The major modes of international trade payment are:
- Advance Payment
- Open Account System
- Documentary Collection
- Documentary Credit (Letter of Credit)
Advance Payment System
Meaning of Advance Payment
Advance Payment is a mode of international trade payment where the importer remits full or partial payment to the exporter before shipment of goods. The exporter receives the funds first and then processes, manufactures and ships the goods as per the agreement.
Process Flow of Advance Payment
In this system:
- Importer remits money in advance
- Exporter receives payment
- Exporter processes and ships goods
- Documents are sent directly to the importer
- Importer receives goods and documents
Risk Position in Advance Payment
Under Advance Payment:
- All risks lie with the importer
- Exporter carries minimal or no commercial risk
- Risk includes non‑shipment, delayed shipment or quality issues
Role of Banks in Advance Payment
Banks only:
- Remit and disburse funds
- Do not assume trade risk or responsibility
There is no banking guarantee attached to the underlying trade transaction.
Suitability of Advance Payment
This system is generally used when:
- Exporter has strong bargaining power
- Goods are customized or made‑to‑order
- Trade relationships are limited or new
- Exporter is unsure of importer’s creditworthiness
Open Account System
Meaning of Open Account
Open Account is a trade arrangement where the exporter ships goods and sends documents directly to the importer without receiving payment initially. Payment is made later, usually after receipt of goods.
Process Flow of Open Account
Under this system:
- Exporter ships goods first
- Documents are sent to importer
- Importer receives goods and documents
- Importer remits payment later through DD, TT or MT
- Exporter collects proceeds through their bank
Risk Position in Open Account
In Open Account:
- All risks lie with the exporter
- Risk includes non‑payment or delayed payment
- Exporter relies on importer’s honesty and capability
Role of Banks in Open Account
Banks:
- Only remit and disburse funds
- Do not handle trade documents
- Bear no commercial or credit risk
Suitability of Open Account
Open Account is suitable when:
- Buyer and seller have long‑standing relationships
- Importer has strong financial standing
- Exporter operates in a highly competitive market
- Countries involved have low political and economic risk
Documentary Collection
Meaning of Documentary Collection
Documentary Collection is a trade payment method where the exporter ships goods and submits trade documents to their bank, which then forwards the documents to the importer’s bank for collection of payment or acceptance.
This method is governed by Uniform Rules for Collections (URC 522).
Parties Involved in Documentary Collection
Under Documentary Collection:
- Exporter is called the Drawer
- Importer is called the Drawee
- Exporter’s bank is called the Remitting Bank
- Importer’s bank is called the Collecting Bank
Process Flow of Documentary Collection
The process involves:
- Exporter ships goods
- Exporter submits documents to remitting bank
- Remitting bank sends documents to collecting bank
- Collecting bank acts as per exporter’s instructions
- Documents are delivered against payment or acceptance
- Collecting bank remits proceeds to remitting bank
- Exporter receives payment
Documents Against Payment (D/P)
Under D/P:
- Collecting bank releases documents only after payment
- Importer must pay to obtain documents
Documents Against Acceptance (D/A)
Under D/A:
- Importer accepts a usance bill
- Documents are released against acceptance
- Payment is made at maturity
Risk Position in Documentary Collection
In this system:
- Risk is moderate for exporter
- Importer may refuse documents or payment
- Banks do not guarantee payment
Role of Banks in Documentary Collection
Banks:
- Act only as intermediaries
- Follow instructions of exporter and importer
- Do not assume payment risk or responsibility
Suitability of Documentary Collection
Documentary collection is suitable when:
- Moderate level of trust exists
- Importer country risk is acceptable
- Goods are easily resellable
- LC is unavailable or costly
Documentary Credit (Letter of Credit)
Meaning of Documentary Credit
Documentary Credit, commonly known as Letter of Credit (LC), is the most secure method of international trade payment. It is an irrevocable undertaking by the issuing bank to pay the exporter, provided that documents are presented in strict compliance with LC terms.
Parties Involved in Documentary Credit
In a Letter of Credit transaction:
- Importer is called the Applicant
- Importer’s bank is the Issuing Bank
- Exporter is the Beneficiary
- Exporter’s bank may act as Advising Bank and Negotiating Bank
Process Flow of Documentary Credit
The LC process includes:
- Importer places order or sends proforma invoice
- Issuing bank opens the Letter of Credit
- LC is sent to advising bank
- Advising bank advises LC to beneficiary
- Beneficiary reviews LC terms
- Beneficiary processes and ships goods
- Documents are presented to negotiating bank
- Negotiating bank scrutinizes and negotiates documents
- Documents sent to issuing bank
- Issuing bank checks documents and makes payment or acceptance
- Proceeds are remitted through correspondent bank
- Transaction is settled
Risk Position in Documentary Credit
Under LC:
- Exporter’s risk is minimal
- Importer receives goods only against compliant documents
- Bank undertakes payment obligation
Role of Banks in Documentary Credit
Banks:
- Examine documents strictly
- Undertake payment obligation
- Act under UCP 600
- Ensure compliance but do not deal with goods
Suitability of Documentary Credit
Documentary Credit is suitable when:
- Trade involves large value
- Buyer and seller are unfamiliar
- Country or transfer risks exist
- Exporter requires bank financing
Comparative Overview of Payment Modes
Risk Comparison
- Advance Payment → Risk on importer
- Open Account → Risk on exporter
- Documentary Collection → Shared risk
- Documentary Credit → Risk minimized through banks
Bank Involvement Level
- Advance Payment → Minimal
- Open Account → Minimal
- Documentary Collection → Moderate
- Documentary Credit → High
Importance of Choosing the Right Payment Mode
Selecting the appropriate mode of international trade payment:
- Reduces commercial and financial risks
- Improves cash flow management
- Enhances trust between trading partners
- Ensures compliance with foreign exchange regulations
Understanding each payment mode is essential for exporters, importers, bankers and trade professionals involved in international commerce.
