Evaluating Standardised Banking for Evaluation Documentary Credit - Essay Example

The increasing trends of globalization have enhanced the bank’s role from mere operations in local market to being active members in the international markets. This increased dimension of the banking role in the international market has given rise to the level of convenience that importers and businesses engaging in foreign markets. A bank can help the importers or those businesses that are engaging in international market by providing them security and assistance in the payments via their services of documentary credit. However, it is considered that some documentary methods are cheaper than others and some are safer than other. A business, therefore, needs to be very wise in deciding which means of documentary credit they will go for. If they are not wise, the results can be fatal and businesses can lose and have lose large sum of money just because they handled the documents of credit carelessly. A business can use either letter of credit or open accounts when making or receiving payments to businesses located abroad. However, when making such payments, a business has to be wary of cost and security of the method it has chosen. The two widely used methods that are used by the businesses all over the world are letters of credit and open accounts. A documentary letter of credit (LC) is a written undertaking by a bank on behalf of the buyer or importer to pay a certain amount of money to the seller over the specified period of time, if the exporter is able to provide the required documents as mentioned in the letter of credit (LCs). The letter of credit (LC) usually also specifies the date by which the documents must be presented. This method is more commonly used by importers when they are selling their products in the less developed economies or third world countries. The reason behind this is because these markets are considered volatile and instable. There are more frauds being done in these markets due to weak business law and legal obligations on the operations of the business. Therefore, businesses do not take the risk by dealing with the exporters in these countries on open account terms. LCs or Letters of credit impose strict payment terms for the importers and hence they are considered safer than trusting the reputation of the seller (exporters). This is one unique feature of security and safety provided by Letter of Credit or more commonly “LCs”. Many law making has been done into make LCs or Letter of Credit safer than other methods of documentary credit and this one reason why this system is so safe. The law that contains terms regarding the documentary credit is known as UCP. In particular, UCP 500 was the section which was about the standardized documentary credits. The revision was made to the old UCP 500 and it was revised and some of the terms were eliminated while other terms were added and the new article was renamed “UCP 600”. The UCP 600 forms a contractual relationship between the buyers and sell and sets out the responsibilities for the buyer and the seller, issuing and advising banks, nominating bank, confirming and reimbursing bank. UCP 600 also makes it obligatory on banks that there staff must be trained on specific lines of operations, sales, legal and customer issue. Failure to comply with these conditions can may lead ICC to impose a fine on the bank. It is believed by the experts in banking field that UCP 600 has laid down more transparent law for documentary credits and this document is more relevant than UCP 500. A new concept introduced in this document is “Honour”. This term is defined as “to pay at sight if the credit is sight payment”. To incur a deferred payment undertaking if the credit made is deferred payment. The document also calls for the bank to accept the” bill of payment” at maturity, and pay the beneficiary. The document also makes it clear that the time taken by the banks to accept or refuse the documents provided is just five business days and cannot be extended more than that. LCs and Letter of credits, under the new document can be cancelled at any time without having to obtain the consensus of banking parties. This is to ensure that no amendment is made to the original document unintentionally. In simple words, this document was more a simplified version of old UCP 500 to appease the people who say that UCP 500 had give rise to unwieldy ambiguity. However, even the new document maintained for the proper procedures to be followed before the documentary credit could be released. This ensured the swift business operations and methods being conducted in the international transaction and hence were viewed as a safer option than open accounts. As a result of this they are still being used by the companies and businessman when trading with developing world like India, Pakistan, and Malaysia etc. The reason why businesses and people are scared or afraid to use open account operations is because it is the most dangerous way of receiving or making international payments. In this method, you can send you delivery or shipping to the buyer’s bank through your bank with the instruction that the documents can be released against the bill of exchange. Bill of exchange is basically the amount which seller gets once his documents are released. The bill of exchange also shows the future date at which the payment will be released. So far, this procedure has looked very similar to letter of credit (LC) and does not pose any danger because in this method the payment is being released once the documents are being released and it is very similar to letter of credit (LC). Now, here comes the dangerous part, since the payment has to released on the future date, the buyer can have the goods and what if he decided not to pay the due amount and refuses to release the payment once he gets the goods. The buyer is in a strong position in this case because he has both the goods and the payment. Many people will argue that in such a case you can sue the buyer. However, this is not as simple as it may seem. The reason behind this is the fact that both the buyer and the supplier of goods are in a different country and hence both face a different legal jurisdiction in this case. Similarly, in order to sue a person who is in a different country you need proper legal advice of the laws of the foreign countries which entails extra cost and effort. This clearly shows the dangers if a country uses open account operations rather than using Letter of Credit (LC). Many firms when trading through open accounts with buyer from developing world have faced such issue. This has resulted in many businesses using the more expensive method of international payment i-e using letter of credits. However, in the modern time, the banking systems have been able answer these issues and propose solution to the problems which intends to make open accounts cheaper and safer option for international payments. The two options that have been proposed are Bank Aval and Credit Insurance. These options intend make open accounts a cheaper and safer option for making international payments. In Bank Aval, the collection instruction state that the required documents are only released to the buyer once Bill of Exchange becomes liquid. Bank Aval also asks for buyer’s bank to make endorsement only after which the payment can be released. This option makes open account very much similar to the Letter of Credit or LC where the documents are released and payment is made at the same time. Credit insurance is provided by either domestic insurance or governmental bodies by Export Assistance bodies. The bill of exchange is sold to these bodies at the 95% or 90% of the original price of the bill. However, with this the risk of the buyer going default also goes to the credit insurers and if the buyer fails to pay then it is the credit insurer who loses out and therefore, the original seller is safe. John Sloman. (2000). Economic. Prentice Hall Wachowicz and Horne. (2004). Fundamentals of Financial Management. Pearson. Learning GTI. (2010). Documentary Credit Evaluation. Retrieved on 7 Jan 2010. http://www.ebsi.ie/files/import_documentary_credits.pdf Tucker and Arensberg. (2007). the new UCP 600: Changes From UCP 500. http://www.tuckerlaw.com/visit/The%20new%20UCP%20600%20BWM%20Presentation.pdf Harold Randall. (1994). Accounting. Letts Educational. Read More