Unit 11: Bank Account Services PDF

3.0 Main Content 3.1 Bank Account Services For Exporters And Importers 3.2 Benefits Of The System 3.3 Risk Of Non Completion 3.4 Protection Against Foreign Exchanges Risk 3.5 Financing The Trade 3.6 Letter Of Credit 3.6.1 Essence Of The Agre...

3.0 Main Content 3.1 Bank Account Services For Exporters And Importers 3.2 Benefits Of The System 3.3 Risk Of Non Completion 3.4 Protection Against Foreign Exchanges Risk 3.5 Financing The Trade 3.6 Letter Of Credit 3.6.1 Essence Of The Agreement 3.6.2 Variations In The Terms Of A Letter Of Credit 3.6.3 Issuers Of Letters Of Credit 3.6.4 Advantages And Disadvantages Of Letters Credit 3.6.5 Liabilities Of Banks Under Letters Of Credit 3.7 Draft 3.7.1 Conversion Of Drafts 3.7.2 Types Of Drafts 3.8 Banker’s Acceptance 3.8 Bill Of Lading 4.0 Summary 5.0 Conclusion 6.0 Tutor-marked Assignment 8.0 References/ further Reading 1.0 INTRODUCTION In the course of this programme, it has been made clear that it is not all who are called customers are actually customers, especially in bank business. A bank customer must be one who has an account with the bank, even if he does not frequent the bank, as he can always send any one to cash( pay in and withdraw) funds for him. Once upon a time, the belief was that the customer must be a current account holder, but that has evolve to include other accounts. The accounts in the banking system has now become so vast and of different types. Most often the accounts are opened to suit specific circumstances. In this instance, however we will be looking at account services for exporters and importers. 2.0 Objectives At the end of the this unit the student should amongst other things be able to:  Liabilities of banks as regards letter of credits  Know the triangular relationship between and among importer,exporter and the bank  Understand letters of credits (variants)  Know the types of Drafts to apply 3.0 MAIN CONTENT 3.1 BANK ACCOUNT SERVICES FOR EXPORTERS AND IMPORTERS Banks are financial institutions that offer diverse services to individuals, group of individuals, firms government agencies etc. The services include acceptance of deposits, granting of loans and advances, agency services, payment and collection of cheques, execution of standing order, remittance of funds, safe custody, performance of government transaction etc. Banks generally operate three types of account which are savings account, fixed deposit account and current account. Hence the bank account suitable for importers and exporters, (businessmen/business organization involved in importing and exporting) is the current account.It concerns the current account used by importer/exporter as Trade Current Account (TCA); others refer to it as Global Current Account (GCA). The use of current account by an exporter and importer is instigated by international trade. The bank services offered to importers and exporter include. Issuing letter of credit, draft, and hill of lading. International trade must work around a fundamental dilemma. Imagine are exporter and an importer and an importer who would like to do business with are another. Imagine also. International trade must work around a fundamental dilemma. Imagine an importer and an exporter who would like to do business with one another. Imagine also that they live in different countries located far apart. They have never met. They speak different languages. They operate in different political environments. They come from cultures that have different standards for honouring obligations to other persons. They both know that is they default on an delegation, the other party will have a hard time catching up to seek redress. White it might be too larsh to say they don’t trust one another, each has perfectly valid reasons for being very countries in dealing with the other. Because of the distance between the two, it is not possible to simultaneously hard over goods with one hand and accept payment with the other. The importer would prefer the following. 1st: Exporter ships the goods Importer Exporter 2nd: Importing pays after the good receive *. Correct importing to Importer pays after the goods have been recieved If done this way, all risk is shifted to the exporter. The exporter’s preferences are exactly the opposite, which of course shift all risk to the importer. 1st: Importer pay for goods Importer Exporter 2nd: Exporter ships goods after being paid The fundamental dilemma of being unwilling to trust a manager in a foreign land is solved by using a highly respected bank as intermediary. A great simplified view is the following: In this simplified view, the importer obtains the bank’s promise to pay on its behalf, knowing the exporter will trust the bank. The bank’s promise to pay is called a letter credit. The exporter ships the merchandised to the importer’s country. Title to the merchandise is given to the bank or a document called an order bill of lading. The exporter asks the bank to pay for the goods, and the bank does so. The document to request payment is sight draft. The bank, having paid for the goods, now passes title for the importer, when the bank trusts. At that time or later, depending on their agreement, the importer reimburses the bank. Financial managers of multinational firms must understand these three basic documents, in part because their firms will often trade with unaffiliated parties, but also because the system of documentation provides a sources of short-term capital that can be drawn on even when shipment are to are to sister affiliates. 3.2 BENEFITS OF THE SYSTEM The three key documents (letter of credit, draft and bill of coding) constitute s system developed and modified over lime to protect both importer and exporter form the risk of non-completion and foreign exchange risk as well as provide a means of financing. 3.3 RISK OF NON COMPLETION As stated earlier, once importer and exporter agree on terms the seller usually prefers to maintain legal title to the goods until paid, or at least until assured of payment. The buyer, however will be reluctant to pay before receiving the goods, or at least before receiving title to them. Each wants assurance that the other party will complete its portion. 3.4 PROTECTION AGAINST FOREIGN EXCHANGES RISK International trade, foreign exchange risk arises from transaction exposure. If the transaction requires payment in the exporter’s currency, the importer carries the foreign exchange risk. If the transaction calls for payment in the importer’s currency, the exporter has the foreign exchange risk. Transaction exposure can be hedged, but in order to ledge the exposed party must be certain that payment of a specified amount will be made on a particular date. The risk of non-completion and foreign exchange risk are most important when the international trade is episode, with no outstanding for agreement for recurring shipments and no sustained relationship between buyer and seller. When the import/export relationship is of a recurring nature, as in its case of manufactured goods shipped weekly or monthly to a find assembly or retail in another, and when it is between countries whose currencies are considered strong, the exporter may well bill the importer an open account after a normal credit check. Banks provide credit information and collection services outside of the system of processing the draft drawn against letter of credit. 3.5 FINANCING THE TRADE Most international trade involves a time lag during which funds are tied up while the merchandise is in transit. Once the risks of non-completion ad of exchange rate charges are eliminated, banks are willing to finance goods in transit. A bank can finance goods in transit, as well as goods held for sale, based on the key documents, without expressing itself to questions about the quality of the merchandise or other physical aspects of the shipment. 3.6 LETTER OF CREDIT The uniform customs and practice for documentary credits, 1962 defines a letter of credit as any arrangement, however named or classified whereby a bank (the issuing banks), acting on the request and in accordance with the instructions of a customer (the oppleant for the credit) is to make payment to or to the order of a third party (the beneficiary or is to pay, accept or negotiable bills of exchange (drafts) drawn by the beneficiary, or authorizes such payments to be made or such drafts to be paid, accepts or negotiated by another against stipulated terms and conditions in other words, a documentary letter of credit is a written undertaking issued by a bank under which it processes another party the (beneficiary usually the seller or exporter) that is presentation of certain documents it will reimburse the beneficiary any amount due to him in respect of certain goods sent to a third party usually a customer of the issuing bank). In international trade a letter of credit is sometimes referred to as a commercial letter of credit, a documentary letter of credit, or simply a credit. A letter of credit reduces the risk of non-completion since the bank agrees to pay against document rather than actual merchandise. The relationship among the three parties is shown below Source: First National Bank of Chicago, financing US Exports, compiled by Patricia A. Ferris, January 1975, p. 3.6.1 ESSENCE OF THE AGREEMENT The essence of a letter of credit is the promise of the issuing bank to pay against specified documents, such must accompany and draft drawn against the credit (the letter of credit is a separate transaction from any sales or other current on which it might be based. To constitute a true letter of credit transaction, all of the following five elements must be present with respect to the issuing bank: 1. The issuing bank must receive a fee or other valid business consideration for issuing the letter of credit. 2. The bank’s letter of credit must contain a specified expiration date or a definite maturity. 3. The bank’s commitment must be have a stated maximum amount of money. 4. The bank’s obligation to pay must arise only on the presentation of specific documents, and the bank must not be called on to determine disputed questions of fact or law. 5. The bank’s customer must have an unqualified obligation to re-imburse the bank on the same condition as the bank has paid. 3.6.2 VARIATIONS IN THE TERMS OF A LETTER OF CREDIT Most commercial letters of credit are documentary, meaning that certain documents must be included with any drafts drawn under their terms. Required documents usually include an order of lading, a commercial invoice, and any of the following: consular invoice, insurance certificate or policy, certificate of origin, weight list, certificate of analysis, packing list. Commercial letters of credit are also classified as follows: 1. Irrevocable Versus Revocable: An irrevocable letter of credit obligates the issuing bank to honour drafts drawn in compliance with the credit and can be rather cancelled nor modified without the consent of all parties, including in particular the beneficiary (exporter). A revocable letter of credit can be canceled or amended at any time before payment; it is intended to serve as a means of arranging payment but not as a guarantee of payment. 2. Confirmed Versus Unconfirmed: A letter of credit issued by one bank cane be confirmed by another, in which case both banks are obligated to honour drafts drawn in compliance with the credit. An unconfirmed letter of credit is the obligation of only the issuing bank. An exporter is likely to want a foreign bank’s letter of credit confirmed bank’s ability to pay. Such doubts can arise when the exporter is unsure of the financial standing of the foreign bank, or if political or economically conditions in the foreign banks are unstable. 3. Revolving Versus None revolving: Most letters of credit are nonrevolving; they are valid for one transactions only. Under some circumstances, a revolving credit issued. A N10,000 revolving weekly credit means the beneficiary is authorized to draw drafts up to N10000 each week until the credit expires. The period of a revolving credit might be daily, weekly or monthly. Because the maximum exposure under an irrevocable revolving credit is very great (the buyer and cannot stop its obligation to pay for future shipments even if it is dissatisfied with the merchandise), most revolving credits are issued in revocable form. A revolving credit may be non-cumulative in which case any amount not used by the beneficiary during the specified period may not be drawn against in a letter period; or at may be cumulative, in which case undrawn amounts carry over to future periods. 3.6.3 ISSUERS OF LETTERS OF CREDIT From an exporter’s point of view, a documentary letter of credit is one of the following types:  1. An irrevocable letter of credit issued by a domestic bank 2. An irrevocable letter of credit issued by a foreign bank and confirmed irrevocably by a domestic bank, or an occasion confirmed by a third-country foreign bank. 3. An irrevocable letter of credit issued by a foreign bank without the confirmation of a domestic bank. This situation the domestic bank simply transmits information (when the letter is opened) and forwards draft for collection but does not guarantee payment. 4. A revocable letter of credit established to arrange for payment. Exporters naturally prefer types 1 and 2, since they need look no further than a bank in their own country for compliance with the terms if the letter of credit. Although a letter of credit issued by a foreign bank along (type 3) might well be of the highest esteem, may exporters, especially smaller firms, are not in a position to evaluate or deal with foreign banks directly if difficulties arise. Every irrevocable letter of credit must indicate an expiration date beyond which documents for payment or acceptance will not be accepted. Documents, just as drafts or bills of lading, must be presented within a reasonable time after issue. If there is undue delay, the bank may refuse to accept them. 3.6.4 ADVANTAGES AND DISADVANTAGES OF LETTERS CREDIT The primary advantages of letter of credit is that the exporter can sell against a bank’s premise to pay rather than position as to commercial firm. The exporter is also in a more secure position as to the availability of foreign exchange to pay for the sale, since banks are more likely to be aware of foreign exchange conditions and rules than is the importing firm itself. If the importing country should charge its foreign exchange rules during the course of a transaction, the government is likely to allow already outstanding bank letters of credit to be honoured for fear of throwing its own domestic banks into international disrepute. Of course if the letter of credit is confirmed by a bank in the exporter’s country, the exporter avoids any problem of blocked foreign exchange. An exporter may fixed that an order backed by an irrevocable letter of credit will facilitated obtaining domestic pre-export financing. If the exporter’s reputation for delivery is good, a local bank may lead fund to process and prepare the merchandize for shipment. Once the merchandise is shipped in compliance with the terms and conditions of the credit, payment for the business transaction is made and funds are generated to repay the pre-export loan. The major advantage to the importer of a letter of credit is that the importer need not payout until the documents have arrived at a local port or airfield and unless all conditions stated in the credit have fulfilled. The main disadvantage are the fee charged by the importer’s bank for issuing its letter of credit, and the possibility that the letter of credit reduces the importer’s borrowing line of credit from its bank. 3.6.5 LIABILITIES OF BANKS UNDER LETTERS OF CREDIT The basic nature of a letter of credit is that the banks is obligated to pay against documents, not actual goods. Thus bank must carefully examine documents to be sure they are in accordance with the original terms and conditions of the letter of credit. Banks are not liable for defects in the documents on the face the document. Thus, for example, the bank is not responsible for detecting false documents, for verifying that the quantities, quality, weights or conditions of the goods is other than what is stated on the documents; or for validating the good faith and performance of any of the parties to the underlying transaction. The bank is not responsible I message are delayed or lost, or of such event as strikes, lockouts, riots, or war. 3.7 DRAFT A draft, sometimes called a Bill of Exchange (B/E) or first of exchange, is the instrument normally used in international commerce to effect payment. A draft is simply an order written by an exporter instructing an importer, or an importer’s agent, to pay a specified amount of money at a specified time. (A personal cheque is another type of draft; the cheque waits as order to a bank to pay a specified amount of money on demand to the order of a designated beneficiary). The person or business initiating the draft is known as the maker, drawer, or originator. Normally this party is the exporter who sells and ships the merchandise. The party to whom the draft is addressed is the drawee. The drawee is asked to honour the draft that is, to pay the amount requested according to the stated terms. In commercial transactions the drawee is either the buyer in which case the draft is called a trade draft, or the buyer’s bank, in which case the draft is called a bank draft. Bank drafts are usually drawn according to the terms of a letter of credit. A draft may be drawn as a bearer instrument, or it may designate a person to whom payment is made. This person known as the payee, may be the drawer itself or it may be some other party such as the drawer’s bank. International practice is to use drafts to settle trade transactions. This differs from domestic practice in which a seller usually ships merchandise on an open account, followed by a commercial invoice that specifies the amount due and the terms of payment. In domestic transaction, the buyer can often obtain possession of the merchandise without signing a formal document acknowledging his or her obligation to pay. In contrast, due to the lack of trust in international transactions, payment or a formal promise to pay is required before the buyer can obtain the merchandise. 3.7.1 CONVERSION OF DRAFTS If properly drawn, drafts can become negotiable instruments. As such, they provide a convenient instrument for financing the international movement of the merchandise. To become a negotiable instrument, a draft or bill of exchange must confirm to the following requirement. 1. It must be in writing and signed by the maker or drawer 2. It must contain an unconditional promise or order to pay a definite sum of money 3. It must be payable on demand or at a fixed or determinable future date 4. It must be payable to order or to bearer. If a draft is drawn in conformity with the requirements just listed, a person receiving it with proper endorsements becomes a “holder in due course”. This privilege legal status enables the holder to receive payment despite any personal disagreements between drawee and maker because of controversy over the underlying commercial transaction. If the drawee dishonours the darft, payment must be made to any holder in due course by any prior endorser or by the maker. This clearer definition of the rights of parties who hold a negotiable instrument as a holder in due course has contributed significantly to the widespread acceptance of various forms of draft, including personal checks 3.7.2 TYPES OF DRAFTS Drafts fall into two categories, sight drafts and time drafts. A sight draft is payable on presentation to the drawee, the drawee must pay at once or dishonor the draft. A time draft allows for a delay in payment normally 30, 60, 90 or 120 days. It is presented to the drawee, into signifies acceptance of it by writing or stamping a notice of acceptance on its face. A time draft is also called usance draft. Once accepted, the time draft becomes a promise to pay by the accepting party. When a time draft is drawn or and accept by a bank, it is called a banker’s acceptance. When it is drawn on and accepted by a business firm, it is called a trade acceptance. The time period of a draft is referred to as its tenor or usuance. To qualify as a negotiable instrument, and so be attractive to a holder in due course, a draft must be payable on a fixed or determinable future date. For example, 60 days after sight is a determinable date, such a maturity being established precisely at the time the draft is accepted. However, payment “on arrived of goods” is not determinable, since the date of arrival cannot be known in advance. Indeed, there is no assurance that goods will arrive at all. Third parties would have no interest in investing in it because they could not be certain they would ever be paid. Note, however, that a non-negotiable acceptance is still a legal device to obtain payment unless a defect exists in the underlying commercial transaction. That is, a non-negotiable draft create a legal obligation between the original parties without giving third parties (holders in due course) any privilege claim. Drafts also classified as clean or documentary. A clean draft is an order to pay unaccompanied by any other documents. When it is used in trade, the seller has usually sent the shipping documents directly to the buyer, who thus obtains possessions of the merchandise independent of its payment (on a clean sight draft) or acceptance (on a clean time draft). Clean drafts are often used by multinational firms shipping to their own affiliates because matters of trust and credit are not owned. Clean drafts are also used for non-trade remittances for example, when collecting of an outstanding debt is sought. Use of a clean draft puts pressure on a recalcitrant debtor by forcing it to convert an open-account obligation into documentary form. Failure to pay or accept such a draft when presented through a local bank can damage the drawee reputation. Most drafts in international trade are “documentary”, which mean various shipping documents are attached to the draft. Payment (for sight draft) or acceptance (for the time) is required to obtain possession of those documents, which are in turn needed to obtain the goods involved in the transaction. If documents are to be delivered for the buyer on payment of the draft, it is known as a “D/P draft”, it the documents are delivered on acceptance, the draft is called a “D/A draft”. 3.8 BANKER’S ACCEPTANCE When a draft is acceptance by a bank, it becomes a banker’s acceptance. As such it is the unconditional promise of that bank to make payment on the draft when it matures. In quality the banker’s acceptance is practically identical to a marketable bank certificate of deposit (CD). Therefore of a banker’s acceptance need not wait until maturity to liquidate the investment, but may sell the acceptance in the money market, where constant trading in such instruments occurs. The first owner of the banker’s acceptance created from an international trade transaction will be the exporter, who receives the accepted draft after the bank has stamped it “accepted”. For example The exporter may hold the acceptance until maturity and then collect. On an acceptance of, say, N125,000 for six months, the exporter would receive the face amount less bank’s acceptance commission o 2.5% per annum. Face amount of the acceptance - N125,000 Less 2.5% per annum commission for banks - N1563 Amount received by exporter in six months - N123, 437 Alternatively, the exporters many “discount” that is sell at a reduced price – the acceptance to its bank in order to receive funds at once. The exporter will then receive the face amount of the acceptance less both the acceptance fee and the going market rate of discount for banker’s acceptances. If the discount rate were 5% per annum, the exporter would receive the following: Face amount of the acceptance - 125,000 Less 2.5% per annum commission for six months - 1,563 Less 5% per a discount sale for - 3,125 Amount received by exporter at once - 120,312 The discounting banking hold the acceptance in its own portfolio earning for itself 7% per annum discount rate, or the acceptance may be resold in the acceptance market to portfolio investor. Investors by buying bankers’ acceptance provide the funds that fence the underlying commercial transaction. 3.9 BILL OF LADING The bill of lading (B/L) is issued to the exporter by a common comers transporting the merchandise. It serves three proposes: a receipt, a contract, and a document of title. A receipt, the bill of lading indicates the carrier has received the merchandise described on the face of the document. The comer is not responsible for ascertaining that the containers hold what is alleged to be their contents, so descriptions of merchandise on bills are usually short and simple. If shipping changes are paid i-advance, the bill of lading will usually be stamped “freight paid” or “freight prepaid”. As a contact, the bill of lading indicates the obligation of the comer to provide certain transportation in return for certain changes. Common comers cannot disclaim responsibility for their negligence through inserting special clauses in a bill of lading. The bill of lading may specify alternative ports in the event that delivery cannot be made to designated port, or it may specify the goods will be returned to the exporter at the exporter’s expense. As a document of little, the bill of lading is used to obtain payment or a written promise of payment before the merchandise is released to the importer. The bill of lading can also function as collateral against which funds may be advanced to the exporter by it local bank prior to or during shipment and before final payment by the importer. 4.0 Summary: Bank customers and accounts , as regards foreign transactions involves set of arrangements that includes services of acceptance of deposits, granting of loans and advances and agency services, which basically concentrates on global current account workings. It involves letters of credits, drafts and bills of lading and the routes that concludes international trade transactions financing. It could be a two steps route or a six steps route that involves the bank. The second route helps in reducing foreign exchange risk and the financing arrangements as regards payments made lesss cumbersome with respect to the use of any of the variants of available letters of credits from the bank's. 5.0 Conclusion: The bank's method of playing the role of acceptance houses, and financing foreign trade transactions is a function that reduces risk to the barest minimum through the nature and accounts created for customers for such circumstances. So far the way and manner the bank's have perform their duties along this lines have made exporter and Importers to be confident in international trade relationship- transactions and payments. 6.0. REVIEW QUESTIONS 1. Discuss the key documents which are necessary for export and import to take place noting the differences and similarities. 2. The area crucial documents have constituted a system to protect both the exporter and importer. Discuss the possibilities of these. 3. Vider what condition can domestic bank (that issued letter of credit) be thrown into international disrepute? 4. Write short notes on the following i. Trade acceptance ii. Banker’s acceptance iii. Holder-in-due-course iv. Drawee v. Drawer 5. Discuss the conditions which provides the conversion of drafts into negotiable instruments 6. Critically explain and examines the uses of clean draft 7. Explain the difference between bill of lading as a document and bill of lading as contract 8. Explain documenting in detail 9. Discuss the following i. The advantages of letter credit to an exporter ii. The disadvantages of letter of credit to an importer 10. Explain the difference between sight drafts and time drafts. 11. What makes a letter of credit revolving, non-revolving and confirmed 12. An exporter is likely to want a foreign bank’s letter of credit confirmed by a domestic bank. Discuss two reasons of the transaction. The three key trade documents – letter of credit, draft and bill of lading – are part of a carefully constructed system to determine who bears the financial loss if one the parties defaults at any time. 7.0. References/ further Reading Jombo, O.C. (2003). Elements of Banking. Owerri: Barloz Publishers Nzotta, S.M. (2004). Money, Banking and Finance: Theory and Practice. Owerri: Hudson- Jude Publishers Oleka, C.D. (2006). Fundamentals of Money Banking and Financial Markets. Enugu:Academic publishing Company. Otu, P.A. (2001). ; in Mbat, D. O. (ED). Topical Issues in Finance.Uyo: Domes Associates Publishers. Rose, P. S. (1999). Commercial Bank Management. Boston: Irwin/ McGraw-Hill