What Are the 4 Payment Methods for International Transactions?

International trade involves complexities due to geographical distances, differing legal frameworks, and various currencies. Businesses engaging in cross-border commerce require payment methods to ensure transactions are completed securely and efficiently. These mechanisms mitigate risks for both buyers and sellers, providing a framework for financial settlement across international borders.

Wire Transfers

Wire transfers represent an electronic movement of funds directly from one bank account to another. This method is widely used for international payments due to its speed and directness. The sender initiates the transfer through their bank, providing specific details for the recipient, including their full name, bank name, account number, and the bank’s SWIFT/BIC code. A SWIFT (Society for Worldwide Interbank Financial Telecommunication) code, also known as a Business Identifier Code (BIC), is an international standard identifier for banks.

Intermediary banks often play a role in facilitating these cross-border transfers, acting as a bridge between the sending and receiving banks, especially when a direct relationship does not exist between them. These intermediary institutions help ensure the secure and timely movement of funds, sometimes also handling currency conversion. While wire transfers are generally fast, with funds often arriving within one to five business days, they are considered final upon receipt, meaning reversals are difficult.

Associated fees for international wire transfers can vary significantly. These fees can be influenced by factors such as the bank, the amount being sent, and whether currency conversion is involved. Some banks may also incorporate a markup on the exchange rate, which effectively adds to the cost of the transfer.

Letters of Credit

A Letter of Credit (LC) is a bank’s commitment to pay a seller a specified amount on behalf of a buyer. This payment is guaranteed provided the seller presents documents that precisely conform to the terms and conditions outlined in the LC. LCs offer a layer of security by mitigating payment risk where trust between parties may be limited.

The parties involved in an LC transaction include:
The applicant (buyer), who requests their bank to issue the LC.
The beneficiary (seller), who receives payment under the LC.
The issuing bank (buyer’s bank), which issues the LC and undertakes the commitment to pay.
An advising bank (in the seller’s country), which informs the seller the LC has been issued and may authenticate it.
A confirming bank, which may add its guarantee to the LC for additional payment assurance.

The LC process begins with the buyer applying to their bank for an LC. The issuing bank then issues the LC to the advising bank, which notifies the seller.

After receiving the LC, the seller ships the goods and prepares the required documents. The seller then presents these documents to their bank for review. Banks examine these documents to ensure compliance with the LC’s terms. Once document compliance is verified, the banks process the payment to the seller, securing the transaction.

Documentary Collections

Documentary Collections (DCs) are a payment method where banks act as facilitators for the exchange of documents and payment. In this arrangement, a seller’s bank, known as the remitting bank, sends documents related to a shipment to the buyer’s bank, the collecting bank. These documents, which are necessary for the buyer to take possession of the goods, are released to the buyer only upon payment or acceptance of a draft.

There are two primary types of documentary collections:
Documents Against Payment (D/P), also known as a Sight Draft, requires the buyer to pay immediately upon presentation of the documents.
Documents Against Acceptance (D/A), or Usance Draft, allows the buyer to accept a bill of exchange, promising to pay at a future specified date. With D/A, the documents are released upon acceptance, granting the buyer a credit period.

The parties involved in a DC include:
The principal (seller or exporter)
The remitting bank (seller’s bank)
The collecting bank (buyer’s bank)
The drawee (buyer or importer)

The process entails the seller shipping the goods and then submitting documents to their remitting bank. The remitting bank forwards these documents to the collecting bank. Upon receiving the documents, the collecting bank presents them to the buyer. The buyer then either makes the payment (for D/P) or accepts the draft (for D/A), after which the documents are released, allowing the buyer to claim the goods. The collecting bank then remits the payment to the remitting bank, which in turn credits the seller’s account.

Open Account

The Open Account method is characterized by its simplicity and reliance on trust between the buyer and seller. Under this arrangement, the seller ships the goods and sends documents to the buyer before any payment is received. The buyer then pays for the goods at a pre-agreed future date, often within a timeframe of 30, 60, or 90 days after shipment or receipt of the goods.

This method extends credit from the seller to the buyer, benefiting the importer in terms of cash flow and cost. From a banking perspective, involvement is minimal, limited to the final transfer of funds when the payment becomes due. This method results in reduced paperwork and administrative costs compared to other methods.

Open account terms are utilized when there is a well-established relationship and a high degree of mutual trust between the buyer and seller. This method is common in competitive export markets where buyers may demand more flexible payment terms. It carries the highest risk for the exporter, as payment is not guaranteed and depends entirely on the buyer’s willingness and ability to pay on time.