Letter of credit, Document against acceptance, Document against payment and Telegraphic Transfers (Mode of Payments In International Business)

In the context of international trade and foreign exchange transactions, several payment mechanisms help manage risks and ensure that transactions proceed smoothly. These mechanisms include

  1. Letter of Credit (L/C),

 2. Document against Acceptance (D/A),

 3. Document against Payment (D/P), and

 4. Telegraphic Transfers (T/T).

Let’s explore each of these in detail:

1. Letter of Credit (L/C)

A Letter of Credit (L/C) is a financial document issued by a bank, guaranteeing that a seller will receive payment from the buyer as long as they meet the terms and conditions specified in the L/C. It is commonly used in international trade to reduce risk for both parties, ensuring that the seller will be paid upon fulfilling their obligations and that the buyer will only pay once the conditions are met.

Key Features:

• Issuance: The buyer applies for an L/C through their bank, which acts as an intermediary.
• Conditions: The seller must provide specified documents (e.g., shipping documents, commercial invoice, etc.) to the bank to prove that the goods have been shipped as agreed.
• Payment Guarantee: The bank guarantees payment to the seller if all terms of the L/C are satisfied, ensuring security for the seller.
• Types of L/C:
• Revocable: Can be modified or canceled by the buyer without the seller's consent.
• Irrevocable: Cannot be changed or canceled without the agreement of all parties involved.
• Confirmed: A second bank confirms the L/C, adding further security for the seller.

Advantages:

• Provides security for both parties by ensuring that the buyer will not pay until the seller has met all conditions.
• Reduces the risk of non-payment for the seller.
• Used in high-value transactions or those where the buyer and seller have no prior relationship or trust.

Disadvantages:

• High cost due to bank fees.
• Complex documentation and processes can delay the transaction.
• Can be time-consuming and may involve intermediary banks.

2. Document against Acceptance (D/A)

Document Against Acceptance (D/A) is a payment arrangement where the buyer agrees to pay for the goods at a later date, typically 30 to 90 days after the acceptance of a draft. The seller ships the goods and submits the shipping documents to their bank, which forwards them to the buyer’s bank. The buyer can take possession of the goods only after agreeing to pay on a future date (i.e., they "accept" the draft).

Key Features:

• Time-Based Payment: The buyer commits to paying after a certain period (e.g., 30 or 60 days) once they accept the terms.
• Documentary Exchange: The seller ships the goods and submits the shipping documents (such as bills of lading) to the bank, which then sends them to the buyer’s bank.
• Buyer’s Obligation: The buyer accepts the draft (a promise to pay) before receiving the documents and taking possession of the goods.

Advantages:

• Less costly than Letters of Credit, as no bank guarantee is involved.
• Suitable for established, trusted trading partners.
• Offers the buyer a grace period to pay.

Disadvantages:

• High risk for the seller since the buyer can delay or default on payment after receiving the goods.
• Not suitable for new or untrusted buyers.
• The seller may not have full control over the goods until payment is made, which could be a concern if the buyer is not reliable.

3. Document against Payment (D/P)

Document Against Payment (D/P) is similar to Document against Acceptance, but the difference lies in the payment terms. Under D/P, the buyer must pay for the goods immediately (or within a very short time) to receive the shipping documents, which allows them to take possession of the goods.

Key Features:

• Payment before Document Release: The buyer pays immediately (or within a very short period) to the bank in exchange for the shipping documents.
• Simplicity: Simpler and more straightforward than Letters of Credit.
• Security: Ensures that the seller will receive payment before the buyer can take possession of the goods.

Advantages:

• Provides more security for the seller compared to D/A, as payment is made before the buyer can claim the goods.
• Less expensive and faster than a Letter of Credit, with fewer bank fees.
• Can be used when there is a trusted relationship between the parties.

Disadvantages:

• Risk for the buyer, as they must make payment without having possession of the goods, which can lead to issues if the goods are not as expected.
• Might not be acceptable in high-risk markets or for larger transactions.

4. Telegraphic Transfers (T/T)

A Telegraphic Transfer (T/T), also known as a wire transfer, is a fast and secure way to transfer funds electronically between banks. T/T is one of the most commonly used payment methods in international transactions. The buyer instructs their bank to send funds directly to the seller’s bank account.

Key Features:

• Electronic Transfer: Funds are transferred electronically from one bank to another, usually via the SWIFT network.
• Fast Processing: T/Ts are typically completed within one or two business days, making them faster than many other payment methods.
• No Documentary Requirement: Unlike L/Cs, T/Ts do not require the buyer to submit documents to the bank before payment.
• Prepayment or Advance Payment: In many cases, T/T is used as a prepayment method, where the buyer pays for the goods before shipment.

Advantages:

• Fast and efficient method of payment, particularly for time-sensitive transactions.
• Relatively low transaction fees compared to letters of credit.
• Suitable for both small and large transactions.

Disadvantages:

• Offers little protection to the seller or buyer since the payment is made upfront (if the buyer is making an advance payment).
• No guarantee of delivery or quality of goods after payment is made.
• Once the transfer is completed, it is difficult to reverse the payment in case of a dispute.

 Summary of Key Differences:

Each payment method has its advantages and is suited to different types of international transactions, depending on factors such as trust, transaction size, and risk tolerance. The Letter of Credit provides the highest level of security but involves higher costs and complexity. Document Against Acceptance and Document Against Payment are less expensive and quicker but carry more risk for the seller in the case of D/A. Telegraphic Transfers are simple and fast but lack the security provided by documentary payments, making them better suited for transactions with established, trusted partners. Choosing the right payment method depends on the specifics of the trade and the level of security required.