Module III: International Trade Finance & Payment Systems

1. Modes of Payment in Trade Cash-in-Advance With this payment method, the exporter can avoid credit risk, since payment is received prior to the transfer of ownership of the goods. There are three types of cash- in advance- payment method: wire transfer, credit card, and payment by check. Wire transfers and credit cards are the most commonly used cash-in-advance options available to exporters. However, requiring payment in advance is the least attractive option for the buyer, as this method creates cash flow problems. Foreign buyers are also concerned that the goods may not be sent if payment is made in advance. Thus, exporters that insist on this method of payment as their sole method of doing business may find themselves losing out to competitors who may be willing to offer more attractive payment terms. Letters of Credit

Letters of credit (LCs) are among the most secure instruments available to international traders. An LC is a commitment by a bank on behalf of the buyer that payment will be made to the exporter provided that the terms and conditions have been met, as verified through the presentation of all required documents. The buyer pays its bank to render this service. An LC is useful when reliable credit information about a foreign buyer is difficult to obtain, but you are satisfied with the creditworthiness of your buyers foreign bank. An LC also protects the buyer since no payment obligation arises until the goods have been shipped or delivered as promised. The letters of credit can take many forms: irrevocable or revocable, confirmed, or special (transferable, revolving or standby) Documentary Collections

A documentary collection is a transaction whereby the exporter entrusts the collection of a payment to the remitting bank (exporters bank), which sends documents to a collecting bank (importers bank), along with instructions for payment. Funds are received from the importer and remitted to the exporter through the banks involved in the collection in exchange for those documents. Documentary collections involve the use of a draft that requires the importer to pay the face amount either on sight (document against paymentD/P) or on a specified date in the future (document against acceptanceD/A). The draft lists instructions that specify the documents required for the transfer of title to the goods. Although banks do act as facilitators for their clients under collections, documentary collections offer no verification process and limited recourse in the event of nonpayment. Drafts are generally less expensive than letters of credit. For more detailed information on the letter of credit payment method see chapter go to Chapter 4 of the Trade Finance Guide. To obtain a letter of credit, contact the international division of your bank

Open Account

An open account transaction means that the goods are shipped and delivered before payment is due, usually in 30 to 90 days. Obviously, this is the most advantageous option to the importer in cash flow and cost terms, but it is consequently the highest risk option for an exporter. Due to the intense competition for export markets, foreign buyers often press exporters for open account terms since the extension of credit by the seller to the buyer is more common abroad. Therefore, exporters who are reluctant to extend credit may face the possibility of the loss of the sale to their competitors. However, with the use of one or more of the appropriate trade finance techniques, such as export working capital financing, government-guaranteed export working capital programs, export credit insurance, export factoring, the exporter can offer open competitive account terms in the global market while substantially mitigating the risk of nonpayment by the foreign buyer. 2. Obtaining payments through Documents against Payment Documents against payment help to define a specific transaction of goods. They are often used in importing/exporting scenarios. The documents serve as a security for an agreement between a buyer and a seller. The items known as documents against payment, or D/P, are one form of commercial safeguard that often relies on a bill of exchange document. The bill of exchange sets up parameters for the use of D/P and the overall sale. The bill of exchange typically includes three parties. The first is the drawer, the party sending the goods. The second party is the drawee, or buyer, and the third is the payee, in many cases, the bank acting on behalf of the seller. In a documents against payment scenario, the bank will hold the ownership documents for the goods until they are paid for. This arrangement provides extra security for the seller, with the bank acting as an effective middleman for the trade. The buyer will often utilize a bank draft, or similar payment method, where the payment is guaranteed to be drawn against existing funds. Despite the design of the documents against payment process, experts reveal that the seller still has some significant risks. One is that the buyer could receive goods before the process is complete. Another very common risk of a D/P setup is that if the buyer refuses to pay, the physical goods are still stuck in the destination country, with the seller paying the tab for shipping them back to where they came from. A failed documents against payment transaction might leave the seller scrambling to offload or sell the assets at their destination, where getting a fair market price could be difficult. Regardless of the risks involved, documents against payment still offer a way for sellers to hedge against nonpayment, in the sense that the buyer typically will not be able to take control of the goods without paying. This process is similar to any document in lieu of payment situation that may be the norm in other kinds of transactions, and in different fields where trusted commerce is a necessity. For example, a vehicle transaction process can be a similar situation, where actual ownership has much less to do with physical control of the vehicle than with the name that is recorded on the vehicle title by the Department of Motor Vehicles. The private used car sale, where the car title is a kind of document

against payment, benefits from the additional paperwork in some of the same ways that an exporting agreement benefits from documents against payment. 3. Documents against Acceptance: Under the documents against acceptance (D/A) the buyer does not have to pay immediately. The buyer is given a credit period. He only pays on the maturity date of the accepted Bill of Exchange, which may be 30 days, 60 days, 90 days later or even longer. This method offers greater flexibility to the buyer in his cash flow and liquidity management as by the time he is required to pay, he should be able to sell the goods and secure payment from his debtors. Under this method, the seller is required to ship the goods first to the buyer. Upon shipment, the seller will obtain all the necessary documents like Bill of Exchange, Invoice, Bill of Lading (or other transport documents), Insurance Policy, Certificate of Origin and etc. He is also need to complete a collection order (furnished by his bank) with the appropriate instruction. The documents then will be presented to his banker (Remitting bank) where the documents will be checked to ensure they tally with the collection order. These documents will be air couriered to the buyers bank (Collecting bank). Upon receipt of the said documents, the collecting bank will present the Bill of Exchange to the buyer for acceptance. Acceptance means the buyer has to endorse on the back of the Bill of Exchange with a company seal. Upon acceptance, the Bill of Exchange will be returned to the collecting bank for safe keeping and the rest of the documents are delivered to the buyer to take possession of the goods. The collecting bank will notify the remitting bank of the acceptance as well as the maturity date. On maturity, the collecting bank shall debit the buyers account and remit the proceeds via MT202 to the remitting bank. What if the buyer fails to pay on maturity? In the first place, can the buyer refuse to pay under documents against acceptance? This is in fact the biggest risk faced by the seller under this method of payment. When the buyer refused to pay, the collecting bank will not pay the remitting bank which means that the seller will not receive his payment. In this case, the seller has to resolve the problem with the buyer. The remitting bank and the collecting bank are only acting as an agent and can not enforce any legal avenue to obtain payment from the buyer. Collections is not governed by the UCP but by another set of rules known as Uniform Rules for Collections (URC). 4. Bills of Exchange A written order from one person (the payor) to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand or at some fixed future date, a certain sum of money, to either the person identified as payee, or to any person presenting the bill of exchange. Notably, a document which purports to be a bill of exchange but which omits direction to the third-party money holder (often referred to as the drawee) to disburse to the payee, is not a bill of exchange. A check (or cheque) is the most common form of bill of exchange where the order is given to a bank in regards to monies on deposit by the payor.

"A bill of exchange is an unconditional order in writing addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand or a fixed or determinable future time, a sum certain in money, to order or to bearer." An instrument that does not comply with (these) requirements, or that orders any act to be done in addition to the payment of money, is not, except as hereinafter provided, a bill." 5. Letters of Credit Letters of credit are often used in international transactions to ensure that payment will be received. Due to the nature of international dealings including factors such as distance, differing laws in each country and difficulty in knowing each party personally, the use of letters of credit has become a very important aspect of international trade. The bank also acts on behalf of the buyer (holder of letter of credit) by ensuring that the supplier will not be paid until the bank receives a confirmation that the goods have been shipped.

A statement issued by a bank to the buyer of a good stating that the seller will receive payment on time and in the correct amount. If the buyer fails to make payment, the bank will do so on his/her behalf. The buyer presents a letter of credit to the seller, which virtually eliminates the risk that the seller will not be paid. Letters of credit have become very common in international commerce, as distance and other factors make it difficult for sellers to establish the creditworthiness of every buyer. 6. Bill discounting with Banks Business activities across borders are done through letter of credit. Letter of credit is an instrument issued in the favor of the seller by the buyer bank assuring that payment will be made after certain timer frame depending upon the terms and conditions agreed, it could be either sight, 30 days from the Bill of Lading or 120 days from the date of bill of lading. Now when the seller receives the letter of credit through bank, seller prepares the documents and presents the same to the bank. The most important element in the same is the bill of exchange which is used to negotiate a letter of credit. Seller discounts that bill of exchange with the bank and gets money. Discounting bill terminology is used for this purpose. Now it is seller's bank responsibility to send documents and bill of exchange to buyer's bank for onward forwarding to the buyer for the acceptance and the buyer finally, accepts bill of exchange drawn by the seller on buyer's bank because he has opened that LC. Buyers bank than get that signed bill of exchange from the buyer as guarantee and release payment to the sellers bank and waits for the time span. 7. Telegraphic transfers The telegraphic transfer is a means of wiring funds from one location to another. Originally, telegraphic transfers made use of the telegraph as a means of transferring money between a point of origin and a point of termination. Today, the process of transferring money between two parties no longer involves the telegraph, but the use of the term remains common in several countries. Sometimes referred to as a Telex Transfer or simply TT, the telegraphic transfer has long been a means of communication between banking institutions. In days gone by, the telegraphic transfer could be used to send money from an account in one bank to an account at a bank located anywhere else in the world. Generally, there were charges associated with the performance of a telegraphic transfer, with both the sender and the recipient paying a small fee for the transaction.

Well into the 20th century, persons could also make use of a telegraphic transfer to move entire balances of funds from one bank to another. For example, a person living in New York City may take a job located in Los Angeles. Rather than withdrawing funds from existing bank accounts and physically transporting the funds across the country, the individual would establish new accounts in Los Angeles and then authorize the two banks involved to transfer all the funds into the new accounts. At that point, the accounts at the New York bank would be closed.
8. SWIFT

The Society for Worldwide Interbank Financial Telecommunication (SWIFT) provides a network that enables financial institutions worldwide to send and receive information about financial transactions in a secure, standardized and reliable environment. SWIFT neither holds funds nor manages client accounts. It began operating in 15 countries in 1973 and now operates in 210 countries. By April 2012, the co-op was delivering an average of 18,306,753 messages a day - up from 12,265,837 messages per day in January 2007. SWIFT is headquartered in Belgium and has offices in the United States, Brazil, Australia, India, Japan, Korea, Austria, Belgium, France, Germany, Italy, South Africa, Spain, Sweden, Switzerland, the United Kingdom, UAE and Russian Federation. Although it does not assist its members with the actual funds transfer, the Society for Worldwide Interbank Financial Telecommunication does send orders for payment that are settled through individual accounts maintained by member institutions. The organizations member institutions create financial messages formatted for use with the specialized SWIFT network so that they can be delivered quickly and securely to other members. A vast amount of the financial messages that are transmitted internationally are sent using this specialized network.

The SWIFT-messaging network operated by the Society for Worldwide Interbank Financial Telecommunication is managed by operational centers located in the Netherlands and the U.S. These secure messaging centers share real-time information with each other so that if one of them encounters a problem, the other center can take over the operations of the entire network. The Society for Worldwide Interbank Financial Telecommunication conducts most of its SWIFT messaging services in areas such as payments and cash management, treasury and derivatives, securities, and trade services. In addition to its financial messaging service, the Society for Worldwide Interbank Financial Telecommunication also offers its members secure personal messaging known as SWIFTNet mail. This service allows members to send their most important email messages by means of the secure SWIFT network rather than via the open Internet. SWIFTNet mail is designed for transmitting sensitive documents such as contracts, signatories, and invoices, and is intended to eliminate the need for traditional courier services. The Society first made this service available to its members in 2007. 9. What is Fraud? Fraud is a deliberate misrepresentation that causes a person or business to suffer damages, often in the form of monetary losses. All of these elements are usually required

for an act to be considered fraud; if someone lied about his name, for example, it would not be fraud unless in so doing, the person caused someone else to lose money or suffer some other damage. There are many different types, from identity theft to insurance fraud to falsifying tax information, and making false statements can often be one element of another crime. Although usually prosecuted in criminal court, fraud can also be tried under civil law. Module IV: International Banking 1. Nostro/Vostro Accounts Both Nostro and Vostro account are normally used in the context of foreign exchange transactions done by the banks or during currency settlement. Nostro Account It is the overseas account which is held by the domestic bank in the foreign bank or with the own foreign branch of the bank. For example the account held by state bank of India with bank of America in New York is a Nostro account of the state bank of India.or A Nostro Account is an account denominated in a foreign currency established through your local bank at a bank in the respective country of the currency desired. The terms "nostro" and "vostro" are derived from Latin terms meaning "ours" and "yours" respectively. For example, if you live in the United States and ask you local bank to set up a Euro account for you, they will most likely open a "Nostro Account" with a correspondent agent bank in the European Union that they have a banking relationship with for that specific purpose. The Euro bank will set up the account, but it is not a typical checking account. These accounts are treated differently on the books of the bank. Transactions to and from these accounts may only be wire transfers to ensure identity credentials are monitored and that special handling is used. Generally, companies will use these types of accounts when they often either buy or sell in another country but do not have a physical presence that would afford them usage of a typical checking account arrangement. Vostro Account It is the account which is held by a foreign bank with a local bank, so if bank of America maintains an account with state bank of India it will be a vostro account for state bank of India. A vostro bank account is an account that one party is holding for another party. In a vostro account, the administrators are not actually the owners of the money. They must keep this account solvent on behalf of its owner. Vostro account administrators, often banks, frequently pay interest to other parties for the use of their money. Vostro accounts are just a way of talking about who owns the capital invested in them. To a customer who puts money into a bank account, that account is a nostro account, meaning that it belongs to that person. From the standpoint of the bank, it is a vostro account, meaning that it is not the banks own money, but the customers, and the bank bears a responsibility for good accounting of the customers money. This makes sense, since voster in Latin or vuestra in Spanish means yours.

From the above one can see that the account which is Nostro for one bank is Vostro for another so when SBI opens a Nostro account with Bank of America, it is a Vostro account for them and vice versa. For example UBS of Switzerland opening an account in SBI in India, this is vostro account for SBI India. 2. CHIPS : Clearing House Interbank Payment System CHIPS is a real-time computerized system for transmitting and settling U.S.-dollar payments among its participating banks. The Clearing House began operating CHIPS in 1970 to simplify and expedite interbank payments in New York City. Is the main privately held clearing house for large-value transactions in the United States, settling well over US$1 trillion a day in around 250,000 interbank payments. Together with the Fedwire Funds Service (which is operated by the Federal Reserve Banks), CHIPS forms the primary U.S. network for large-value domestic and international USD payments. 3. CHAPS : Clearing House Automated Payments System. A British company that facilitates the trading of European currency. CHAPS provides same-day fund transfers for the sterling and the euro. CHAPS transfers are used when money needs to be moved from one account to another. CHAPS transfers are fairly costly, with an average fee of 30 pounds per transfer. CHAPS eliminates float time that occurs with cheque writing and prohibits the sender from rescinding the payment CHAPS was first established in London in 1984. It is currently used by 19 settlement banks (including the Bank of England) and over 400 submember institutions. In 2004, CHAPS averaged 130,000 transactions per day, moving 300 billion pounds sterling. New, lower cost transfers have recently become available from the CHAPS system. The Clearing House Automated Payment System or CHAPS is a British company established in London in 1984, which offers same-day sterling fund transfers. CHAPS is a member of the trade organisation APACS, and the EU-area settlement system TARGET. 4. Electronic banking : For many consumers, electronic banking means 24-hour access to cash through an automated teller machine (ATM) or Direct Deposit of paychecks into checking or savings accounts. But electronic banking involves many different types of transactions. Electronic banking, also known as electronic fund transfer (EFT), uses computer and electronic technology as a substitute for checks and other paper transactions. EFTs are initiated through devices like cards or codes that let you, or those you authorize, access your account. Many financial institutions use ATM or debit cards and Personal Identification Numbers (PINs) for this purpose. Some use other types of debit cards such as those that require, at the most, your

signature or a scan. For example, some use radio frequency identification (RFID) or other forms of "contactless" technology that scan your information without direct contact. The federal Electronic Fund Transfer Act (EFT Act) covers some electronic consumer transactions. EFTs offer several services that you may find practical: ATM, Direct Deposit, Pay by Phone, Personal Computer, Debit Card, Electronic Check. 5. Role of International Banks : An international bank is a financial entity that offers financial services, such as payment accounts and lending opportunities, to foreign clients. These foreign clients can be individuals and companies, though every international bank has its own policies outlining with whom they do business. According to OCRA Worldwide -- an organization that matches people and companies to international banking -- international banks tend to offer their services to companies and to fairly wealthy individuals, i.e., people with $100,000 and counting [source: OCRA]. But plenty of international banks, particularly Swiss banks, open their doors to customers of any income bracket Companies do business with international banks to help facilitate international business, the complexities of which can be quite costly. Individuals work with international banks for a number of reasons, including tax avoidance, probably the term you've heard the most in relation to offshore banking. Tax avoidance isn't necessarily illegal, as you will learn on the pages that follow. But there are plenty of other hazards in international banking. 6. Role Of Corresponding Banks:
A financial institution that provides services on behalf of another, equal or unequal, financial institution. A correspondent bank can conduct business transactions, accept deposits and gather documents on behalf of the other financial institution. Correspondent banks are more likely to be used to conduct business in foreign countries, and act as a domestic bank's agent abroad. Correspondent banks are used by domestic banks in order to service transactions originating in foreign countries, and act as a domestic bank's agent abroad. This is done because the domestic bank may have limited access to foreign financial markets, and cannot service its client accounts without opening up a branch in another country

7. Bid Price:
The price a buyer is willing to pay for a security. This is one part of the bid with the other being the bid size, which details the amount of shares the investor is willing to purchase at the bid price. The opposite of the bid is the ask price, which is the price a seller is looking to get for his or her shares.

The use of bid and ask is a fundamental part of the market system, as it details the exact amount that you could buy or sell at any point in time. Remember that the current price is not the price for which you can purchase the security, but the price at which the shares last traded hands. If you want to get an idea of the price for which you can buy a security, you need to look at the bid and ask prices because they will often differ from the current price. 8. Ask Rate: ask rate is the lowest amount a seller is willing to accept for a given currency trade. It is also known as the ask price, best ask price, or ask amount. Ask rates have an equivalent opposite in the world of currency trading known as the best offer or offer rate. The difference between these two amounts is known as the spread. The spread is typically a few tenths to hundredths of cent in value. This amount is simply the space between where two parties looking to trade a currency exist. Much like any purchase, such as a car or home there exists an amount the seller wants and an amount a buyer is willing to pay. If you were to ask someone what was the lowest amount they would be willing to accept for the car or house they were selling, in currency trading that amount would be their ask rate. Except in currency trading the amount set is not up to the investor themselves, but rather determined by market makers. Sellers and buyers of currency on the major markets, typically major international banks. 9. Travelers Cheques A traveler's cheque is a preprinted, fixed-amount cheque designed to allow the person signing it to make an unconditional payment to someone else as a result of having paid the issuer for that privilege. They were generally used by people on vacation instead of cash as many businesses used to accept traveller's cheques as currency. If a traveler's cheque were lost or stolen, they could be replaced by the issuing financial institution. Their use has been in decline since the 1990s as alternatives, such as credit cards, debit cards and automated teller machines became more widely available and were easier and more convenient for travelers One of the most important benefits of using travelers checks is that it is virtually impossible to use a stolen travelers check. This is because the checks are signed at the time of purchase, and then must be countersigned when they are redeemed with a vendor or bank. Since the likelihood that it would be possible to replicate the original signature without hesitation, thieves do not find the checks as attractive as credit or debit cards. Travelers checks can also allow the international traveler to take advantage of attractive rates of exchange. 10. Fixed vs. Floating Rate Loans 1. Interest Rate Trends Economists are predicting low interest rates to continue in end of 2011 after which interest rates will start rising again.* A floating rate on a business loan converted into a fixed rate takes advantage of imminent rate decreases while giving the borrower an opportunity to lock in a low rate after a period of one to two years. Over the next year when interest rates bottom out, entrepreneurs should apply for

business loans with fixed interest rates in case the Fed increases rates. Repeated Fed rate cuts (for at least three quarters) indicate that interest rates have bottomed out. Similarly, when the Fed stops raising the interest rates for two to three quarters, it means rates are on their way down and it may be an opportune time to apply for a business loan with a floating interest rate. 2. Cash Flow Needs Generally, floating interest rate business loans require lower (anywhere between 50 to 75 basis points) initial payments than fixed rate products. This frees up cash flow for startup companies or other businesses with large initial costs or break even periods like franchises or security services. Enterprises like hotels and restaurants that have large initial capital outlay should also take a business loan with floating rates. Fixed interest rate business loans provide more capital support for needs like expansion plans or refinancing, especially in a rising interest rate environment. Businesses with low initial outlay like real estate brokerage and advisory business require consistent money for marketing and meeting payroll expenses. Such enterprises should apply for business loans with fixed interest rates. 3. Time Horizon In selecting a business loan product, the owner needs to consider how long they want to keep the business, their exit strategy and the types of improvements they can make to increase the business valuation. This will help them choose a business loan based on prepayment penalties. For example, normally an SBA-backed business loan has three years of prepayment penalties. If somebody is planning to refinance or sell a business within three years, they will have to pay the penalty. Other product lines like conventional commercial asset-backed business loans may provide a longer fixed rate term and prepayment penalty period.