“International Finance and Payments” Lecture VII “International Payments” Lect. Cristian PĂUN Email: [email protected] [email protected]@ase.ro URL:

“International Finance and Payments”

Lecture VII

“International Payments”

Lect. Cristian PĂUNLect. Cristian PĂUN

Email: Email: [email protected]

URL: http://www.finint.ase.roURL: http://www.finint.ase.ro

Academy of Economic Studies

Faculty of International Business and Economics

Lecture 6: International FX Markets 2

International FX Markets - review

• FX Markets is the place where we can buy or sell different currencies;

• FX Rates;

• Convertibility of a currency;

• FX Regimes;

• Depreciation vs Appreciation of a currency;

• Direct Quote vs Indirect Quote

• FX Rate Determinants;

• Fisher Relationships;

• FX Transactions: Spot Transactions vs Forward Transactions


International payments

• Commercial banks play a fundamental role;

• More complex than local payments;

• Higher risks require specific money transfer procedures;

• In international payments are used:

• Non – cash payments (barter, compensation, clearing, buy

– back)

• Cash payments

• Payment instruments

• Payment techniques.


International Payments Methods

I. Cash in advance

II. Consignment

III. Open Account Payments

IV. Bank Drafts:

- bill of exchange (sight and time drafts)

- checks

- money orders

- promissory note

V. Letter of Credit

VI. Documentary collection

• Documents against payments

• Documents against acceptance


I. Cash in advance

• The goods will not be shipped until the buyer has paid the seller.

• Time of payment : Before shipment

• Goods available to buyers : After payment

• Risk to exporter : None (maximum security for the seller)

• Risk to importer : Relies completely on exporter to ship goods as

ordered

• Used for: small amounts, new customers, one-time sales

Exporter

Goods


II. Consignment

• The exporter retains actual title to the goods that are shipped to the

importer.• Time of payment : At time of sale to third party• Goods available to buyers : Before payment• Risk to exporter : Allows importer to sell inventory before paying exporter• Risk to importer : None

Exporter (consigner)

Importer (consignee)

Delivering of goods (1)

Clients (third part)

Selling of goods (2)Payment in the local currency (3)

Payment of Import at a

specific date (4)


III. Open Account Payments

1. In an open account trade arrangement, the goods are shipped to a buyer without

guarantee of payment.

2. The credit terms are arranged between the importer and the exporter.

3. These are usually afforded to longstanding partners, or to foreign affiliates

where payment is reasonably assumed

4. Quite often, the buyer does not pay on the agreed time.

3. Unless the buyer's integrity is unquestionable, this trade arrangement is risky to

the seller.

4. Time of payment : As agreed upon

5. Goods available to buyers : Before payment

6. Risk to exporter : Relies completely on buyer to pay account as agreed upon

7. Risk to importer : None

Exporter Importer

Payment on the agreed time (2)

Delivery of goods (1)


IV. Bank Drafts: Check

Check = an order given to a bank in order to pay a specific amount to a person from the company current account.

Exporter

Exporter bank Importer bank

Importer

Cash deposit (1)Cheque remittance (2)

Delivery (3)

Payment (4)

Presenting the cheque for

payment (5)

Money transfer (6)

Payment (7)

Risk vs Simplicity


Problems with the payments by checks

Risk of non-payment for lack of funds (the cheque is uncovered);

Banks usually place a hold on funds for 3-4 weeks from deposit date

May be post-dated Must ensure cheque is properly filled out Used for: small payments or well-known clients.


Check - example

Check Issuing Date at Issuing Place

This check is to be

Paid to the Order of Exporter € Value

Value Euros

by the:

Importer Bank

Importer Bank Address

____Importer Signature____


Bank Drafts: Money Orders

beneficiary stipulates the account to which funds will be paid cannot place conditions on payment, so cannot require proof of

delivery of goods therefore, must exist high level of trust between the parties to

use this method

Delivery (1)Importer

Importer Bank

Exporter)

Exporter Bank

Presenting the documents (4)

Payment (5)

Money transfer (3)

Money Order = is an order given by a person to its bank in order to pay a specific amount directly in the beneficiary’s account.


Bank Drafts: Bill of Exchange Bill of Exchange = unconditional order in writing to pay a specified amount of money to a specified person or to the bearer, upon presentation of the bill or at a specified future date

BE Bearer

Beneficiary

Debtor

BE Remittance (1)

BE Acceptance (2)

BE Remittance (3)

Presenting BE for payment

(4)

Payment at the BE’s maturity (5)

may be endorsed and passed on to another, or just passed on if to the bearer


Bill of Exchange - sight drafts (documents against payment)

Time of payment : On presentation of draft Goods available to buyers : After payment Risk to exporter : Disposal of unpaid goods Risk to importer : Relies on exporter to ship goods as described in

documents

Sight drafts (documents against payment) : When the shipment has been made, the draft is presented to the buyer for payment. (THE DRAFT ACCEPTANCE IS BEFORE THE DELIVERY OF GOODS)

BE Bearer (Exporter)

Beneficiary (Exporter)

Importer

BE Remittance (1)

BE Acceptance (2)

BE Remittance (3)

Presenting BE for payment

when exporter delivers the

goods (4)



Bill of Exchange - time drafts (documents against acceptance)

BE Bearer (Exporter)

Beneficiary (Exporter)

ImporterBE Acceptance (2)

BE Remittance (3)

Presenting BE for payment at a

specified maturity (4)


Time of payment : On maturity of draft Goods available to buyers : Before payment Risk to exporter : Relies on buyer to pay Risk to importer : Relies on exporter to ship goods as described in

documents

Time drafts (documents against acceptance) : When the shipment has been made, the buyer accepts (signs) the presented draft. (THE DRAFT ACCEPTANCE IS IN THE MOMENT OF THE DELIVERY OF GOODS.)

BE Remittance (1)


Bill of Exchange - example

BILL OF EXCHANGE

Issuing Data US$: BE Value On Payment Data, for value received, pay against this only set of bill of exchange to the order of Exporter the sum of BE Value Dollars of the United States of America and BE Value cents, effective payment to be made in Dollars of United States of America only, without deduction for and free of any taxes, impost, levies or duties present or future of any nature under the laws of Importer’s Country or any political subdivision thereof or therein. This bill of exchange is payable at Importer’s Place Drawn on: Exporter: Importer’s Name Exporter’s Name

Accepted: Importer’s Signature

Per aval for account of Importer’s Name Aval Bank (Full name and Address


Bank Drafts: Promissory Notes Promissory note is a written promise to pay a determinate sum of money made between two parties.

• Maker: The issuer of a promissory note (the importer)• Payee: The person to whom the note is to be paid (the exporter)• Difference Between a Promissory Note and a Bill of Exchange: The maker of a note promises to personally pay the payee rather than ordering a third party to do so


Promissory Notes - Example

Nov. 2, 2004 $ 10,000

New York, New York

Ninety days after the above date for value received, the under-

signed jointly and severally promise(s) to pay to the order of: BANK OF THE RIVER, at

100 Hudson Ave., New York, New York 02167

Ten Thousand and oo/100 DOLLARS

With interest from the date above at the rate of -11- percent per annum (computed on

the basis of actual days and a year of 360 days) payable at maturity

Officer: Jones

No: 990-11-9999 Importer’s Signature


V. Letter of Credit - definition

A letter addressed to a beneficiary (exporter) by a bank (issuing bank)

• wherein the bank undertakes, on behalf of an applicant (importer)

• to effect payment to the beneficiary for merchandise shipped or services performed

• provided that the beneficiary presents the required documents in compliance with the terms of the letter of credit

- Letters of Credit (l/c) are the means by which the majority of international transactions occur.

- This is a letter written to the seller, signed by the buyer’s bank.


Letter of Credit - Mechanism


Letter of Credit - Terminology

Documentary Requirement – L/C is required for most import/export

transactions and is based on documents being independent from de

import / export contract

Clean L/C – presented without other documents, it is useful for

overseas bank guarantees or security purchases

Irrevocable L/C – cannot be revoked without the specific permission

of all parties involved, including the exporter

Confirmed L/C – is issued by on bank and confirmed by another,

obligating both banks to honor drafts drawn in compliance

Validity Period: maximum 21 working days from the opening

moment (can be extended with an additional cost)

Domiciliation of L / C: the place where the payment is realized

(exporter country, importer country, other country)


Documents Common to an Export L/C

Commercial Invoice Packing List Bills of Lading Certificate of Origin Other Certificates: Quality, Inspection Beneficiary Statements

A. Commercial documents

B. Transport documents

C. Insurance documents

D. Other documents


Benefits of Letters of Credit

To the Exporter: Payment protection Reliance on issuing bank’s

credit rather than buyer’s Rapid, local source of

repayment, if payable at a local bank

To the Importer: Documentary evidence that

the ordered goods have been shipped on time

Assurance that necessary clearance documents will be provided

Payment deferred until goods are shipped and documents presented (use of funds)


Problems of L/C

Shipping schedule is not met Stipulations concerning freight cost are

unacceptable Price is insufficient due to FX rate changes Unexpected quantity of product Description of product insufficient or too

detailed Documents are impossible to obtain specified

in L/C

Special Letters of CreditThe Transferable L/C – is where a beneficiary has the right to instruct the paying bank to make credit available to one or more secondary beneficiaries The Back to Back L/C – exists where the exporter, as beneficiary, offers its credit as security in order to finance the opening of a second creditThe Revolving L/C – exists where the tenor or amount of the L/C is automatically renewed pursuant to terms and conditions. These can be cumulative or non-cumulativeThe Red-Clause L/C – used in case of an advance payment in favor for an exporter (a method of finance for the exporter).Banker’s Acceptance – On a time draft, the bank on whom the draft is drawn commits to pay the face amount at maturity by stamping “Accepted” across the draft . Stand-by L/C - are an irrevocable commitment issued by a bank for a stated time period to pay a beneficiary a stated amount of money upon presentation of specified documents stating that the applicant did not fulfill their contractual obligations.

Banker’s Acceptance

8. Pay Discounted Value of BA

1 - 7 : Prior to BA

1. Purchase OrderImporter Exporter

5. Ship Goods

Importer’sBank

2. Applyfor L/C

11.Shipping

Documents

14. PayFace Value

of BA

10. SignPromissoryNote to Pay

6.Shipping

Documents& TimeDraft

4. L/CNotification

9. PayDiscounted

Value ofBA

7. Shipping Documents &Time Draft

Exporter’sBank

3. L/C

12. BA

Money Market Investor

13. Pay Discounted Value of BA

16. Pay Face Value of BA

15. Present BA at Maturity

14 - 16 : When BAmatures

8 - 13 : When BAis created


Standby Letter of Credit

Exporter ImporterExport contract (1)


Importer’s Bank

Importer’s Bank

3. Apply for Standby L/C

4. Standby L/C remittance

5. Standby L/C remittance

It is used if Importer didn’t fulfill it’s obligations


Transferable Letter of Credit

Exporter

Exporter’sBank

Importer’sBank

Importer

Order to open the L of C (1)

Beneficiary

Open L of C (2)

Advising the transfer (3)

Delivery (4)

Presenting the documents (5)

Transfer L of C (6)

Payment (7)

Documents and payment (9)

Documents and payment (8)


“Back-to-back” Letter of Credit

Documents shipment (8)

Importer

Importer’s Bank

Exporter’s Bank

Exporter

ImporterBeneficiary (real exporter)

Beneficiary’s Bank



Apply for L/C 1 (3)

L/C 2 delivery (7)

L/C1 delivery (5)

Apply for L/C 2 (6)

L/C1 delivery (8)



L/C1 delivery (4)

Funds (11)Funds (12)

Letter of credit - example

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Documentary Collection

Documents against Payment (D/P)

the buyer may only receives the title and other documents

after paying for the goods

Documents against Acceptance (D/A)

the buyer may receive the title and other documents after

signing a time draft promising to pay at a later date.

Acceptance Documents against Payment

(Acceptance D/P)

the buyer signs a time draft for payment at a later date.

Goods remain in escrow until payment is made


Documents against payment (D/P) flow


Documents against acceptance (D/A) flow

Documentary collection - example

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Documentary collection – example (2)

34


International Methods of Payment: Advantages and Disadvantages

Method Risk Chief Advantage Chief Disadvantagecash in advance L No credit extension required Can limit sales potential, disturb

some potential customers.Sight draft M/L Retains control and title; If customer does not or cannot

ensures payment before accept goods, goods remaingoods are delivered at port of entry and no payment is due

Letters of credit Banks accept responsibility If revocable, terms can change Irrevocable M pay; payment upon during contract work. Revocable M/H presentation of paper; costs

go to buyerTime draft M/H Lowers customer resistance Same as sight dragt, plus goods by allowing extanded paymentdelivered before payment is due after receipt of goods or receivedConsignment sales M/H Facilitates delevery; lowers Capital tied up until sales; must

customer resistance establish distributor's creditworthinessneed political rish insurance in somecountries; increased risk from currency controls

Open account H Simplified procefure; no High risk; seller must finance customer resistance production; increased risk from

currency controls


Buyer Max

Min

Min

Max

Con-firmed

Uncon-firmed

SightDraft

TimeDraft

Cash in Advance

Letter ofCredit

DocumentaryCollection

OpenAccount

Seller

Risk protection in case of international payments


Society for Worldwide Interbank FinancialTelecommunications (SWIFT)

Additional Topic



•Secure, inexpensive international messaging system that exchanges financial data.

•More than 7,500 financial institutions in 199 countries.

•Helps members, sub-members, and participants reduce costs, improve automation, and manage risk.



SWIFT can only be used between member banks for administrative messages such as:

payment instructions; funds transfers for customers; funds transfers for the bank’s account; advices and foreign exchange transactions; confirmations and advices concerning loans and deposits; collection advices and payment acknowledgments; letters of credit; balance reports; and advices and confirmations of securities transactions.


SWIFT - US DollarsUS Importer

New York Bank

Exporter’s Foreign Bank

SWIFTNetwork

Exporter

Payment instructions

Funds USDO Bank in US

US$US$

US$

US$

(U.S. Disbursing Officers)


SWIFT - Foreign CurrencyUS Importer

New York Bank

Exporter’s Foreign Bank

SWIFTNetwork

Exporter

USDO Bank overseasUSDO Bank

in US

Bank (or foreign exchange house)

US$

US$

US$



SWIFT BENEFITS Companies

• Eliminates bank and check cashing fees.• Eliminates lost or delayed mail• Assures receipt of payment on payment due date

Agency/Government• Facilitates the elimination of imprest funds.• Maintains funds in the Treasury Account until

withdrawn.• Eliminates costs of processing checks

SWIFT - Example

43