Module IV – Int’l Financial SystemSession 29-30 dtd 18.3.14

International Trade Transactions

EXPORTER(SELLER)

GOODS

IMPORTER(BUYER)

$ MONEY $

SALES/PURCHASE AGREEMENT

Sales/Purchase Agreement specifies :Buyer/seller details, Goods description, Unit price, Quantity, Amount, Quality, Shipment date, Mode of transport, Port of loading/destination, INCOTERMS etc.

Complexities

Int’l Trade ComplexitiesParties unknownGeographic distanceDifferences:

• Social• Economic• Political• Legal• Language • Customs & Culture • Marketing & Attitudes• Financial condition & Currency• Business Practices

Int’l Trade Complexities• Currency Risk• Logistics & Transit Risk• Govt. Regulations• Trade & non-trade barriers• Time duration• Buyer’s apprehension of timely & quality

delivery• Sellers apprehension of timely payment

Types of Trade Distortions & Barriers

Tariff barriers - tax on imports or exports:Customs duty, protective tariffs, revenue tariffs, surcharge, countervailing duties, specific & Ad valorem duties, sales tax, value-added tax (VAT), excise tax, turnover tax, consumption tax, anti-dumping duties.

Non-tariff barriers - restrict imports by non-tariff means: Quotas, Licenses & permits, subsidies, incentives, Govt. procurement & State Trading, Govt. procedures regarding classification, valuation & documentation procedures, health & safety regulations, packaging/labeling/marking & product testing regulations.

Distortions & Barriers to Free Trade

Why ??• Protection to local industries

• Earn revenue for Govt.

• Conserve forex

• Reduce unemployment

• Equalize domestic costs & price of imported goods

• Enhancing national security

• To favour certain or prohibit trade with certain countries

Modes of PAYMENT

in International Trade

Payment TermsMode depends on :• Nature of business/trade• Transaction amount• Buyer’s credit rating• Economic condition in importing country• Credit terms of competitors• Financial strength of exporter• Level of trust • Foreign exchange regulations

Payments Modes

1. Advance Payment2. Open Account3. Documents on Collection 4. Documentary Credit (D/C) or

Letters of Credit (L/C’s)5. Consignment Purchase/Sale

Payments Modes1. Advance Payment Payment received before delivery. Minimum risk for the exporter. Maximum risk for the importer. Exporters may loose business to competitors

offering better payment terms.

2. Open Account Delivery made by exporter Payment received after goods delivered to

importer. Maximum risk for exporter.

Payments Modes3. Documents on Collection (Documentary Collections) Exporter gives documents for collection to

the Remitting bank (exporter’s bank) which sends documents to a Collecting bank

(importer’s bank) along with instructions for payment.

Delivery & payment made simultaneously by Collecting bank either upon payment or acceptance of B/E (Bill of exchange) by importer:

D/P - Documents against Payment for “SIGHT” D/A – Documents against Acceptance for “USANCE” Bills with a credit period

Payments Modes4. Documentary/Letters of Credit (L/C’s) Importer’s bank provides payment

guarantee prior to delivery.

5. Consignment Purchase/Sale Payment is received after goods are sold. Till then, goods remain overseas with

importer or in exporters warehouse. Unsold goods returned to exporter. Minimum risk for importer. Risky & time-consuming for exporter. e.g. Used for auctions sale like tea/coffee/Art

Payments Modes – Pro’s & Con’sMode Pro’s Con’sAdvance Simple

Secure for exporterMinimal transaction cost

Highly unsecure for importer

Open Account SimpleMinimal transaction costTrustworthy association

Unsecure for exporterBuyer may defaultNo recourse to 3rd party

Documents on collection

Bank acts as intermediary Delivery of title either on:• Payment for SIGHT• Acceptance for CreditModerate transaction cost

Unsecure for exporter Buyer may defaultNo recourse to bankPrior association desired

Payments Modes – Pro’s & Con’sMode Pro’s Con’sDocumentary Credit (L/C)

Bank guarantees payment.Bank pays even if buyer defaults. Both buyer/seller protected.Recommended for first time association.

High transaction cost

Document must comply with L/C terms

Consignment- purchase

Local presence Overseas warehouse Costly & CumbersomeTime-consuming

DOCUMENTARY CREDIT (D/C) or LETTERS OF CREDIT (L/C’s)

Bank’s unconditional undertaking of payment• given on behalf of the buyer• upon presentation of documents by seller • which comply with certain conditions.

Origin in London in 1840’s. Earlier, Traveler’s Letter of credit.

Payment is exchanged for documents provided stipulated doxs. are presented and the terms & conditions of the L/C are complied with.

SALE CONTRACT (Bipartite Commercial Agreement)

SELLER BUYERSALES CONTRACT

SELLER(Beneficiary)

DOCUMENTS

$ MONEY $

Buyer’sBANK

(Issuing bank)

BUYER(Applicant)

DOCUMENTARYCREDIT

Letter of Credit (Tripartite Agreement)

ALL PARTIES DEAL WITH DOCUMENTS AND NOT WITH GOODS, SERVICES AND/OR PERFORMANCES TO WHICH THE DOCUMENTS MAY RELATE ( ICC’S UCPDC 600)

Seller’sBANK

(Advising/Nominated bank)

12

3

GOODS & DOCUMENTS

$ MONEY $

Parties to L/C’s1. APPLICANT - Buyer or importer ; opener 2. ISSUING BANK - Buyer’s bank, importing country 3. BENEFICIARY - Seller or exporter 4. ADVISING/Notifying BANK – Branch or

Correspondent Bank of the issuing bank which receives, notifies & authenticates the L/C in the exporting country

5. NOMINATED BANK - bank authorised to receive doxs and/or pay exporter in exporter’s country.

Optional :6. CONFIRMING BANK - provides guarantee in

addition to the Issuing Bank

Parties to L/C’s cont…….. Optional :

7. RE-IMBURSING BANK - a bank authorized to make the payment to the Nominated Bank (exporter’s bank). Can be a bank other than the issuing bank.

6. NEGOTIATING BANK –bank authorised to negotiate doxs./draft, generally but not always in exporter’s country.

NegotiableThe ability to be sold or transferred to another party

as a form of payment. Negotiable instruments are transferable by

endorsement and delivery. e.g. Promissory notes, Bills of exchange, Bills of

Lading and cheques are Negotiable instruments.

Types of Documentary Credit (L/C’s)1. Revocable / Irrevocable L/C2. Confirmed / unconfirmed L/C3. SIGHT / Acceptance Credit4. Transferable / non-transferable L/C

(i) amount, (ii) unit price, (iii) expiry date, (iv) shpt date, (v) last date of presentation & (vi) insurance %

4. Back-to-back L/C5. Revolving L/C – cumulative & non-cumulative6. Advance payment (Red clause L/C)7. Evergreen or Annually renewable L/CICC Publication 600 – UCPDC (Uniform Custom and Practice

for Documentary Credit) 8. Standby Letters of Credit (Bank Guarantee)International Standby Practices (ISP 98)

Payment Modes - Risk Ladder

BUYER’S PERSPECTIVE SELLER’S PERSPECTIVE

Source: Adapted from Chase Manhattan Bank, Dynamics of Trade Finance (New York: Chase Manhattan Bank, 1984),5