Documentary Collection

There are several financial instruments used in international trade for payments. These instruments come with different features and offer a varied form of financial security to both parties in trade agreements. A documentary collection is a form of payment where the payment is made on the exchange of trade documents. The exporters (sellers) are the Principal initiator of the documentary collection through their bank. Unlike a documentary credit, it works only as a method of payment against the exchange of agreed documents. The involved banks in a documentary collection do not offer any financial guarantee as in a letter of credit.

What is Documentary Collection?

A documentary collection is a process in which an exporter instructs its bank to forward the trade documents to the importer’s bank. The exporter entrusts its bank (called remitting bank) to collect the payment from the importer’s bank (called collecting bank). Exporters receive funds through an exchange of documents with two banks acting as facilitators to the trade parties.

A documentary collection requires the exporter to present a set of required documents to the remitting bank. These documents include a bill of exchange, invoices, certificate of origin, insurance certificate, bill of lading, and packing list, etc.

How Does Documentary Collection Work?

Two banks involve in a documentary collection process and facilitate the two parties in international trade. When both parties in international trade agree on sale terms, they can agree upon the documentary collection as the mode of payment.

A common step-by-step process in a documentary collection works as following.

  1. The exporter prepares the goods and ships through a freight forwarder. The exporter gets the necessary documents for the shipment of goods.
  2. The exporter presents these documents and entitles the remitting bank to proceed with the payment.
  3. The remitting bank sends the documents to the buyer’s nominated collecting bank.
  4. The remitting bank presents the documents to the importer and receives the payment.
  5. The importer presents the documents to claim the goods and clears the customs.
  6. The collecting bank forwards the payment to the remitting bank.
  7. The remitting bank then credits the exporter account with the payment received.
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Although there are two banks involved in the documentary collection, both banks act as facilitators. Neither bank offers the guarantee of financial payment or the verification of documents.

Both parties in a trade agreement can decide the timing of payment. There two common options with a documentary collection.

Documents Against Payment Collection

Documents against payment collection is a relatively safer option for the exporter. The process begins with the exporter shipping the goods to the importer. The exporter collects the necessary documents including the bill of exchange and presents them to the remitting bank. The exporter includes the instructions on how to collect the payment from the importer.

In this method, the importer’s collecting bank releases the documents only upon receiving the payment from the importer. Once the collecting bank receives the payment, it releases the documents. The importer then collects the goods and the exporter receives the payment.

Documents Against the Acceptance Collection

Documents against the acceptance collection method involves a credit option extended by the exporter using a time draft. The time draft includes a maturity date for the payment after the goods are released to the importer. The shipping documents to the importer are released only after signing the time draft. The signed time draft agreement legally obliges the importer to make the payment at the maturity date.

On the maturity date, the collecting bank asks for the payment from the importer. Once the payment is cleared, the collecting bank transfers the funds to the remitting bank. The remitting bank then credits the exporter’s account.

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Key points to Note with a Documentary Collection

The documentary collection is an alternative payment method in international trade. Here are some key points to note with its process.

  • It should be used by the established trade partners in international trade.
  • Both parties should use it if the political and economic risks are lower.
  • The Exporter should use it if there are no letters of credit or bank guarantees available.

Documentary Collection V Documentary Credit

Importers and exporters can agree upon different payment methods. Documentary credits with several types of letters of credit provide great options for both parties in international trade. Both documentary collection and documentary credit can be used as a mode of payment, but both come with different features.

Here are some key points to remember when choosing between a documentary credit and the documentary collection method.

  • A letter of credit offers a financial guarantee to the exporter if the importer fails to make the payment, while documentary collection does not.
  • The banks can control the shipment documents and verify with special features in a documentary credit, while banks do not verify documents in Documentary collection.
  • The bank cannot debit the importer’s account if it fails to make the payment in the documentary collection, while the bank can proceed with the collateral seizure in case of default in the documentary credit.

Generally, a documentary credit is a much secure form of payment for both parties. The importer can also embed different features in a letter of credit to ensure the shipping of goods. However, a documentary collection cannot guarantee the payment to the exporter, neither can assure the importer for the shipment of goods.

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Advantages of Documentary Collection

A documentary collection is a less common method in international trade these days, but it offers some advantages to both parties.

  • It is less expensive than a letter of credit facility.
  • It is a simpler and less complicated process than a letter of credit.
  • Unlike a letter of credit, the exporter initiates and controls its process.
  • It allows faster trade transactions for well-established trade partners.

Disadvantages of Documentary Collection

Despite the simplicity and easy access, the documentary collection method comes with several disadvantages.

  • It works only as a payment and documentary collection method.
  • It offers no financial guarantee to the exporter in case of the importer’s default.
  • Both banks involved in documentary collection act as facilitators only and do not offer financial guarantees or document verification services.
  • The importer cannot ensure the delivery of timely and quality goods either.
  • Both parties may have to incur additional costs with third-party arrangements for the shipment of goods and collection agents.
  • It may not work with new international trade partners, as it lacks trust and regulatory control.

Conclusion

A documentary collection is a process where the exporter entrusts the bank to remit the shipment documents and collect the payment from the importer. Two banks act as facilitators for the documentary collection but do not offer any financial guarantee. It is an easier and less expensive method than a letter of credit. However, it is riskier and less common in international trade than a letter of credit.

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