Question
What are the various methods of payment in International Trade? How do a Letter of Credit and Banker's Acceptance help in making international trade safe and smooth?
Answer :
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Skip in 10
International trade involves buyers and sellers located in different countries, operating under different legal systems, currencies, and business practices. Because of distance, time lag, political risk, exchange risk, and lack of mutual trust, settlement of payments becomes a critical issue. To overcome these difficulties, various methods of payment have evolved in international trade, each differing in terms of risk, cost, and convenience for exporters and importers. The commonly used methods include advance payment, open account, documentary collection, letters of credit, and banker’s acceptance, along with modern electronic and interbank settlement mechanisms. Advance payment is the simplest method from the exporter’s point of view, where the importer pays the full amount or a substantial part of the value of goods before shipment. This method minimizes the exporter’s risk of non-payment but places a heavy risk on the importer, who must rely on the exporter to ship goods of the agreed quality and quantity. Therefore, advance payment is generally used when the exporter has strong bargaining power, when goods are made to order, or when there is high political or credit risk in the importer’s country. The open account method represents the opposite situation. Under this arrangement, goods are shipped first and payment is made by the importer at a later date, usually within 30, 60, or 90 days. This method is highly favorable to the importer as it improves cash flow and reduces financing costs, but it exposes the exporter to the risk of delayed payment or default. Open account transactions are common when there is a long-standing relationship between the trading partners, strong mutual trust, or when exporters face intense competition in international markets. Documentary collection is a widely used intermediary method governed by the rules of the International Chamber of Commerce. Under this method, the exporter ships the goods and submits shipping documents such as the bill of lading, invoice, and insurance policy to their bank, which forwards them to the importer’s bank for collection of payment. Documentary collection may be either documents against payment, where documents are released
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