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?
1. SHENYANG AEROSPACE UNIVERSITYINTERNATIONAL BUSINESS
Dr. JUN-QI LIU
Professor
Shenyang Aerospace University
RoniBhowmik
Master’s Program
International Business
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# How to manage the risk for the principal under the documentary collection in
International Business?
How risky is it?
A variety of payment methods is used in international business, with payment taking place
at a different stage of the export deal in each. In general, this means that each method has a
different level of non-payment risk for the exporter, and non-delivery risk for buyer.The
diagram below illustrates the risk of documentary collection compared with other payment
methods.
As my study, Documentary Collections may be settled in two different ways. A document
against Payment (D/P) refers to a Collection where the Importer receives the documents
only in exchange for payment. With Documents against Acceptance (D/A), the Importer may
obtain the documents in exchange for the acceptance of the obligation to pay at a specified
future date. These two methods of settlement carry different risks for both Importers and
Exporters.Generally risk can be categorized in lack of credit information, lack of personal
contract, difficult expensive collections, no easy legal recourse, higher litigation costs and
mistrust.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,
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Commercial Credit risk,
Transfer risk,
Country risk etc.
I just try to share my study and experience opinion –
1. Payments after arrival of goods
Exporter is exposed to more risk as documentary collectionterms are more convenient and
cheaper than documentary collection to the importer. So in this situation, generally
importer most of the time choose to documentary collection process. Documentary
collection may be favour the importer or buyer since payment is deferred by him until the
goods arrive or even later if delayed payment arrangements are agreed to.May increase
buyer market competitiveness, as this payment method is relatively low risk for overseas
buyers and may also help their cash flow. But by defaulting on a bill of exchange he/she
may become legally liable. Not only legally liable also his/her trade reputation may be
damaged if the collection remains unpaid.
2. High risk of exporter for getting payments
Most importantly, the seller must realize that the banks will pay only if and when the buyer
pays them, Banks do not assume the obligation to pay. Documentary collections do not
guarantee that the buyer will be willing and able to pay as agreed. Sometimes buyer delay
to pay and sometimes will not agree to pay. However, ifpayment is not made, the buyer
won’t be able to obtain title to the goodsif the buyer is unwilling or unable to pay or accept
the order to receive the documents, then the seller will retain titleto the goods and control
of the documents.Seller risk of non-payment after delivery of Seller goods may be greater
than in some other payment methods. If seller bill of exchange specifies payment at a date
after delivery, seller hand over control of the goods but run the risk of non-payment on the
due 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 the
goods.The seller will also face the effort and expense of dealing withgoods already shipped
to a foreign port.
If the buyer defaults on an accepted draft, then the seller will have a strong legal position
but will also be confrontedwith the cost and effort associated with legal action. If more
protection is needed, then the seller should considerrequiring the buyer to use a letter of
credit.
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3. Currency risk
Currency risk can arise due to variations in exchange rates, currencies fluctuate regularly
and there may be a delay between the time of entering into a contract and the making of
the foreign payment to the supplier. In Sometimes buyer delay to pay in the documentary
collection method, that times seller face the currency risk.The local currency amount
payable on settlement may be higher than the amount calculated when entering the
contract, due to an adverse movement in the market price of the currency. Movements in
exchange rates may significantly affect the profit margin seller expect to retain on seller’s
international 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 period
between prices being agreed and payment being received.
4. Non-performance/non delivery risk
When dealing with a seller there is always a risk of non-performance, this may be
heightened when dealing with an overseas seller. Seller may not perform according to the
sales contract, either by delivering the wrong or inferior goods or not delivering at all or not
at the agreed time. Because in documentary collection methods will not obligated or
guarantee seller/buyer must do this. Seller may not be willing or able to perform as
contracted; these events may be the result of things outside the control of the seller, like
industrial 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 lose
customers 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
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5. Commercial Credit risk
Credit 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 import
documentary collection. In this method payment is not assured by the bank which issues a
documentary collection. If full or partial payment is made to the seller prior to shipment, the
importer may find that any payments made are not returned.
Consider importing goods using conditional methods of payment such asimport
documentary letter of credit. Import Documentary Letter of Credit is an ideal way to
facilitate payment to the supplier with some in-built safeguards.
6. Transfer risk
When a contract of sale specifies payment is to be made in a particular currency, a 'Transfer
risk' may also exist.A change in government regulations may prevent or restrict ability to
make payments or exchange foreign currency; many countries regulate the transfer of
money and conversion of foreign currency receipts.Unexpected regulatory changes may
occur without warning, meaning that transactions already agreed to may not be able to be
completed, resulting in financial loss to either or both parties.
7. Country risk
Country risk may occur if government regulations prevents or restricts the movement of
particular goods, this could occur during a significant event such as war, terrorism,
government bankruptcy or economic embargoes.Many countries regulate the import and
export of goods. Unexpected regulatory changes can occur without warning, such as
cancellation of permits or licences, transactions already agreed to, may not be able to be
completed, resulting in financial loss to either party. In documentary collection methods
seller and buyer both are face this problem.
In any business transaction, there are risks. However, these risks are emphasized when
dealing internationally. Added to the commercial risks present in a domestic transaction are
foreign exchanges as well as country risks. Exporter is exposed to more risk as documentary
collection terms are more convenient and cheaper than documentary credit to the
importer.All included the documentary collection offers straightforwardness between trade
partners as well as the payment is quicker than other methods. Usually the political and
transfer risks are not covered, I try to share my idea how to manage the risk-
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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 of
businesses that we, the People don’t want.”Government creates the “public structures” that
support smaller, innovative business. Government defines the playing field for business,
right down to defining and regulating the money itself. Government creates the laws that
define what business even is, and the police and courts to enforce that law. Government
provides the infrastructure that is the soil in which businesses thrive or wither and die.
Government educates the employees and innovators. Government negotiates the trade
agreements that let businesses sell outside the country, and is supposed to protect country
businesses from being undercut by those in other countries.
It is a universal economic fact that without a proper Governance the trade and businesses
would not thrive along the right direction. After the Second World War the totally destroyed
nations such as Japan and Germany were helped to revive their economy. These two
national economies went forward whereas that of other countries involved in the war
gradually went down and down. If we look at the fate of recession in Russian economy, the
unemployment rate in America and the totality of degradation in the other European
countries including that of Great Britain. Whereas the economies of emerging Nations such
as China, India and Singapore as well as Malaysia, not to mention those affected by the Arab
Spring movements, is much safer to follow as models. The Good Governance for
International Business index provides a timely and useful resource for business leaders and
governments alike. International payment transactions with the importing country must not
be hampered or threatened by currency controls or any other such restrictions.Sellerhas no
doubts about the buyer's ability to meet its payment obligations, if the political and
economic situation in the buyer's country is stable, if there are no foreign
exchange restrictions in the seller's country. So need strong and stable political government
for managing the all type business risk.
2. Need strong Banking support
The bank’s legal liability is set out in the uniform rules for collections. Banks, therefore, act
as intermediaries to collect payment from the buyer in exchange for the transfer of
documents that enable the holder to take possession of the goods. Bank must check that
they appear to have received the documents specified in the collection order, but they have
no liability to examine the documents in more detail. However, in practice the remitting
bank will make the some additional check before it sends the documents abroad. Bank
makes sure that the instructions on the collection order are logical, and also the bill of
exchange is correctly drawn, signed and endorsed. If any are missing, an explanation should
be obtained and the collecting bank must be advised accordingly. If bank make sure all
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documentscheck clearly maybe document collection method day by day continuing their
popular 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 importer
To understand your fear is the beginning of really seeing- Bruce Lee. Make any relationship
at first need believe. As like also, business at first condition need to be a relationshipof trust
between the seller and the buyer.There must be no doubt as to the importer's willingness
and ability to pay.
At last I say that, make international tradeoperations more flexible, use documentary
collection in cases when the seller does not want to deliver goods to the buyer on “open
account” basis, but due to a long-term stable business relationship between the parties
there 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 buyer's
ability to meet its payment obligations, if the political and economic situation in the buyer's
country is stable, if there are no foreign exchange restrictions in the seller's country.
Documentary collection is convenient for the buyer also because: there is no need for an
advance payment; payment for goods can be made when shipping documents have been
received, in cases of documents released against acceptance the buyer has the possibility to
sell the goods first and afterwards make payment to the seller. Documentary Collection
assures the seller that the shipping documents will be released to the buyer only upon
payment or acceptance of a bill of exchange.
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# Please do some compare between documentary collection and documentary credit?
Exporting overseas is one way for a business to grow, but it won't succeed if the buyers fail
to pay promptly. The business world has developed several methods for guaranteeing
payment even when the buyer and seller are half the world apart. At first necessary to know
what 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 seller
sends the shipping documents and a draft for payment to the buyer's bank. The bank, acting
as middleman, sends the documents to the buyer, who's the one responsible for paying the
draft.
Documentary Credit or Letter of Credit:
A letter of credit is a commitment by the buyer's bank to pay for the goods, according to the
U.S. Department of Agriculture. Before paying, the bank will require the seller fulfil the
terms of the letter exactly. Typically, that includes delivering the goods and providing
documentation for example an invoice, a packing list, and a certificate of origin drawn up
exactly as the letter dictates.
Documentary credit and documentary collections both guarantee payment when the terms
are met but there are important differences between them. I try to show my study learning
and my little experience-
1. Will They Pay
Documentary credit or letters of credit is measured a dependable guarantee of payment,
which makes it an outstanding choice when the consumer and supplier haven't done
business together. If a Bangladeshi bank working with the buyer's bank confirms the letter,
it's even safer. Documentary collection is less sure because the cash comes from the buyer,
not the buyer's bank, so if the buyer refusesor declines to pay for any reason, the supplier is
out of luck.
2. Commercial Credit Risk
In documentary credit or letters of credit eliminates the commercial credit risk, because
payment is assured by the bank which issues an irrevocable documentary credit. The seller
no longer needs to rely on the willingness and capability of the buyer to make payment.
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Consider importing goods using unconditional methods of payment such as import
documentary collection. In documentary collection method payment is not assured by the
bank which issues a documentary collection.
3. Cost or Expense
Documentary credit or letter of credit is more costly than documentary collection because
of the fees charged by the buyer's bank. If one supplier insists on a letter while another bids
to accept a cheaper method, such as documentary collection, the lower fees may give the
second trader an edge in doing trade.While a letter of credit often costs between 1%-2% of
the total payment obligation,documentary collection can be much straightforward and less
expensive settlement process.
4. Exact Requirements
One disadvantage to documentary credit or letter of credit compared to documentary
collection is that any departure from the terms of the letter, including improperly prepared
documents, gives the bank grounds to reject payment. The supplier must then pay to have
the goods returned, find a new buyer or negotiate a lower sales price in return for the
bank's receiving.
5. Prepares and Presents Documents
In a documentary collection, the seller prepares and presents documents to the bank in
much the same way as for a documentary letter of credit. However, there are two major
differences between a documentary collection and a documentary credit: (1) the draft
involved is not drawn by the seller (the "drawer") upon a bank for payment, but rather on
the buyer itself (the "drawee"), and (2) the seller's bank has no obligation to pay upon
presentation but, more simply, acts as a collecting or remitting bank on behalf of the seller,
thus earning a commission for its services.
6. Boat Freight
Documentary collection is supremesuitable when goods are shipped overseas by boat or
ship. The ocean bill of lading is a negotiable document that gives title to the goods; the
shipper won't release the goods unless the buyer has the bill of lading, and the buyer can't
get the bill without paying the draft.
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7. Banking Guaranty
In documentary collection bank have no liability to examine the documents in more detail
and also don’t guarantee that the buyer will be willing and able to pay as agreed. But in vase
versa letter of credit are highly secure because if the buyer doesn’t agree to pay, buyer bank
will be willing and able to pay as agreed.
8. When Use
Letters of credit are used primarily in international trade for large transactions between a
supplier in one country and a customer in another. Letters of credit are perhaps most useful
for doing business with a person or company that you do not know well.In such cases, the
International Chamber of Commerce Uniform Customs and Practice for Documentary
Creditsapplies (UCP 600 being the latest version). But if the relationship of trust between
the exporter and the importer that time normally use documentary collection.
9. Political or Economic Instability
Letters of credit are highly useful when a buyer’s country has political or economic
instability or restrictive foreign exchange controls. International payment transactions with
the importing country must not be hampered or threatened by currency controls or any
other such restrictions. In strong government politically, economically and legally stable
country normally use documentary collection.
10. Time Consuming
In documentary collection no need long time for opening bank account, so Payment is
usually quicker than with open account, but on the other hand letters of credit or
documentary credit have need long time for opening bank account. So, documentary credit
use only when the buyer has enough time available, because in this method need long time.
11. High Value Shipment/s
High value shipments need more safety or security, but in documentary collection bank
have no liability to examine the documents in more detail and also no guarantee of payment
or immediate payment by the buyer. Another side documentary credit or letters of credit
normally use the high value shipments. Because documentary credit are more safety, in this
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method provides a specific transaction with an independent credit backing and a clear cut
promise of payment.
Importers need inbound collections handled expeditiously. Exporters needto reduce the risk
of non-payment associated with selling goods overseas onan open-account basis. Both need
to control the exchange of documents andreduce associated payment risk.Documentary
credit are highly useful when a buyer’s country has political or economic instability or
restrictive foreign exchange controls. Documentary collection, on the other hand, can be a
better 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 any
financial problems between them, nor much risk of the buyer rejecting the goods. After this
two circumstances study my opinion documentary collection is best if the bank check that
they appear to have receive the documents specified in the collection order. But if bank
don’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
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