Mauritius: Banking Perspective - Introduction To International Trade

As natural resources are unevenly distributed in different countries, a country cannot produce everything it needs. As a result, a country will buy what it needs from countries that are good at producing them and in return will sell its products to countries, which require them. The products will be moved from one country to another by means of aircraft, railways, trucks, ships or a combination of two or mode modes of transport.

This buying or importing and selling or exporting of goods is known as International Trade.

Main parties involved in International Trade

• The buyer, who places orders and imports goods.
• The Seller, who manufactures and exports goods.
• The Manufacturer, if the seller does not make his own goods.
• The Shipping or Airline Company who transport the goods overseas and issue Bills of Lading or Airway Bills.
• The Insurance Company which insures the goods against risk.
• Governments who give permission to import and export specific types of goods by issuing Import and Export Licences.
• The Customs and Excise, who levy import duty and issue Custom's Invoices.
• Various professional bodies, who issue Inspection Certificates certifying that the goods have been inspected and meet certain quality standards.
• Lawyers, who draw up contracts of sale.
• Agents, who represent either the buyer or seller overseas.
• Chambers of Commerce, who issue Certificates of Origin.
• Banks, who offer trade banking services.

There are four main ways for a buyer to pay for his imports in international trade:

• Advance payment
• Open Account trading
• Documentary credits
• Documentary collections

The buyer agrees a price for goods from an overseas exporter and sends his payment with the confirmed order, before the goods are shipped. In return, the importer may be allowed a discount on the price of the goods in consideration of its being paid in advance. The importer must be confident of the reliability of the exporter and the stability of the exporter's country. The risk is borne by the importer.

This is the opposite of advance payment, whereby the exporter gets paid by the importer after the goods have been shipped. Depending on the agreement between the exporter and the importer, payment is made on sight of Bill of Lading or say one month after shipment date. There is usually a long-standing or regular business relationship between the two parties.

The risk is borne by the exporter.

Also known as Letters of Credits, they are a favoured and widely recognised risk mitigator as they provide security for the buyer and seller.

A Documentary Credit (DC) is a commitment given by the buyer's bank, to the seller, that they will make payment upon presentation of a pre-agreed, specified set of documents of a bank. Both parties receive protection as payment will only be processed once the seller provides the specified set of documents.

The usage of a Documentary Credit works in the following sequence:

• Buyer and Seller agree terms.
• Buyer's applies for DC at his bank (Issuing Bank).
• Issuing Bank send DC to the sellers bank (Advising Bank).
• Advising Bank establishes authenticity of DC.
• Seller checks that DC matches commercial agreement
• Seller ships goods to Buyer
• Documents are presented to advising bank, who will then forward the documents to the issuing bank.
• Issuing bank will examine the documents for compliance. If they are in order, the issuing bank will debit buyer's account and reimburses sellers bank
• Issuing bank then forwards the documents to the buyer
• Buyer claims the goods from Carrier.

Standby Letter of Credit
While the Commercial Letter of credit serves as the primary payment mechanism for a transaction, the standby letter of credit serves as a secondary payment mechanism. A bank will issue a standby letter of credit on behalf of a customer to provide assurances of his ability to perform under the terms of a contract between the beneficiary. In cases where the customer has not performed his obligation, the beneficiary is able to draw under the credit by presenting a draft, copies of invoices to the bank. The bank is obligated to make payments if the documents presented comply with the terms of the standby letter of credit.

Back-to-Back Letter of Credit
This letter of credit is opened based on an already existing, non-transferable letter of credit, used as collateral. A trader receives a letter of credit from the buyer and then opens another letter of credit in favour of the supplier. The first letter of credit serves as collateral for the second credit.

Transferable Letter of Credit
This type of letter of credit allows the seller to transfer all or part of the proceeds of the original letter of credit to a second beneficiary. The letter of credit must clearly state that is transferable.

Revolving Letter of Credit
With a Revolving Letter of Credit, the issuing bank restores the credit to its original amount once it has been drawn down.

Red Clause Letter of Credit
Red Clause Letter of Credit provides the seller with cash prior to shipment to finance production of the goods. The buyer, in essence, extends financing to the seller and incurs the risk for the advanced credits.

Documentary Collection is a process, in which the seller instructs his bank to forwards documents related to the export of goods to the buyer's bank with a request to present these documents to the buyer for payment, indicating when and on what conditions these documents can be released to the buyer.
Documentary Collections do not provide the same level of Security as Letters of Credits, but, as a result the costs are lower. The bank only acts as a channel for the documents, it may debit the buyer's account and make payment only if authorised by the buyer.

Although, International trade are still conducted on 'Open Account Basis', the use of Letters of Credits as a tool to reduce risk has grown substantially. Letters of Credits accomplish their purpose by substituting the credit of the bank for that of the customer, for the purpose of facilitating International trade.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.