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What is the use of documentary collection in international trade?

A documentary collection is a process where an exporter instructs their bank to forward export documents to importer’s bank for payment. Learn more in this blog.

In international trade, exporters often rely on banks to handle the paperwork associated with the shipment of their goods. Acting as intermediaries, the banks request payment from the importer in exchange for the documents required for the products' release from customs. This creates the need for a streamlined documentary collection process. Success in documentary collection depends on the trust and relationship between the importer and exporter. In this blog post, we will discuss how documentary collection works, and its various advantages and disadvantages in facilitating international trade.

What is documentary collection?

Documentary collection (D/C) is a transaction in which the exporter entrusts the collection of payment to their bank (the remitting bank). The remitting bank sends the necessary papers and payment instructions to the importer’s bank (the collecting bank). In return for the documents, the banks collect money from the importer and transfer it to the exporter.

In D/Cs, a bill of exchange, commonly known as a draft, is used. The importer is required to pay the face amount either immediately or on a specified future date. The collection cover letter outlines instructions specifying the documents needed to deliver the goods to the importer¹.

Types of documentary collection

Some of the types of documentary collection are:

Documents Against Payment (D/P)

A D/P transaction uses a sight draft, and payment is made at the time of transaction. In other words, the importer is required to settle the payment with the collecting bank as soon as they receive the draft, before the shipping documents are made available to them. This is the most popular form of documentary collection as it poses the least amount of risk to all parties.

Documents Against Acceptance (D/A)

A D/A transaction utilizes a time draft or term draft which provides a credit arrangement to the importer. The documents are released to the importer after they sign and accept the draft. The importer can claim goods, however, they are legally obligated to complete payment by a previously agreed-upon date. On the specified date, the collecting bank sends a payment request to the importer. Once the collecting bank has received the amount, it transfers the money to the remitting bank so that the exporter can be paid².

List of prohibited goods when shipping from India to the UK

Every country has its own set of regulations concerning what can and cannot be shipped across its borders. Before packing your goods, familiarize yourself with prohibited goods to ensure smooth customs clearance. Some of the following products are under prohibited category to ship to the UK³:
• Illegal drugs
• Animal products not fit for human consumption
• Counterfeit currency or banknotes
• Toxic and hazardous materials
• Obscene material
• Tobacco and alcohol

When to use documentary collection?

Documentary collection can be useful in the following instances³:

Established business relationships:

Documentary collection is often used between parties with a well-established business relationship. If the exporter and importer have a history of successful transactions and trust each other's integrity, this method can be a cost-effective and efficient choice.

Lower-risk transactions:

Documentary collection can be suitable for lower-risk transactions where the exporter is confident in the importer's capacity and willingness to pay. It offers an alternative to more complex and expensive methods like letters of credit.

Cash flow considerations:

Documentary collection offers the exporter greater control over payment timing. By sending shipping documents to the importer's bank, the exporter can ensure that the documents are only released upon payment or acceptance. This can be beneficial for managing cash flow and reducing the risk of delayed payments.

Importer's country regulations:

Certain countries have specific regulations or restrictions on the use of letters of credit. In such cases, documentary collection can serve as a viable alternative that complies with local regulations while facilitating the trade transaction.

Cost considerations:

Documentary collection typically involves fewer fees and administrative costs compared to letters of credit. This makes it an attractive option for smaller transactions or businesses with limited resources.

Advantages of documentary collection

Documentary collection offers several advantages for exporters and importers engaged in international trade. Some key benefits are⁴:

Cost-effective:

Compared to letters of credit, documentary collection involves fewer fees and administrative costs. This can be advantageous for smaller businesses or transactions with lower values.

Flexible:

Documentary collection provides more flexibility in terms of payment arrangements. The exporter can negotiate payment terms directly with the importer, offering options such as sight payment (immediate payment upon presentation of documents) or acceptance (payment at a later agreed-upon date).

Complies with local regulations:

In some countries, specific regulations or restrictions may limit the use of letters of credit. Documentary collection can serve as a viable alternative that complies with local regulations, facilitating smoother trade transactions.

Disadvantages of documentary collection

These are some of the disadvantages of documentary collection⁵:

Limited role of the bank:

The bank does not assume liability to settle the payment if the importer refuses or is unable to pay.

Unconfirmed document integrity:

The authenticity of the documents is not verified.

Risk of non-payment:

If the importer declines or is unable to pay, there is the challenge of covering the cost of return transportation.

Steps involved in documentary collection

The process of documentary collection in international trade involves several steps. Here is an overview of the commonly followed process6:

Step 1: Agreement

The exporter and importer agree to use documentary collection as the method of payment in their trade transaction. They establish terms and conditions, specifying the documents required for collection and the payment terms.

Step 2: Shipment and document preparation

The exporter ships the goods to the importer and prepares the necessary shipping and financial documents, including the invoice, bill of lading, packing list, and collection instructions.

Step 3: Submission to the bank

The exporter submits the documents to their bank, the remitting bank, along with instructions for the collection process. The remitting bank verifies the documents and forwards them to the importer's bank, known as the collecting bank.

Step 4: Presentation to the importer

The collecting bank presents the documents to the importer, notifying them of the collection’s arrival. The importer reviews the documents to ensure compliance with the agreed terms.

Step 5: Payment or acceptance

After reviewing the documents, the importer makes the payment to the collecting bank or accepts the draft, depending on the agreed payment terms.

Step 6: Document release

Once payment is received or the draft is accepted, the collecting bank releases the documents to the importer, allowing them to take possession of the goods.

Difference between documentary collection and letter of credit

A letter of credit is a legal document provided by a bank or a financial institution, that guarantees that the exporter will be paid the full and correct amount on time. If the importer backs out and is unable to make the payment, the bank will make the remaining payment to the exporter.7
Letters of credit are useful when engaging in business with unfamiliar entities or corporations. A letter of credit is also helpful when an importer's nation experiences political unrest, economic instability, or tight foreign exchange regulations.

On the other hand, documentary collection may be more suitable in certain scenarios as it is more cost-effective than a letter of credit, which typically costs 1% to 2% of the total payment obligation. Documentary collection is most effective when the parties involved are familiar with each other, foresee no financial issues, and when it is unlikely that the importer will reject the products⁸.

In international trade, exporters and importers employ different financial transaction methods based on various factors. Documentary collection is one such method wherein exporters entrust the handling of shipping documents to their bank, which presents them to the importer's bank in exchange for payment or acceptance.

In recent years, e-commerce exports have transformed the way international trade works. It has reduced entry barriers and enabled Indian businesses to tap into global markets without having to establish local presence in a foreign country.

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Frequently Asked Questions

What is the purpose of documentary collection?

The primary aim for a documentary collection transaction is to facilitate trade with the assistance of the exporter and importer’s banks. In this process, the banks exchange shipping documents, ensuring that payment is made in return⁹.

Who is the drawer in documentary collection process?

The exporter is the drawer in documentary collection¹⁰.

Who issues documentary collection?

The exporter initiates the documentary collection process. The exporter requests payment by submitting their shipping and collection records to the remitting bank. These documents are then forwarded to the importer’s bank, and delivered in exchange for payment or acceptance¹¹.

How does documentary collection work as a payment method?

Documentary collection works by using banks as intermediaries to collect payment from the importer in exchange for shipping documents¹².

Who is the drawee in the documentary collection process?

The importer is the drawee in documentary collection.

Published on January 31, 2024.

Sources:
1. https://www.privacyshield.gov/article?id=Trade-Finance-Guide-Chapter-4-Documentary-Collections
2. https://www.wallstreetmojo.com/documentary-collection/#types
3. https://iccwbo.org/resources-for-business/banking-and-finance/documentary-collections/
4. https://iccwbo.org/resources-for-business/banking-and-finance/documentary-collections/
5. https://www.emeriobanque.com/blogs/documentary-collection-meaning-types-and-process
6. https://iccwbo.org/resources-for-business/banking-and-finance/documentary-collections/
7. https://www.investopedia.com/terms/l/letterofcredit.asp
8. https://theblakefirm.com/letters-of-credit-documentary-collection-international-business-finance/
9. https://www.trade.gov/documentary-collections#:~:text=In%20a%20Documentary%20Collections%20transaction,do%20with%20Letters%20of%20Credit
10. https://iccwbo.org/resources-for-business/banking-and-finance/documentary-collections/
11. https://www.dripcapital.com/en-in/resources/blog/documentary-collection-process
12. https://www.trade.gov/documentary-collections#:~:text=In%20a%20Documentary%20Collections%20transaction,do%20with%20Letters%20of%20Credit

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