Exploring Documentary Collections in Trade Finance
When it comes to trade finance, documentary collections play a role in ensuring smooth and secure transactions. Documentary collections are a payment method that offers a common ground between open accounts and letter of credit transactions. This blog aims to provide an understanding of documentary collections in trade finance, including their benefits and how they operate.
What Are Documentary Collections?
At its core, a documentary collection is a payment method that involves the use of trade documents to facilitate trade between buyers and sellers. Unlike a letter of credit transaction, where the issuing bank guarantees payment to the seller, documentary collections involve the transfer of documents through banks without the collecting bank being obligated to make the payment.
Types of Documentary Collections
There are two types of documentary collections used in trade finance – Documents Against Payment (D/P) and Documents Against Acceptance (D/A):
Documents Against Payment (D/P): In D/P collections, also known as sight collections, the exporter only releases the shipping documents to the importer after receiving payment or accepting a draft. This kind of collection provides exporters with added security as the collecting bank retains control over the documents until payment is made.
Documents Against Acceptance (D/A): In a D/A collection, the exporter hands over the shipping documents to the importer once they accept a draft. Payment is usually expected on a specific later date, depending on the agreed terms between the buyer and seller. This collection method gives flexibility to importers as they can receive the goods before making payment.
Advantages of Documentary Collections
Documentary collections offer benefits for both buyers and sellers involved in international trade;
Cost-effectiveness: Compared to letters of credit, documentary collections generally incur lower costs since they do not involve banking charges and fees.
Flexibility: With documentary collections, buyers and sellers have flexibility in negotiating payment terms and conditions that suit their requirements.
Simplified process: The documentary collections process is comparatively straightforward when compared to letters of credit, making it a viable option for small and medium enterprises (SMEs) with limited resources.
Lower risk: Although documentary collections do not offer the same level of protection as letters of credit, they still provide a level of security for both the buyer and seller involved in the transaction.
How Does Documentary Collection Work?
The process of documentary collection involves the following steps;
Agreement on terms: The buyer and seller come to an understanding regarding the transaction terms, including the type of collection (D/P or D/A), payment due date, and any additional conditions.
Shipment of goods: The seller sends out the goods to the buyer, preparing all shipping and commercial documents, such as invoices, bills of lading, and packing lists.
Submission of documents: The seller submits these documents to their bank, also known as the presenting bank. The presenting bank reviews the documents for compliance and forwards them to the buyer's bank, referred to as the collecting bank.
Notification to the buyer: The collecting bank informs the buyer about document arrival and availability while advising them to make payments or accept drafts.
Acceptance: In a D/P collection scenario, payment is made by the buyer to the collecting bank in exchange for receiving possession of these documents. In a D/A collection, the buyer agrees to accept the draft and acknowledges that the payment is due at a certain date.
Delivery of documents: Once the payment has been made or the draft has been accepted, the collecting bank releases the documents to the buyer. The buyer can then collect the goods from the shipping company.
Payment to the seller: The collecting bank sends the payment to the presenting bank, which then credits it to the seller's account.
Conclusion
Documentary collections play a key role in facilitating trade by offering a secure and cost-effective payment method for buyers and sellers. Although they may not provide as much protection as letters of credit, documentary collections are extremely popular because of their flexibility and simplicity, particularly among small and medium-sized enterprises (SMEs). Having an understanding of how documentary collections work and their benefits can help businesses make informed decisions when engaging in international trade transactions.