UNIT VI - INTERNATIONAL TRADEPresented by:Shah Hardik CIF 14

1

Why Trade?

Non availability of specific factors of production in some countries.

(Land, Labour, Capital and Entrepreneurship)

Product differentiation in different countries.

Differences in comparative cost between countries e.g. Law of comparative Advantage

2

What is International Trade?

International trade isexchange of capital, goods, and servicesacross international borders or territories.

3

Gains From International Trade International trade leads to mutual gain

because it allows each country to specialize in the production of those things that it does best.

Trade permits each country to use more of its resources to produce those goods that it can produce at a relatively low cost.

With trade, it is made possible for the trading partners to consume a bundle of goods that it would be impossible for them to produce domestically.

Trade encourages competition & efficiency.

4

Risks in International Trade

Buyer insolvency (purchaser cannot pay); Non-acceptance (buyer rejects goods as different

from the agreed upon specifications); Credit risk (allowing the buyer to take possession of

goods prior to payment); Regulatory risk (e.g., a change in rules that prevents

the transaction); Intervention (governmental action to prevent a

transaction being completed); Political risk (change in leadership interfering with

transactions or prices); War and other uncontrollable events; and Unfavorable exchange rate movements (and, the

potential benefit of favorable movements) – Hedging (Direct/indirect hedging through Banking Channels)

5

Role of Banks (Commercial / Central) It is impossible to be in international trade without

involving your bank for all the services they provide such as advice on financial issues and the potential risks involved. It is true that one critical hurdle is the lack of information on international trade processes, documentation and banking procedures necessary to carry on with business abroad. For result oriented and cost effective international trade, you will very definitely need access to accurate and timely information and a sound knowledge of banking.

Continue ...

6

Role of Banks (Commercial / Central) Attractions for banks in international trade;

A. ProfitabilityB. Low Risk Nature-The Six “S”si. Short-Termii. Smalliii. Securediv. Self-Liquidatingv. Specificvi. SelectiveC. A large growing MarketD. Well spread over marketE. Easy to MonitorF. Cross Selling informationG. Capital efficient

Continue …

Overview of International TradeA. Flow of goods from seller to buyerB. Flow of Payment from buyer to sellerC. In accordance with a contract of sale

Documentary requirementsBuyer - What documents does he needs?Seller - With what documents will he be able to supply?Country of export - what documents are required under the regulations of the exporting country?Country of import - what documents are required under the regulations of the importing country?

7

Role of Banks (Commercial / Central) Wants / needs and problem of trading

partnersPartner Wants / Needs Problems

Buyer Wants

1. Contract fulfillment.

2. Convenience.3. Credit.4. Advice and

assistance

1. Am I going to get the goods? (in good condition / in time)

2. Does the settlement method safeguard these risks?

3. Before we pay—how to check the goods are exactly those ordered?

4. Any credit terms available Prefers to delay paying for the goods until they are sold.

5. From where can I get information on the exporter’s creditability

Seller Needs

1. Contract fulfillment.

2. Convenience.3. Prompt

payment.4. Advice and

assistance

1. Will I be paid?2. When will I be paid?3. How to minimize risk of non-payment?4. How to maintain secrecy of our supplier?

8

Role of Banks (Commercial / Central) Basic agreement (International Trade – Sale Contract)1. Preliminary Quotation & Commitment (Invoicing / order

etc)2. The Merchandise (goods to be imported / exported)3. Packing (instructions regarding packing of imported /

exported merchandise)4. Method of Settlement (Immediate or Credit /

Advance / LC Collection???) 5. Shipping Instructions (trans shipment – partial

shipment etc)6. Price and its components (INCOTERMS 2010)7. Delivery Mode ,Period, Place (Sea, Air, Road – place of

shipment and last date of shipment)8. Documents (Invoice, packing list, inspection report,

certificate of origin, BL/AWB etc) Continue

…

9

Methods of Settlement

Considerations of trading partners;

Methods of settlement (Payments)

Partner

Consideration

Buyer 1. Goods in advance.2. Payment at the time of receipt of goods.3. Payment after receipt of shipping documents.4. Need bank finance.

Seller 1. Payment in advance.2. Payment at the time of shipment of goods.3. Payment after delivery of shipping documents.4. Need bank finance.

Direct between buyer and seller (trading partners) / Clean Payments

Indirect through involvement of banks

1. Open Account / Extended Terms

2. Advance Payments

1. Documentary Collections2. Documentary Credits

10

Methods of Settlement 11

Clean Payments

Clean Payments are characterized by trust. Either the Exporter sends the goods and TRUSTS the Importer to pay once the goods have been received (Open Account / Extended Terms), or the Importer TRUSTS the Exporter to send the goods after payment is affected (Advance Payments).

12

Documentary Collection A method of payment used in international trade whereby the

Exporter entrusts the handling of commercial and financial documents to banks and gives the banks instructions concerning the release of these documents to the Importer.

Banks involved do not provide any guarantee of payment.

Documentary collection may be carried out in two following ways;Documents against Payment (DAP) / Sight Collection (SC) / Cash Against Documents (CAD)Documents are released to the Importer only against payment.Documents against Acceptance (DAA) / Term Collection (TC)Documents are released to the Importer only against acceptance of a draft/promissory note. Also known as a Term Collection. Due date can be from any document date (BL/AWB etc) or from acceptance of promissory note date.

13

Documentary Collection

Parties to a Collection – General

International Terminologies (URC 522)

1. Importer2. Importer’s bank3. Bank in exporter’s

country4. Exporter

1. Drawee (Importer)2. Collecting bank – of proceeds (Importer’s

bank)3. Remitting bank – of documents (Bank in

exporter’s country)4. Drawee (Exporter)

14

Documentary Collection15

Documentary Collection - Mechanism

Mechanism of Documentary Flow

The mechanics of a Documentary Collection are separated into the following three steps:

A. Flow of Goods

After the Importer and the Exporter have established a sales contract and agree on a Documentary Collection as the method of payment, the Exporter ships the goods.

B. Flow of Documents

After the goods are shipped, documents originating with the Exporter (e.g. commercial invoice) and the transport company (e.g. bill of lading) are delivered to a bank (Remitting Bank). The role of the Remitting Bank is to send these documents accompanied by a Collection Instruction giving complete and precise instructions to a bank in the Importer’s country (Collecting/ Presenting Bank).

The Collecting/ Presenting Bank acts in accordance with the instructions given in the Collection Order and releases the documents to the Importer against payment (DAP/SC/CAD) or acceptance (DAA/TC), according to the Remitting Bank’s Collection instructions.

C. Flow of Payment

Payment is forwarded by Collecting / Presenting Bank to the Remitting Bank for the Exporter’s account and the Importer can now present the transport/title document to the carrier in exchange for the goods.

16

Documentary Credit / Letter of Credit The LC in its modern shape appeared for the 1st time in

1840s in London for the settlement of trade transactions. A Documentary Credit (DC) is • a written undertaking by a bank (Issuing Bank)• given to the exporter (Beneficiary) • at the request of the importer (Applicant) • to effect payment (Reimbursement) up to a stated amount

(Credit Amount) within a stated time period (Expiry date) • against presentation of compliant documents (LC terms).

In other words, DC is a conditional payment undertaking from a bank

17

Parties to a DC/LC – General International Terminologies (URC 522)

1. Importer2. Importer’s bank3. Bank in exporter’s country4. Exporter’s other bank

(optional)5. Exporter

1. L.C applicant (Importer)2. L.C Issuing bank (Importer’s

bank)3. Advising / Nominated /

Negotiating / Presenting bank (Bank in exporter’s country)

4. Confirming Bank (Exporter’s other bank – optional)

5. Beneficiary (Exporter)

18

Documentary Credit / Letter of Credit

Documentary Credits - Cycle

19

Documentary Credits - Mechanism

A. Issuance of Documentary Credit / Letter of Credit 

After the trading parties agree on a sale of goods where payment is made by Letter of Credit, the Importer requests that its bank (the Issuing Bank) issue a Letter of Credit in favor of the Exporter (Beneficiary).

The Issuing Bank then sends the Letter of Credit to the Advising Bank. A request may be included for the Advising Bank to add its confirmation. The Advising Bank is usually located in the country where the Exporter does business and may be the Exporter’s bank, but does not have to be.

Next, the Advising/ Confirming Bank verify the Letter of Credit for authenticity and sends it to the Exporter.

B. Flow of Goods

Upon receipt of the Letter of Credit, the Exporter reviews the Letter of Credit to ensure that it corresponds to the terms and conditions in the purchase and sales agreement; that the documents stipulated in the Letter of Credit can be produced; and that the terms and conditions of the Letter of Credit can be fulfilled. Assuming the Exporter is in agreement with the above, it arranges for shipment of the goods.

C. Flow of Documents & Payments

After the goods are shipped, the Exporter presents the documents specified in the Letter of Credit to the Advising/ Confirming /Negotiating Bank.

Once the documents are checked and found to comply with the Letter of Credit (i.e. without discrepancies), the Advising/ Confirming Bank forward these documents to the Issuing Bank. The drawing is negotiated, paid or accepted as the case may be.

In turn, the Issuing Bank examines the documents to ensure they comply with the Letter of Credit. If the documents are in order, the Issuing Bank will obtain payment from the Importer for payment already made to the Confirming Bank.

Documents are delivered to the Importer to allow him to take possession of the goods

20

Parties Involved in Letter of Credit

21

Types of Letter of Credit

Revocable & Irrevocable Letter of Credit Confirmed Letter of Credit  Sight Credit and Usance Credit  Back to Back Letter of Credit  Transferable Letter of Credit  Stand by letter of credit

22

REVOCABLE LETTER OF CREDIT A revocable letter of credit may be revoked

or modified for any reason, at any time by the issuing bank without notification.

It is rarely used in international trade and not considered satisfactory for the exporters but has an advantage over that of the importers and the issuing bank.

It should be indicated in LC that the credit is revocable. if there is no such indication the credit will be deemed as irrevocable

23

IRREVOCABLE LETTER OF CREDIT In this case it is not possible to revoked or

amended a credit without the agreement of the issuing bank, the confirming bank, and the beneficiary.

 From an exporters point of view it is believed to be more beneficial.

An irrevocable letter of credit from the issuing bank insures the beneficiary that if the required documents are presented and the terms and conditions are complied with, payment will be made

24

CONFIRMED LETTER OF CREDIT Confirmed Letter of Credit is a special

type of L/C in which another bank apart from the issuing bank has added its guarantee.

Although,  the cost of confirming by two banks makes it costlier, this type of  L/C is more beneficial for the beneficiary as it doubles the guarantee.

25

SIGHT CREDIT & USANCE CREDIT Sight Credit states that the payments

would be made by the issuing bank at sight, on demand or on presentation.

In case of Usance Credit, draft are drawn on the issuing bank or the correspondent bank at specified usance period. The credit will indicate whether the usance draft are to be drawn on the issuing bank or in the case of confirmed credit on the confirming bank

26

BACK TO BACK LETTER OF CREDIT Back to Back Letter of Credit is also

termed as Countervailing Credit. A credit is known as back to back credit

when a L/C is opened with security of another L/C.

Counter credit is actually a method of financing both sides of a transaction in which a middleman buys goods from one customer and sells them to another

27

TRANSFERABLE LETTER OF CREDIT A Transferable Credit is one under which

the exporter has the right to make the credit available to one or more subsequent beneficiaries.

Credits are made transferable when the original beneficiary is a middleman and does not supply the merchandise himself, but procures goods from the suppliers and arrange them to be sent to the buyer and does not want the buyer and supplier know each other.

28

STANDBY LETTER OF CREDIT Initially used by the banks in the United

States, the standby letter of credit is very much similar in nature to a bank guarantee. 

The main objective of issuing such a credit is to secure bank loans.

Standby credits are usually issued by the applicant’s bank in the applicant’s country and advised to the beneficiary by a bank in the beneficiary’s country.

29

Advantages of using Letter of Credit

30

31