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1) How to manage the risk for the principal under the documentary collection in International Business?
2) Please do some compare between documentary collection and documentary credit?

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Finance

  1. 1. SHENYANG AEROSPACE UNIVERSITYINTERNATIONAL BUSINESSDr. JUN-QI LIU Professor Shenyang Aerospace UniversityRoniBhowmik Master’s Program International Business RONI BHOWMIK1
  2. 2. SHENYANG AEROSPACE UNIVERSITYINTERNATIONAL BUSINESS# How to manage the risk for the principal under the documentary collection inInternational Business?How risky is it?A variety of payment methods is used in international business, with payment taking placeat a different stage of the export deal in each. In general, this means that each method has adifferent level of non-payment risk for the exporter, and non-delivery risk for buyer.Thediagram below illustrates the risk of documentary collection compared with other paymentmethods.As my study, Documentary Collections may be settled in two different ways. A documentagainst Payment (D/P) refers to a Collection where the Importer receives the documentsonly in exchange for payment. With Documents against Acceptance (D/A), the Importer mayobtain the documents in exchange for the acceptance of the obligation to pay at a specifiedfuture date. These two methods of settlement carry different risks for both Importers andExporters.Generally risk can be categorized in lack of credit information, lack of personalcontract, difficult expensive collections, no easy legal recourse, higher litigation costs andmistrust.As my study I found some risk-  Payments after arrival of goods,  High risk of exporter for getting payments,  Currency risk,  Non-performance/non delivery risk, RONI BHOWMIK2
  3. 3. SHENYANG AEROSPACE UNIVERSITYINTERNATIONAL BUSINESS  Commercial Credit risk,  Transfer risk,  Country risk etc.I just try to share my study and experience opinion – 1. Payments after arrival of goodsExporter is exposed to more risk as documentary collectionterms are more convenient andcheaper than documentary collection to the importer. So in this situation, generallyimporter most of the time choose to documentary collection process. Documentarycollection may be favour the importer or buyer since payment is deferred by him until thegoods arrive or even later if delayed payment arrangements are agreed to.May increasebuyer market competitiveness, as this payment method is relatively low risk for overseasbuyers and may also help their cash flow. But by defaulting on a bill of exchange he/shemay become legally liable. Not only legally liable also his/her trade reputation may bedamaged if the collection remains unpaid. 2. High risk of exporter for getting paymentsMost importantly, the seller must realize that the banks will pay only if and when the buyerpays them, Banks do not assume the obligation to pay. Documentary collections do notguarantee that the buyer will be willing and able to pay as agreed. Sometimes buyer delayto pay and sometimes will not agree to pay. However, ifpayment is not made, the buyerwon’t be able to obtain title to the goodsif the buyer is unwilling or unable to pay or acceptthe order to receive the documents, then the seller will retain titleto the goods and controlof the documents.Seller risk of non-payment after delivery of Seller goods may be greaterthan in some other payment methods. If seller bill of exchange specifies payment at a dateafter delivery, seller hand over control of the goods but run the risk of non-payment on thedue date.If buyer doesn’t accept the bill of exchange, or delays or defaults on payment,seller may incur unplanned expenses such as storing, disposing of or redirecting thegoods.The seller will also face the effort and expense of dealing withgoods already shippedto a foreign port.If the buyer defaults on an accepted draft, then the seller will have a strong legal positionbut will also be confrontedwith the cost and effort associated with legal action. If moreprotection is needed, then the seller should considerrequiring the buyer to use a letter ofcredit. RONI BHOWMIK3
  4. 4. SHENYANG AEROSPACE UNIVERSITYINTERNATIONAL BUSINESS 3. Currency riskCurrency risk can arise due to variations in exchange rates, currencies fluctuate regularlyand there may be a delay between the time of entering into a contract and the making ofthe foreign payment to the supplier. In Sometimes buyer delay to pay in the documentarycollection method, that times seller face the currency risk.The local currency amountpayable on settlement may be higher than the amount calculated when entering thecontract, due to an adverse movement in the market price of the currency. Movements inexchange rates may significantly affect the profit margin seller expect to retain on seller’sinternational trade transaction.The currency fluctuation may be solved with using the option for a third currency (US$),there is the possibility of sharing the currency fluctuation risk. This risk accrues in the periodbetween prices being agreed and payment being received. 4. Non-performance/non delivery riskWhen dealing with a seller there is always a risk of non-performance, this may beheightened when dealing with an overseas seller. Seller may not perform according to thesales contract, either by delivering the wrong or inferior goods or not delivering at all or notat the agreed time. Because in documentary collection methods will not obligated orguarantee seller/buyer must do this. Seller may not be willing or able to perform ascontracted; these events may be the result of things outside the control of the seller, likeindustrial action, shipping availability or in extreme cases, acts of war or other violence.Non-performance, whatever the cause, may adversely affect buyerbusiness; that time may losecustomers or sales as a result.Whilst there are no guaranteed ways to eliminate these risks,may be they can managed by- Seeking trade references before entering into a contract with a new trading partner, investigate their reputation and the product Request appropriate shipping documentation to be presented before making payment Arrange inspection of the goods by an acceptable independent inspection agency (this can be costly) Have an alternate or secondary supplier available to source the goods from, this may limit damage caused by loss of supply RONI BHOWMIK4
  5. 5. SHENYANG AEROSPACE UNIVERSITYINTERNATIONAL BUSINESS 5. Commercial Credit riskCredit risk is the risk of seller insolvency or other related parties in the payment chain.Consider importing goods using unconditional methods of payment such as importdocumentary collection. In this method payment is not assured by the bank which issues adocumentary collection. If full or partial payment is made to the seller prior to shipment, theimporter may find that any payments made are not returned.Consider importing goods using conditional methods of payment such asimportdocumentary letter of credit. Import Documentary Letter of Credit is an ideal way tofacilitate payment to the supplier with some in-built safeguards. 6. Transfer riskWhen a contract of sale specifies payment is to be made in a particular currency, a Transferrisk may also exist.A change in government regulations may prevent or restrict ability tomake payments or exchange foreign currency; many countries regulate the transfer ofmoney and conversion of foreign currency receipts.Unexpected regulatory changes mayoccur without warning, meaning that transactions already agreed to may not be able to becompleted, resulting in financial loss to either or both parties. 7. Country riskCountry risk may occur if government regulations prevents or restricts the movement ofparticular goods, this could occur during a significant event such as war, terrorism,government bankruptcy or economic embargoes.Many countries regulate the import andexport of goods. Unexpected regulatory changes can occur without warning, such ascancellation of permits or licences, transactions already agreed to, may not be able to becompleted, resulting in financial loss to either party. In documentary collection methodsseller and buyer both are face this problem.In any business transaction, there are risks. However, these risks are emphasized whendealing internationally. Added to the commercial risks present in a domestic transaction areforeign exchanges as well as country risks. Exporter is exposed to more risk as documentarycollection terms are more convenient and cheaper than documentary credit to theimporter.All included the documentary collection offers straightforwardness between tradepartners as well as the payment is quicker than other methods. Usually the political andtransfer risks are not covered, I try to share my idea how to manage the risk- RONI BHOWMIK5
  6. 6. SHENYANG AEROSPACE UNIVERSITYINTERNATIONAL BUSINESS 1. Need strong governmentpolitically, economically and legally stable“You can’t have strong, healthy, prospering businesses without a big, strong government.The kinds of businesses that don’t want a big, strong government are exactly the kinds ofbusinesses that we, the People don’t want.”Government creates the “public structures” thatsupport smaller, innovative business. Government defines the playing field for business,right down to defining and regulating the money itself. Government creates the laws thatdefine what business even is, and the police and courts to enforce that law. Governmentprovides the infrastructure that is the soil in which businesses thrive or wither and die.Government educates the employees and innovators. Government negotiates the tradeagreements that let businesses sell outside the country, and is supposed to protect countrybusinesses from being undercut by those in other countries.It is a universal economic fact that without a proper Governance the trade and businesseswould not thrive along the right direction. After the Second World War the totally destroyednations such as Japan and Germany were helped to revive their economy. These twonational economies went forward whereas that of other countries involved in the wargradually went down and down. If we look at the fate of recession in Russian economy, theunemployment rate in America and the totality of degradation in the other Europeancountries including that of Great Britain. Whereas the economies of emerging Nations suchas China, India and Singapore as well as Malaysia, not to mention those affected by the ArabSpring movements, is much safer to follow as models. The Good Governance forInternational Business index provides a timely and useful resource for business leaders andgovernments alike. International payment transactions with the importing country must notbe hampered or threatened by currency controls or any other such restrictions.Sellerhas nodoubts about the buyers ability to meet its payment obligations, if the political andeconomic situation in the buyers country is stable, if there are no foreignexchange restrictions in the sellers country. So need strong and stable political governmentfor managing the all type business risk. 2. Need strong Banking supportThe bank’s legal liability is set out in the uniform rules for collections. Banks, therefore, actas intermediaries to collect payment from the buyer in exchange for the transfer ofdocuments that enable the holder to take possession of the goods. Bank must check thatthey appear to have received the documents specified in the collection order, but they haveno liability to examine the documents in more detail. However, in practice the remittingbank will make the some additional check before it sends the documents abroad. Bankmakes sure that the instructions on the collection order are logical, and also the bill ofexchange is correctly drawn, signed and endorsed. If any are missing, an explanation shouldbe obtained and the collecting bank must be advised accordingly. If bank make sure all RONI BHOWMIK6
  7. 7. SHENYANG AEROSPACE UNIVERSITYINTERNATIONAL BUSINESSdocumentscheck clearly maybe document collection method day by day continuing theirpopular face in the buyer and also seller for using export import business. 3. Need to be a relationship of trust between the exporter and the importerTo understand your fear is the beginning of really seeing- Bruce Lee. Make any relationshipat first need believe. As like also, business at first condition need to be a relationshipof trustbetween the seller and the buyer.There must be no doubt as to the importers willingnessand ability to pay.At last I say that, make international tradeoperations more flexible, use documentarycollection in cases when the seller does not want to deliver goods to the buyer on “openaccount” basis, but due to a long-term stable business relationship between the partiesthere is no need for security provided by a Letter of Credit or payment guarantee.Documentary collection is suitable to the seller: if the seller has no doubts about the buyersability to meet its payment obligations, if the political and economic situation in the buyerscountry is stable, if there are no foreign exchange restrictions in the sellers country.Documentary collection is convenient for the buyer also because: there is no need for anadvance payment; payment for goods can be made when shipping documents have beenreceived, in cases of documents released against acceptance the buyer has the possibility tosell the goods first and afterwards make payment to the seller. Documentary Collectionassures the seller that the shipping documents will be released to the buyer only uponpayment or acceptance of a bill of exchange. RONI BHOWMIK7
  8. 8. SHENYANG AEROSPACE UNIVERSITYINTERNATIONAL BUSINESS# Please do some compare between documentary collection and documentary credit?Exporting overseas is one way for a business to grow, but it wont succeed if the buyers failto pay promptly. The business world has developed several methods for guaranteeingpayment even when the buyer and seller are half the world apart. At first necessary to knowwhat is documentary collections and documentary credit or letter of credit, follow-Documentary Collection:In the documentary collection process, the U.S. Department of Agriculture says, the sellersends the shipping documents and a draft for payment to the buyers bank. The bank, actingas middleman, sends the documents to the buyer, whos the one responsible for paying thedraft.Documentary Credit or Letter of Credit:A letter of credit is a commitment by the buyers bank to pay for the goods, according to theU.S. Department of Agriculture. Before paying, the bank will require the seller fulfil theterms of the letter exactly. Typically, that includes delivering the goods and providingdocumentation for example an invoice, a packing list, and a certificate of origin drawn upexactly as the letter dictates.Documentary credit and documentary collections both guarantee payment when the termsare met but there are important differences between them. I try to show my study learningand my little experience- 1. Will They PayDocumentary credit or letters of credit is measured a dependable guarantee of payment,which makes it an outstanding choice when the consumer and supplier havent donebusiness together. If a Bangladeshi bank working with the buyers bank confirms the letter,its even safer. Documentary collection is less sure because the cash comes from the buyer,not the buyers bank, so if the buyer refusesor declines to pay for any reason, the supplier isout of luck. 2. Commercial Credit RiskIn documentary credit or letters of credit eliminates the commercial credit risk, becausepayment is assured by the bank which issues an irrevocable documentary credit. The sellerno longer needs to rely on the willingness and capability of the buyer to make payment. RONI BHOWMIK8
  9. 9. SHENYANG AEROSPACE UNIVERSITYINTERNATIONAL BUSINESSConsider importing goods using unconditional methods of payment such as importdocumentary collection. In documentary collection method payment is not assured by thebank which issues a documentary collection. 3. Cost or ExpenseDocumentary credit or letter of credit is more costly than documentary collection becauseof the fees charged by the buyers bank. If one supplier insists on a letter while another bidsto accept a cheaper method, such as documentary collection, the lower fees may give thesecond trader an edge in doing trade.While a letter of credit often costs between 1%-2% ofthe total payment obligation,documentary collection can be much straightforward and lessexpensive settlement process. 4. Exact RequirementsOne disadvantage to documentary credit or letter of credit compared to documentarycollection is that any departure from the terms of the letter, including improperly prepareddocuments, gives the bank grounds to reject payment. The supplier must then pay to havethe goods returned, find a new buyer or negotiate a lower sales price in return for thebanks receiving. 5. Prepares and Presents DocumentsIn a documentary collection, the seller prepares and presents documents to the bank inmuch the same way as for a documentary letter of credit. However, there are two majordifferences between a documentary collection and a documentary credit: (1) the draftinvolved is not drawn by the seller (the "drawer") upon a bank for payment, but rather onthe buyer itself (the "drawee"), and (2) the sellers bank has no obligation to pay uponpresentation but, more simply, acts as a collecting or remitting bank on behalf of the seller,thus earning a commission for its services. 6. Boat FreightDocumentary collection is supremesuitable when goods are shipped overseas by boat orship. The ocean bill of lading is a negotiable document that gives title to the goods; theshipper wont release the goods unless the buyer has the bill of lading, and the buyer cantget the bill without paying the draft. RONI BHOWMIK9
  10. 10. SHENYANG AEROSPACE UNIVERSITYINTERNATIONAL BUSINESSPicture Documentary Collection and Documentary Letter of Credit working process: RONI BHOWMIK10
  11. 11. SHENYANG AEROSPACE UNIVERSITYINTERNATIONAL BUSINESS 7. Banking GuarantyIn documentary collection bank have no liability to examine the documents in more detailand also don’t guarantee that the buyer will be willing and able to pay as agreed. But in vaseversa letter of credit are highly secure because if the buyer doesn’t agree to pay, buyer bankwill be willing and able to pay as agreed. 8. When UseLetters of credit are used primarily in international trade for large transactions between asupplier in one country and a customer in another. Letters of credit are perhaps most usefulfor doing business with a person or company that you do not know well.In such cases, theInternational Chamber of Commerce Uniform Customs and Practice for DocumentaryCreditsapplies (UCP 600 being the latest version). But if the relationship of trust betweenthe exporter and the importer that time normally use documentary collection. 9. Political or Economic InstabilityLetters of credit are highly useful when a buyer’s country has political or economicinstability or restrictive foreign exchange controls. International payment transactions withthe importing country must not be hampered or threatened by currency controls or anyother such restrictions. In strong government politically, economically and legally stablecountry normally use documentary collection. 10. Time ConsumingIn documentary collection no need long time for opening bank account, so Payment isusually quicker than with open account, but on the other hand letters of credit ordocumentary credit have need long time for opening bank account. So, documentary credituse only when the buyer has enough time available, because in this method need long time. 11. High Value Shipment/sHigh value shipments need more safety or security, but in documentary collection bankhave no liability to examine the documents in more detail and also no guarantee of paymentor immediate payment by the buyer. Another side documentary credit or letters of creditnormally use the high value shipments. Because documentary credit are more safety, in this RONI BHOWMIK11
  12. 12. SHENYANG AEROSPACE UNIVERSITYINTERNATIONAL BUSINESSmethod provides a specific transaction with an independent credit backing and a clear cutpromise of payment.Importers need inbound collections handled expeditiously. Exporters needto reduce the riskof non-payment associated with selling goods overseas onan open-account basis. Both needto control the exchange of documents andreduce associated payment risk.Documentarycredit are highly useful when a buyer’s country has political or economic instability orrestrictive foreign exchange controls. Documentary collection, on the other hand, can be abetter option in some circumstances. Documentary collection can be much less expensive.This method is best used for parties that know each other well and do not anticipate anyfinancial problems between them, nor much risk of the buyer rejecting the goods. After thistwo circumstances study my opinion documentary collection is best if the bank check thatthey appear to have receive the documents specified in the collection order. But if bankdon’t follow their specified work that situation documentary credit better.References:  International Settlement Book – School of Economic- 2012  Trade Finance Guide  www.en.wikipedia.org/wiki/Credit_risk  Trade Payment Methods  www.pnc.com/international  www.exportbureaux.com  Credit and Collection Handbook by Michael Dennis  www.ubs.com  www.theblakefirm.com/finance-export-documents-letters-of-credit-international- trade  www.worldtraderef.com RONI BHOWMIK12

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