External Payment Methods in International Trade: Remittances and Documentary Credits

Summary

This document explains the main external payment methods used in international trade, including payment orders, simple and documentary remittances, and documentary credits. It outlines the trade-off between security and flexibility, the role of financial documents such as bills of exchange, promissory notes and checks, and how each method allocates risk between importer and exporter.

Key points

Greater security in international payments generally means less flexibility, and vice versa.
Financial documents such as bills of exchange, promissory notes and checks guarantee payment.
Payment orders rely on high trust because goods are usually delivered before payment is made.
Simple remittance sends goods and documents separately, while the bill of exchange is sent for collection.
Documentary remittance releases documents against payment or acceptance, but the exporter still risks refusal of the goods.
Documentary credits are governed by the UCP and require the issuing bank to pay on presentation of specified documents.
A confirming or advising bank in the exporter's country can add certainty to a documentary credit.

Test yourself

External Payment Methods in International Trade

The choice of external payment methods in international transactions often involves a trade-off: greater security typically results in less flexibility, and conversely, less security means more flexibility.

Essential Documents in International Transactions

Documents are crucial in international transactions and are often categorized into business documents, financial documents, transport documents, and insurance documents. Financial documents, directly related to formalizing payment and guaranteeing repayment, commonly include:

Bills of exchange
Promissory notes
Checks

Key External Payment Mechanisms

Payment Orders

Payment orders are similar to bank transfers. Their use is common when there is a high level of trust between the importer and exporter. Unlike checks and bills of exchange, there is a lack of uniform international law governing payment orders. They involve an issuing bank and a paying bank. The exporter typically delivers the goods prior to the importer issuing the payment order, thus requiring a significant level of trust between the parties.

Simple and Documentary Remittances

Sometimes, international sales are conducted through a bill of exchange that the exporter presents for acceptance by the importer. In these cases, we primarily find two types of remittances:

Simple Remittance: The exporter sends the goods along with accompanying documents, while the bill of exchange is sent separately for collection.
Documentary Remittance: This method aims to mitigate the risks associated with delivering goods' documents prior to acceptance or payment. With a documentary remittance, the delivery of documents related to the goods is made by the exporter against either payment or the acceptance of a bill of exchange. It is a widely used payment method offering an adequate level of security for both parties, as the delivery of goods is simultaneous with payment or a legal commitment to it. However, from the exporter's perspective, there is still a risk of the importer refusing the goods, which can cause serious harm, especially with perishable materials or custom-made items.

Documentary Credits

Documentary credits are a widely used payment method in international trade that balances the interests of both importer and exporter, minimizing uncertainty for all parties. Supranational rules, such as the Uniform Customs and Practice for Documentary Credits (UCP), govern their use.

A documentary credit is an effective payment method where the importer (applicant/payer) instructs their bank (issuing bank) to open a letter of credit in favor of the exporter (beneficiary). This instructs the bank to pay the transaction price upon the presentation of specified documents, which confirm the dispatch of goods to the importer. While a documentary credit can involve only the issuing bank, it is common and often provides more certainty to involve a second bank in the exporter's country (e.g., an advising or confirming bank).

FAQ

What is a documentary credit in international trade?

A documentary credit is a payment method in which the importer instructs their bank to open a letter of credit in favor of the exporter. The bank pays the transaction price when the specified documents confirming dispatch of the goods are presented.

Why is a payment order considered risky for the exporter?

The exporter typically delivers the goods before the importer issues the payment order, so it requires a significant level of trust between the parties. There is also no uniform international law governing payment orders.

What is the main risk of documentary remittance for the exporter?

Even though documents are delivered against payment or acceptance, the importer may still refuse the goods. This can cause serious harm, especially with perishable or custom-made items.