UNIT 4

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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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.
• 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 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.

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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;
• Paying bank;
• Accepting bank;
• Negotiating bank.

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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.

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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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Time Letter of Credit

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

as stated in the time 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
Time LC vs Deferred payment LC

Time LC Deferred payment LC

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

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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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• Shield the name of the buyer

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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 methods of
payment

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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
• 1.The 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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Conclusions about each method of
payment mentioned above.

Open account
Documentary letter of credit
Bills for collection
Advance payment

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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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