Seeking international growth by going global as an importer/exporter offers a multitude of opportunities, but also may have potential difficulties. Trading overseas also involves political, economic and transfer risks, in addition to the commercial and contractual risks existing in every transaction. However, the good news is that, although these risks can’t be entirely avoided, your bank can offer you different trade finance solutions to help you manage them.
Here are some of your options:
- Confirmed letter of Credit
- Documents against payment
- Documents against Acceptance
- Confirmed Standby Letter of Credit
Also called Documentary Credit, this trade finance solution is highly secured and is the most adapted when you don’t know your trade partner very well. By issuing a Letter of Credit, the importer’s bank takes on the payment risk, and also gives its client the guarantee that he will be delivered the exact product he ordered.
How does it work?
1. The seller and buyer agree on the transaction and establish a commercial contract.
3. The importer’s bank – also called the issuing bank – issues the Letter of Credit.
4. The exporter’s bank – also called the negotiating or advising bank – notifies their client.
5. The exporter sends the goods to the buyer.
6. The exporter presents the documents stipulated in the contract to their bank. Usually these documents include the commercial invoice, the bill of lading, the warehouse receipt or the order for the delivery of goods.
7. In the meantime, the buyer makes the payment to their bank.
8. The exporter’s bank transfers the documents to the importer’s bank for control.
9. The importer’s bank transfers the funds to the negotiating bank.
10. The exporter’s bank transfers the payment to the seller.
Now, if the buyer can’t pay for the transaction, their bank has to make the payment on their behalf and collect the funds from their client afterwards. This way, the seller is protected from the risk of non-payment.
- Confirmed Letter of Credit
In the context of international trade, there are two other risks that must be taken into account: the banking and political risk. The banking risk is the possibility that the importer’s bank fails to advance the funds for the payment, whereas the political risk includes any political change or instability that can disrupt trade. These risks, that are beyond the seller’s and the buyer’s control can’t be entirely avoided but can be managed if the exporter’s bank agrees to confirm the Letter of Credit. In the latter case, the seller’s bank obligates itself to pay their client. Of course, it is up to your bank to accept to confirm the Letter of Credit or not, depending on the country’s level of risk.
The Coface can help you evaluate your trade partner’s country risk with their risk assessments.
B. Documentary Collection
Also called a Documentary Remittance or Bill for Collection, this trade instrument is less secured than a Letter of Credit and is therefore the most adapted when you know your trade partner and have already established a trusted business relation with him. A Documentary Collection is a less costly option than the Letter of Credit but it still gives a certain level of security. It is also easier and faster to implement. In this case, the banks don’t undertake to pay their clients if the transaction doesn’t go as planned. Their role is limited to forwarding and releasing the documents.
How does it work?
2. The seller then sends the goods to their buyer.
3. The seller sends the documents and collection instructions to their bank – the remitting bank.
4. Here the bank kind of plays the role of a mailbox, as it will only forward the documents and instructions to the importer’s bank – the collecting bank – without controlling them.
5. The collecting bank advises the importer of the Documentary Collection and its collection obligations.
6. The importer fulfills them.
7. The importer’s bank forwards its payment or acceptance, depending on the terms, to the exporter’s bank.
8. Finally the remitting bank credits their client account.There are two different types of Documentary Collection.
- Documents against Payment
To obtain their goods from customs after the shipping, the importer needs several documents such as invoices, transport documents and property deeds. The buyer therefore has to settle the payment with their bank to get these documents. If the importer refuses or fails to pay, the exporter can recover the goods and even resell them.
- Documents against Acceptance
In this case, the buyer doesn’t have to pay at sight to take possession of the goods. He only has to accept the documents by signing bills of exchange sent by the exporter, and agree to pay the value of goods shipped within a certain period of time. The payment terms are usually after sight – for example “60 days after sight” – or set after a specific date – “at 90 days Bill of Lading date”.
C. Stand By Letter of Credit
Basically, a Stand By Letter of Credit (SBLC) is a bank guarantee in the format of a Letter of Credit. By issuing a SBLC, the importer’s bank gives the exporter the guarantee that it will pay the invoice if their client fails to. Unlike a Letter of Credit, a SBLC is a last resort, and can only be used if the buyer indeed fails to pay or can’t respect certain terms of the contract.
How does it work?
2. Before the shipment, the importer opens a request for a SBLC to their bank.
3. After controlling its terms, the importer’s bank issues the SBLC.
4. The exporter’s bank then advises their client that the SBLC has been issued.
5. The exporter sends the goods to their buyer.If the buyer fails to pay, that’s when the Stand By Letter of Credit comes into play.6. The seller requests the payment to their bank.
7. The bank sends the documents and the payment request to the importer’s bank.
8. The importer’s bank makes the payment provided all the documents are in order.
9. The advising bank then credits the seller’s account.
10. The issuing bank collects the debt from its client.
- Confirmed Stand By Letter of Credit
Under certain conditions, the exporter’s bank can offer to confirm the SBLC. In that case, the advising bank, now confirming bank, advances the funds immediately after receiving notice from the seller that the buyer failed to pay. This is the most secure type of SBLC for an exporter, as it covers the banking and political risks as well.
The best trade finance solution for you will depend on your situation – if you are an importer or exporter – but also on the level of trust between you and your trade partner. It’s also important to be aware that the trade finance solution your bank will be inclined to offer you will depend on the level of risks associated with the trade exchange in question. To decide on which trade instrument you should use, don’t hesitate to contact your bank’s Trade Finance Specialist Team.
Flore Soules
International Trade Intern
Sources
https://corporate.bankofireland.com/app/uploads/2016/03/BOI-GM-Trade-Finance-Brochure-AUG-2016.pdf
https://corporate.bankofireland.com/products-and-services/trade-finance/
http://www.investopedia.com/terms/l/letterofcredit.asp
http://www.investopedia.com/terms/b/billoflading.asp
http://www.investopedia.com/terms/c/confirmed-letter-credit.asp
http://www.coface.com/
http://www.esandis.com/uk/import_export_training/documentary_remittance.php
http://www.businessdictionary.com/definition/bill-of-exchange-BOE.html
https://www.thebalance.com/standby-letter-of-credit-315039
http://www.investopedia.com/terms/c/confirmed-letter-credit.asp
