, or LCs.The currency of imports can be different from the funding currency, which enables importers to take a favourable view of a particular currency.They can negotiate interest rate, repayment schedule, and other conditions of the loan.The borrower does not have to qualify with a loan underwriter.The seller can receive a higher yield on his/her investment by receiving equity with interest.The seller could negotiate a higher interest rate.The seller could choose which security documents (mortgage, deed of trust, land sales document, etc.) to best secure his/her interest until the loan is paid.It helps importer in working capital management.DrawbacksThe buyer might not have the protection of a home inspection, mortgage insurance, or an appraisal to ensure that he/she is not paying too much for the property.The seller might not get the buyers full credit or employment picture, which could make foreclosure more likely.Depending upon the security instrument that was used, foreclosure could take up to a year.The seller could agree to a small down payment from the buyer to assist in the sale, only to have the buyer abandon the property because of the minimal investment that was at stake.

Buyers Credit Process flowThe customer will import the goods either under LC, collections or open accountThe customer requests the Buyer's Credit Arranger to arrange the credit before the due date of the billArrange to request overseas bank branches to provide a buyer's credit offer letter in the name of the importer. Best rate of interest is quoted to the importerOverseas bank to fund Importer's bank for the required amountImporter's bank to make import bill payment by utilizing the amount credited Importer's bank will recover the required amount from the importer and remit the same to overseas bank on due date.

30Cost Involved Interest cost:This is charged by overseas bank as a financing cost. Letter of Comfort / Undertaking:Your existing bank would chargethis cost for issuing letter of comfort / Undertaking Arrangement fee:Charged by Buyers Credit Agents / Brokers how is arranging buyers credit for you. Other charges: Intermediary bank charges,etc. Withholding Tax(WHT):The customer has to pay WHT on the interest amount remitted overseas to the Indian tax authorities. (The WHT is not applicable where Indian banks arrange for buyers credit through their offshore offices.)31