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Trade Settlement Options (other than Letter of Credit)

Updated: Jul 2, 2020

Why is Letter of Credit (LC) commonly used in the international trade? What about other alternatives to it? Is there any other settlement method that can be used for my trades?


In this post, we would like to give some ideas as to how trades settlement is commonly conducted. The following are most commonly use settlement options in a trade.



1. Open Account


In an open account payment settlement arrangement, a seller agrees to deliver the goods or services without first receiving the payment from the buyer. The process goes like this:

  • The buyer and the seller agreed on the terms of the sale, including the detail description of the goods or services, price, and settlement method.

  • The seller then delivers the goods to the buyer in accordance with the terms previously agreed.

  • The buyer then instructed their appointed bank to make payment to the bank account of the seller's that was stated in the agreement.


This method offers the least risk to the buyer and the highest risk to the seller.


As a seller, you can agree to such payment term when you :

  • are confident of the credit-worthiness of the buyer

  • are encouraging the buyer to get into a long term trade relationship with you

  • are satisfied with the country risk of the buyer

  • are able to finance the production or procurement of the goods or services agreed to be supplied

  • are comfortable with your relationship with the buyer


2. Advance Payment


In an open account payment settlement arrangement, a buyer agrees to make payment for the goods or services in advance without first receiving goods or services from the seller. The process goes like this:


  • The buyer and the seller agreed on the terms of the sale, including the detail description of the goods or services, price, and settlement method which states such agreement to the advance payment.

  • The buyer then instructed their appointed bank to make payment to the bank account of the seller's that was stated in the agreement.

  • The seller then delivers the goods to the buyer in accordance with the terms previously agreed.


In direct contrary to the Open Account settlement method, this method offers the least risk to the seller and the highest risk to the buyer.


As a buyer, you can agree to such payment term when you :

  • are confident of the credit-worthiness and reputation of the seller

  • are encouraging the seller to get into a long term trade relationship with you, and encourage them to grant your some more lenient credit terms as you build relationship with them.

  • understand that the seller are unable to finance the production or procurement of the goods or services sold

  • are comfortable with your relationship with the seller

  • understand that the seller are not confident of your country risk


Often times, the buyer and seller agree to a combination between those two settlement methods. For instance, the seller might request for a 30% down payment and will require for the balance to be paid upon delivery of the goods and/or services. It can also be agreed that the payment to be made by the buyer in a future date, such as 30 days, 60 days, or even 90 days after the delivery of the goods and/or services.


3. Documentary Collection payable on a sight basis


This settlement method is technically almost similar to Open Account, but with some submission of documents by the seller side to their appointed bank, known as the Remitting Bank, after they fulfill the delivery of goods and/or services as per stipulated in the agreement terms.


In the layman term, Documentary Collection payable on a sight basis is often called as "Document against Payment (D/P)" for fast and easy communication purposes.


The Remitting Bank will then forward the documents to the bank that is appointed by the buyer, known as the Collecting Bank.


This form of settlement can reduce the risk for the buyer, because they are not required to make payment until they have viewed those submitted documents at the office of the Collecting Bank.


This means that the seller has to be comfortable with the fact that the delivery documents are held within the banking system until such time they are honored.


Nevertheless, the seller still have no guarantee of getting their payment, even though technically the buyer is supposed to make the payment after they are satisfied with the submitted documents that they view at the office of the Collecting Bank.


The best way to serve the seller's interest in this case is to ensure that the buyer is not able to obtain possession of the goods without first accepting the submitted documents, making the payment, and obtaining those documents that are sent through the banking system.


4. Documentary Collection payable on a usance basis


This settlement method is technically almost similar to Open Account, but with some submission of documents by the seller side to their appointed bank, known as the Remitting Bank, after they fulfill the delivery of goods and/or services as per stipulated in the agreement terms.

In the layman term, Documentary Collection payable on a sight basis is often called as "Document against Acceptance (D/A)" for fast and easy communication purposes.


It is similar to D/P explained in the previous point, except that the seller generally will also be required to submit a draft stating that the payment will be made in some stipulated future date.

The Remitting Bank will then forward the documents to the bank that is appointed by the buyer, known as the Collecting Bank.

This form of settlement can reduce the risk for the buyer, because they are not required to accept the draft presented until they have viewed those submitted documents at the office of the Collecting Bank.

This means that the seller has to be comfortable with the fact that the delivery documents are held within the banking system until such time the draft is accepted.

Nevertheless, the seller still have no guarantee that the draft will be honored on its due date, and no guarantee that they are getting their payment, even though technically the buyer is supposed to make the payment on the due date of the draft after they are satisfied with submitted documents and accepted the draft that they view at the office of the Collecting Bank.

The best way to serve the seller's interest in this case is to ensure that the buyer is not able to obtain possession of the goods without first accepting the draft and all the submitted documents, and obtaining those documents that are sent through the banking system. Even so, there's still no guarantee that the draft will be honored on its due date.


5. Secured Payment by Bank Guarantee


In the first four methods stated above, the seller is not guaranteed to receive their payment as there is no undertaking that assures such payment to be made to them. This is so even if the buyer has accepted all the draft, in the case of a D/A.


The solution to this would be for the seller to require the buyer to apply for the issuance of a bank guarantee, or a standby letter of credit (SBLC), to add security to the transaction.


In some counties, the term Bank Guarantee, or sometimes Demand Guarantee, is interchangeable with Standby Letter of Credit, as they just serves as different terminology, especially in countries whereby the banks are not permitted to give any guarantee, and therefore prohibited to use the term "guarantee".


If the payment terms stated in the Open Credit or Documentary Collection had been honored, the bank guarantee is not utilized. On the other hand, in the event that there is a default in the payment, or the term in the transaction is not honored in the manner that had been agreed, the seller can issue a demand in accordance with the requirement of the guarantee, and submit it to their appointed bank, known as the Advising Bank. The advising bank will then forward the documents to the bank appointed by the buyer to issue the bank guarantee, known as the Issuing bank.


In this settlement method, the seller can submit the the documents to either the buyer directly (in open account terms) or to the Remitting Bank (in documentary collection terms).


The issuing bank will the receive the documents from the advising bank and determine whether the the demand complies. If it determines that the demand complies, it will then arrange to debit the funds from the buyer's account and effect the reimbursement to the advising bank. The demand is also handed over to the buyer.


You mentioned the issuing bank will determine if the demand complies. So what constitute as compliance? How do we make sure there is a common understanding to such compliance?


We get it that you might think that the seller might have felt that they have complied to all the terms stated in the LC, and yet they worry that the buyer's side and the issuing bank disagrees to that fact.


This is why the examination of an LC and SBLC as the case may be, is regulated by the International Chamber of Commerce, under the Uniform Customs Practice (UCP). The latest version of the UCP is currently the UCP600, with a supplement to its electronic version eUCP.


We hope this article helps with some of your questions around different types of trade settlement method. If you wish to find out more, do check out our blog https://www.lcassistsg.com/blog-1


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