International Payment of Settlement

8/8/2019 International Payment of Settlement

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CHAPTER - IVMETHODS OF INTERNATIONAL PAYMENT SETTLEMENT

The objective of this chapter is to make the reader understand :

1. The meaning of terms of payment2. The four methods of payment namely Advance Payments, Open Account System, Consignment

Sale and Bill for Collection.3. The advantage of the different methods to the buyer and seller.4. Different financial instruments used in settlement namely Telegraphic Transfer, Demand Draft,

Travellers Cheques and SWIFT.

To be very clear as to how payments for goods are to be sent, it is necessary that the buyer and the sellerincorporate the details in the contract of sale itself. Depending upon the bargaining power of the buyerand seller, provisions of Exchange Contracts in the countries concerned, the duration of trade relationshipbetween the buyer and seller and also the credit worthiness of the parties concerned, terms of payment

are arrived at. It can also be said in general that, terms of payment reflects the extent to which the sellerrequires a guarantee of payment before he loses control over the goods.

ADVANCE PAYMENT

When there is a sellers market for the goods, the Exporter can demand that the Importer should make fulladvance payment before the goods are despatched. Even though this method is the most desirable forthe Exporter, the Importer has to rely on the integrity of the Exporter and his capacity to execute the orderin time. More than that, the entire transaction is financed by the Importer in this method thereby makingthe transaction more costly for him; besides exposing the Importer to credit risks. On account of theabove factors some countries have imposed Exchange Control restriction regarding imports. For examplein India advance payment is allowed only in respect of import of books, periodicals, life saving paymentapparatus, capital goods, machinery and a few other items. Bankers may stipulate that the Importers

produce documentary evidence showing the supplier demanding the advance payment. Advancepayment of USD 2500/- or its equivalent can be made for commercial imports subject to the followingconditions.

1. Production of docume ntary evidence showing the demand of the overseas supplier.2. Remittance will be made direct to the overseas supplier.3. Endorsement in the import licence if any.4. Undertaking that the Importer will submit evidence of import in the Exchange Control Copy of Bill

of Entry/Postal wrapper within a period of 3 months from the date of remittance.

5. Import is permitted either by a licence covered under OGL. As regards exports, depending on thenature of goods exported and the competitiveness of the product, advance payments is insisted.For example in the case of export of vegetables and fruits, it is customary to demand 100%

advance payment.6. Application in F.A.I. in duplicate.

Even though advance payment cannot be insisted upon on all trade transactions it is quite common for asale contract to require a partial payment in advance and the balance payable after despatch of goods.

Open Account System


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When an Exporter agrees to sell the commodity on open account system to the Importer, he despatchesthe goods to the buyer directly followed by the transport documents and an invoice requesting payment.You may observe that the Exporter loses control over the goods completely and leaves everything on theintegrity of the buyer. To put it in other words, the effect of this system is just opposite to advancepayment system. While open account system is most advantageous to the Importer, the Exporter bearsthe entire financial and commercial risks. This system is normally resorted to when the goods commandbuyers market. The commercial risk is, to some extent minimised by taking a policy of ECGC. To takecare of the interest of the Indian Exporters, there are Exchange Control restrictions imposed by RBI onopen account export Sales.

Consignment Sale

While the ownership and possession passes to the buyer in the case of open account system, theownership remains with the seller in the case of consignment sale. The consignee in this case will beselling agent of the Exporter. The goods are sold by the consignee on behalf of the Exporter and as andwhen the proceeds are received, they are remitted to the Exporter. The agent/consignee may deduct fromthe sale proceeds of the goods, the expresses normally incurred such as warehousing & handlingcharges, Jewellery, precious stones and engineering goods are normally sold by this method. In the caseof goods exported on consignment basis, freight and marine insurance must be arranged in India.

Engineering Export promotion council maintains a warehouse at Rotterdam to assist the Exporters. Thetime limit for realisation of export proceeds is 15 months as against the usual 6 months.

Documentary collection

In the methods mentioned above, either the Exporter benefits or the Importer benefits. Can there be amethod where the Exporter does not lose control over the goods (title to goods) and the Importer is notrequired to make payment before the document are received evidencing despatch of goods? Yes, it iscalled the documentary collection, using the services of the Bank. The Exporter prepares the properfinancial and commercial document including the transport document and hands over to his Bankerrequesting in clear terms as to how the documents are to be delivered to the Importer at the other end.The uniform rules for collection (International Chamber of Commerce, Publication No. 322) with effectfrom January 1979 form an internationally accepted code of practice covering documentary collection.

There are four main parties to a documentary collection.

They are :

1. The Principal i.e.. the Exporter or Drawer of bill of exchange2. The Remitting Bank - The Exporters Bank who has been entrusted the job of collection.3. The Collecting Bank - The Bank in the Importers country who is normally a branch or

correspondent of the remitting Bank.4. The Importer, the consignee or the drawee of the Bill of Exchange.

When the Exporter wants the Bank to hand over the export documents to the Importer only againstpayment immediately, the Bill of Exchange is called a Sight Draft. In case the Exporter wishes to givesome time (30 days, 60 days, 90 days etc.) to the Importer to arrange for the funds but at the same time

would not like to part with the documents before payment of money, the appropriate bill of exchange iscalled a D/P (Document against Payment) - In some cases, depending upon the mutual confidencebetween the buyer and acceptance and await payment after an agreed time. The appropriate Bill ofExchange in this case is called a "Usance Draft" or D/A (Document against acceptance). Here thebuyer/importer has the permission to take delivery of goods without payment, use the commodity in histrade or manufacturing process, sell the final product and remit the contracted amount on or before thedue date.

Different financial instruments used in settlement


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Telegraphic Transfer :

Telegraphic transfer or TT as it is commonly known is an instruction from a Bank by cable (remittingBank) to pay a certain amount of money to a specified person. Such instructions are addressed either toits own overseas branch or its correspondent. If the amount involved is expressed in foreign currency, thedrawee Bank who has been instructed to pay will makes payment in the currency of the beneficiary and

would obtain can be inward TTs and outward TTs. Let us examine the case of an Exporter who isreceiving an advance payment in foreign currency. Bank already received the money in its NOSTROaccount, it is not running any risk and therefore, the most favourable rate for the Exporter is applied. Thisis an inward TT remittance as far as Indian Overseas Bank is concerned Now let us also take the case ofan Importer in India wanting to remit GBP 1500 for importing a life saving apparatus from London, veryurgently. He can approach an Authorised Dealer with whom he is banking and request for TT remittancein Form A1. The Bank, say Indian Overseas Bank will recover the equivalent of GBP 1500 for importing alife saving apparatus from London, very urgently. He can approach an Authorised Dealer with whom he isbanking and request for TT remittance in Form A1. The Bank, say Indian Overseas Bank will recover theequivalent of GBP 1500 applying Bills Selling Rate prevailing on that day plus charges from thecustomers account and send a telex to its London correspondent, say Midland Bank instructing them topay the money to the named beneficiary to the debit of its NOSTRO account. Midland Bank will verify theauthenticity of the message and pay the supplier GBP 1500 to the debit of the NOSTRO account ofIndian Overseas Bank. You may notice here that even though the remittance was made bytelex/telegraphic transfer, the Bank did not apply the most favourable rate of TT selling while recoveringthe money in Indian Rupees from the customer. Though the money was transferred by the quickestmethod, as the payment is in respect of imports, when the Bank has to handle documents, it will applyonly bills selling rate. In this context TT refers to immediate reimbursement for the paying Bank. Thepayment to the supplier in London and recovery of GBP 1500 from the NOSTRO account was done bymidland Bank simultaneously. This is an outward TT remittance.

Foreign Demand Draft

It is an instrument in writing by the issuing Bank requesting a Bank in the other country to pay the namedbeneficiary a certain sum of money. Though the payment mechanism is the same as i the case ofTelegraphic Transfer, in this case Demand Draft is handed over to the purchaser who can in turn

despatch it to the beneficiary. It is a slow method of payment, but at the same time has betteracceptability than a personal cheque. The major disadvantage for a draft is the time taken in transmittingthe money inspite of the fact that the issuing bank has recovered the money from the purchaser on thedate of issue itself. Further, in case the instrument is lost in transit, a duplicate draft can be obtained onlyafter a lot of formalities including executing an indemnity bond.

Travellers Cheque

companies. It is a convenient mode of carrying purchasing power. The currency anddenomination can bechosen depending on our destination and purpose. For example if an exporter is planning for an exportpromotion trip to Germany, he can obtain travellers cheques in Deutsche Marks. At the time of purchasingthem from a Bank he has to apply in Form A2 and indicate the currency and denomination in therequisition slip. The Bank will handover the travellers, cheques after ensuring that your specimen

signature is put on the face of the travellers, cheques. When the Exporter is in Germany he can use thesecheques for payment of his hotel bills or purchases or encash them freely at any Bank. At that time hehas to put his signature and date in the presence of the concerned official in the space provided on theface of the travellers cheques. In the case of loss of travellers cheque, refund can be obtained through aBank after submitting a report. There is no expiry date for travellers cheques.

Swift


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SWIFT is an acronym for Society for Worldwide Interbank Financial Telecommunication system and itprovides telecommunication services and more importantly uniform procedures that are understandableto the banking industry throughout the world by use of standard message formats. SWIFT is a co-operative body of financial institutions with headquarters at Belgium.

In the 1960s and 1970s banks across the globe used to sent their financial payment advices, letters of

credit and amendments etc., by the conventional mail or telex. This was found to be expensive as welltime-taking. Also banks worldwide used different terms and different instructions to convey the meaning.This resulted in ambiguity leading to delay in execution of payment etc. A need was felt to have onecommon structured language for all banks so that delay in correspondence and payment of damagescould be avoided and speedier transmission of data could be introduced.

As a result, SWIFT was introduced. Banks universally could understand the language since it iscommonly structured and conforms to ISO standards.

What to look for in SWIFT message :

Whether it an authenticated message or not.

All messages are not authenticated.

Message types 100, 200, 400, 500, 600, 700, 800 series are authenticated and message types 300 and900 series are not authenticated. Authenticated messages are identified by a caption AUTH correct with"current key". This is a valid message and can be acted upon.

SWIFT operates in more than 75 countries and is available 24 hours a day throughout the year. It is themost widely used financial network around the world by over 3000 financial institutions.

Last year only, banks in India joined SWIFT network and presently one designated branch in Bombay ofeach SWIFT member bank is linked to the network. Shortly some of the up-country branches dealing inforeign exchange will also be connected to the network.

The main benefits of using the computer network provided by SWIFT are speed, reliability and security intransfer a part from lower costs compared to conventional communication methods.

MAIN POINTS

1. Different terms of Payments:

1.a Advance payment: When there is a sellers market.

Full/or partial payments are advanced before the goods are despatched. Importer bears the entirecommercial/financial risks till the goods are received by him as per terms of agreement

1.b Open Account System: When there is buyer's market.

Goods are despatched to Importer directly followed by Invoice requesting payment & transportdocuments

Risks of Exporter

a. Exporter bears entire commercial & financial risks till payments are received.


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b. Exporter loses control over goods till payments are received safely.

1.c Consignment Sale

Owner ships remains with the exporter to the extent of sale of goods. Time to realize payments is 15months

1d. Documentary Collections

Exporter does not lose control on title of goods and importer also does not make payment beforedocuments.

2 types of documentary collections

i. D/P sight (or) credit 30/60/90 days etc., D/P sight Backhands are does to import against hisimmediate payment D/P Credit: As Bk.s hands are do again stipulated credit days againstpayment remittance by importers Bank hands over documents to importer and awaits paymentsas per credit term of agreement.

ii. D/A usance or D/A

Exporter permits the delay of goods and documents immediately on acceptance and awaits payment afteran agreed time.

2. Different modes of Financial instruments2.1 Telegraphic Transfer (or) TT

Instruction for remittance by cable through NOSTRO account to make paymentThis is usually for its overseas branch or correspondent.

2.2 Foreign demand draft

The DD is handed over to buyer & who in turn despatches to the beneficiary

It is time consuming and involves a lot of formalities if the DD is lost in transit.

2.3 Travellers cheque,are sold by all Authorised dealers and authorised money changes . It is issued inmany currencies and denominations and accepted by world over. Specimen signatures have to be affixedone while getting and the other at the time of en cashing it anywhere in the world. There is no expiry datefor Travellers cheques.

3. SWIFT (Societyfor world wide Inter bank Telecommunication system)

It is used to send the f inancial payments advise / L/Cs and their amendment in one common language forclarity & simplicity speedier transmission.

Authenticity of the message to be verified.

Documents

International Payment of Settlement