SOLUTIONS TO ENHANCE THE EFFICIENCY OF THE INTERNATIONAL PAYMENT OPERATION BY DOCUMENTARY CREDIT METHOD AT SACOMBANK

VIETNAM GENERAL CONFIDERATION OF LABOUR TON DUC THANG UNIVERSITY DEPARTMENT OF BUSINESS ADMINISTRATION SOLUTIONS TO ENHANCE THE EFFICIENCY OF THE INTERNATIONAL PAYMENT OPERATION BY DOC

VIETNAM GENERAL CONFIDERATION OF LABOUR

TON DUC THANG UNIVERSITY DEPARTMENT OF BUSINESS ADMINISTRATION

SOLUTIONS TO ENHANCE THE EFFICIENCY OF THE INTERNATIONAL PAYMENT OPERATION BY

DOCUMENTARY CREDIT METHOD AT

SACOMBANK

Thesis submitted as a requirement for the degree

Bachelor of Business Administration

Student: PHAM THI QUYNH NHU Student ID: 080869Q

Intake: 2008 - 2012

HO CHI MINH CITY, August, 2012

VIETNAM GENERAL CONFIDERATION OF LABOUR

TON DUC THANG UNIVERSITY DEPARTMENT OF BUSINESS ADMINISTRATION

SOLUTIONS TO ENHANCE THE EFFICIENCY OF THE INTERNATIONAL PAYMENT OPERATION BY

DOCUMENTARY CREDIT METHOD AT

SACOMBANK

Thesis submitted as a requirement for the degree

Bachelor of Business Administration

Student: PHAM THI QUYNH NHU Student ID: 080869Q

Intake: 2008 - 2012

HO CHI MINH CITY, August, 2012

My sincere thanks also go to all staffs in the international payment section at Sacombank- Cho Lon Branch Especially, my warm thanks are sent to Nguyen Ho Duy Han who helped me so much with professional knowledge and specialist skill

in international payment, UCP and Incoterms as well during my internship time at Sacombank- Cho Lon branch It is worth to point out that my work today cannot be perfect without her guidance and willing help

Many thanks to my trusted friends Vu Hoang Thi, Huynh Nguyen Ngoc Anh Dao, Nguyen Thi Anh Dao for the stimulating discussions, for the sleepless nights when we were working together before deadlines Thank you for spending time on solving my problems and for always being by my side whenever I need

Last but not least, I would like to express a deep gratitude to my parents who are the most meaningful people in my life

COMMENT OF SUPERVISOR

Student: Phạm Thị Quỳnh Nhƣ Student ID: 080869Q

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TABLE OF CONTENTS

ABBREVIATIONS

LIST OF TABLES

LIST OF FIGURES

CHAPTER 1: INTRODUCTION 1

1.1 Introduction 1

1.2 Research objective 2

1.3 Research methodology 2

1.4 Scope 3

1.5 Data source 4

1.6 Research structure 4

1.7 Research organization 5

CHAPTER 2: LITERATURE REVIEW 6

2.1 The overall of international payment and the main 6

2.1.1 The overall international payment 6

2.1.2 The main methods of international payment 7

2.2 General concepts of Letter of Credit 8

2.2.1 Characteristic of Letter of Credit 8

2.2.2 Contents of Letter of Credit 9

2.3 Types of Letters of Credit 9

2.3.1 Basic Types of Letters of Credit 9

2.3.2 Special types of Letter of Credit 10

2.3.3 Other types of Letters of Credit 12

2.4 Advantages and Disadvantages in using Letter of Credit method 12

2.4.1 Advantages in using Letter of Credit 12

2.4.2 Disadvantages in using Letter of Credit 13

2.5 Process of Letter of Credit Transaction 14

2.5.1 Parties involved in a Letter of Credit Transaction 14

2.5.2 Steps in Letter of Credit‘s transaction 15

2.6 The legal documents in L/C 16

2.6.1 Introduction of UCP 17

2.6.2 Executive Summary of UCP 18

2.6.3 New and Simplified Structure of UCP 600 in comparison with UCP 500 19

2.7 The efficiency of international payment under Letter of Credit service

in commercial bank 20

2.7.1 Concept on the efficiency of international payment under Letter of Credit method

20

2.7.2 Criteria in the efficiency of international payment under Letter of Credit 20

2.7.2.1 Qualitative criteria 20

2.7.2.2 Quantitative criteria 21

2.8 The factors influencing on the efficiency of international payment by L/C method in commercial bank 21

2.8.1 External factors 21

2.8.2 Internal factors 24

2.9 Risks in using Letters of Credit 25

CHAPTER 3: THE CURRENT STATUS OF SACOMBANK FROM 2007 TO 2011 29

3.1 Profile of Sacombank 29

3.1.1 Development history of Sacombank 29

3.1.2 Vision – Mission – Core Value 32

3.1.3 Business area and function of Sacombank 32

3.1.4 Awards and Rankings 33

3.1.5 Sacombank‘s facilities 34

3.2 Organizational Structure and Policies 34

3.2.1 Organization Chart 35

3.2.2 Personnel Structure 37

3.2.3 Personnel Policies 38

3.3 Products and services of Sacombank 40

3.3.1 Capital mobilization activity 40

3.3.2 Consignment capital 41

3.3.3 Credit activities 41

3.3.4 Service activities and foreign currency trading 43

3.4 Assets – Capitals – Network operations 45

3.4.1 Assets 45

3.4.2 Capitals 46

3.4.3 Network operation 46

3.5 Business operations in Sacombank 47

3.5.1 Income structure of Sacombank 47

3.5.2 Revenue and Profit 48

3.5.3 Revenue and Cost analysis 50

3.5.6 The main profit margin analysis 50

3.6 Competiveness in banking industry 51

3.6.1 Competitors 51

3.6.2 Position in competitiveness of Sacombank 52

3.7 Strategic orientation for 2011-2020 periods 53

3.7.1 Strengthening internal resources – developing sustainably 53

3.7.2 Stabilizing and strengthening to create a firm foundation 53

3.7.3 Prioritising Strategic Solutions in line with market moves 55

CHAPTER 4: CURRENT OPERATIONS IN INTERNATIONAL PAYMENT UNDER LETTER OF CREDIT AT SACOMBANK FROM 2007 TO 2011 57

4.1 International payment (IP) performance at Sacombank during 2007-2011 57 4.1.1 The overall international payment at Sacombank 57

4.1.2 International payment (IP) turnover under each method at Sacombank in the period 2007-2011 57

4.2 International payment under letter of credit performance at Sacombank period of 2007-2011 58

4.3 Process in international payment under letter of credit method at Sacombank: 60

4.3.1 Profession in imported Letter of Credit 60

4.3.2 Profession in exported Letter of Credit 66

4.4 Strong and weak point in profession of international payment under letter of credit at Sacombank 68

4.4.1 Strong point 68

4.4.2 Weak points 69

CHAPTER 5: SOLUTIONS TO ENHANCE THE EFFICIENCY OF THE INTERNATIONAL PAYMENT OPERATION BY DOCUMENTARY CREDIT METHOD AT SACOMBANK 71

5.1 SWOT analysis: 71

5.1.1 S – Strenghts: 72

5.1.2 W- Weakness: 76

5.1.3 O – Opportunities: 78

5.1.4 T – Threats: 79

5.2 Solution for international payment operation under documentary

credit at Sacombank 81

5.2.1 Solution for the process of international payment under documentary credit method 81

5.2.2 Solutions about training management 82

5.2.3 Technology solution 83

5.2.4 Marketing solution 84

5.2.5 Solution for enhance position Sacombank in international payment market 85 5.2.6 Solutions about choosing and developing bank agency 86

5.2.7 Solution about foreign currency supply 87

5.3 Some recommendations for the Government and Central bank 87

5.3.1 Some recommendations for the Government: 87

5.3.2 Some recommendations for Central Bank 88

CHAPTER 6: CONCLUSION 89 APPENDICES

ACB Stock code of Asia Commercial Bank

CAR Capital Adequacy Ratio

CEO Chief Executive Officer

CIF Cost, Insurance and Freight

CTG Stock code of Vietinbank

D/A Documents against Acceptance

D/P Documents against Payment

EIB Stock code of Eximbank

HBB Stock code of Habubank

SHB Stock code of SaHabank

STB Stock code of Sacombank

SWOT Strengths, Weakness, Opportunities, Threats

T/T Telegraphic transfer

TLS Thang Lond Securities

UCC Uniform Commercial Code

UCP Uniform Customs and Practice for Documentary Credit VCB Stock code of Vietcombank

VIB Vietnam International Bank

VP Vietnam Prosperity Bank

WTO World Trade Organization

LIST OF TABLES

Table 2.1: Article of UCP 600

Table 3.1: Sacombank‗s awards from 2008 – 2011

Table 3.2: Sacombank personnel from 2007 to 2011

Table 3.3: Sacombank‘s Income and Labour Structure in 2009 - 2010 Table 3.4: Mobilized Capital

Table 3.5: Credit activities at Sacombank

Table 3.6: Investment Activity

Table 3.7: Transaction office of some banks in Vietnam from 2007-2010 Table 3.8: The main profit margin of Sacombank 2007-2011

Table 3.9: Bank rating of Vietnam Credit in 2009

Table 4.1: International payment turnover at Sacombank 2007- 2011

Table 4.2: Proportion in methods of international payment from 2007-2011

Table 4.3: L/C performance between 2010 and 2011 at Sacombank

LIST OF FIGURES

Figure 1.1: SWOT matrix

Figure 1.2: Research structure

Figure 2.1: Basic process of Letter of Credit transaction

Figure 3.1: Sacombank‘s organization structure

Figure 3.2: Sacombank‘s personnel by education level from 2008 to 2010 Figure 3.3: Mobilization Capital of Sacombank

Figure 3.4: The quality of credit in Sacombank

Figure 3.5: The sales of foreign currency trading and international payment Figure 3.6: Total assets of Sacombank from 2007-2011

Figure 3.7: Sacombank equity and charter capital from 2007-2011

Figure 3.8: Network operation of Sacombank 2007 -2010

Figure 3.9: Structure income of Sacombank 2006 – Q1/2011

Figure 3.10: Revenue and Profit before tax of Sacombank 2007 -2011

Figure 3.11: Revenue and Cost analysis

Figure 4.1: Structure of L/C at Sacombank between 2010 and 2011

Figure 4.2: Process of issuing Letter of Credit

Figure 4.3: Process of handling and endorsing documents

Figure 4.4: Process of payment in imported L/C

Figure 4.5: Process of receiving, inspecting and handling of documents in

exported L/C from customers Figure 4.6: Process of payment in exported L/C

The letter of credit (L/C) is an important payment method and financial instrument in international trade Two fundamental principles are independence and strict compliance Its operation was standardized in UCP 600, which is used widely all over the world Moreover, international payment is being interested significantly

in Vietnamese banks and Sacombank in particular

This study concentrate on the issues and solution to enhance efficiency of documentary credit transactions in the commercial join stock bank and Sacombank

in particular To begin with, the current thesis provides overall of letter of credit which developed base on reliable literature review Furthermore, it also shows the analysis in business result in documentary credit sector of Sacombank with reliable data in the period 2007 – 2011 and my own experiences during internship time After conducting the analysis, it is found that there are many competitive advantages as well as drawbacks in the process of international payment under letter

of credit at Sacombank More importantly, basing on the profession knowledge from Sacombank‘s staff in international payment, data from Sacombank and literature as well, this study supply some recommendations to improve the problems which is existing in documentary credit at Sacombank

Finally, the results of this study brings about a reference for policy maker and banking manager who are interested in documentary credit in general as well as documentary credit at Sacombank in particular to enhance the efficiency of documentary credit operations

As a powerful tool to support the development of international trade, international payment activities are constantly expanded and developed

Commercial bank is a type of banks that appears first and is currently the most popular It is a depository institution that plays a role as the financial agent to mobilize idle money from deposit services and to provide those in need of capital, such as entrepreneurs, in the form of direct loans Anywhere in the world, commercial bank is the largest financial agent that economic subjects use the most frequently For these reasons, commercial banks obviously keep the important role

in the economy

Among the trading stock commercial banks in Vietnam, Sacombank is one

of the banks that possess the largest total assets and networks According to statistics provided by the State Bank of Vietnam, Sacombank has a strong and stable financial position Sacombank operates efficiently and always ensures the full compliance of the safety ratios of the banking activities In addition, creditable international organizations, including Moody‘s and S&P, rank Sacombank as

―stable‖ with B+

Since Vietnam joined World Trade Organization (WTO), Sacombank not only got many opportunities but also many challenges in maintaining market share and expanding network as well as the amount of customers So, it is important that Sacombank makes efficient adjustments to enhance its competitive advantages to survive and develop in competitive environment Moreover, Sacombank has only operation over 11 years In particular, from personal experiences and observations, I recognize that documentary credit is the payment method that is the most popular today The wide use of documentary credit is attributed to its ability to satisfy the needs of both sides: the sellers are guaranteed to receive money - the buyers are guaranteed to receive the items and are responsible for paying This is the international credit-method that is currently the most common and safely being used, especially in the transactions of goods importing and exporting On top of

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that, in term of bank factor, the bank can obtain huge revenue from document credit transaction in comparison with all international payment method As a result, I

decide to choose the topic: “SOLUTIONS TO ENHANCE THE EFFICIENCY

OF THE INTERNATIONAL PAYMENT OPERATION BY DOCUMENTARY CREDIT METHOD AT SACOMBANK” as the thesis for

 What is the current documentary credit performance at Sacombank?

 What are the major external and internal factors that may effect to Sacombank‘s documentary credit processing performance?

 How to enhance the document credit performance of Sacombank?

1.2 Research objective

The research aims to:

 Understand the current documentary credit operation at Sacombank and find out its strengths and weaknesses

 Analyze the external and internal factors that influence on documentary credit operations at Sacombank Based on these factors, find out the opportunities and threats that affect on it

 Give the solutions to enhance efficiency of documentary credit performance

at Sacombank

1.3 Research methodology

Starting with the research objectives as the foundation to consider and analyze the international payment by letter of credit method performance at Sacombank

The literature of the international payment by letter of credit method processing with the relevant theories and factors affecting on efficiency of the letter

of credit operation are the key concepts that will be used in the framework of this study

Analyzing the current international payment by letter of credit processing operation at Sacombank helps to find out its strengths and weaknesses Then,

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examining and evaluating internal and external environment to find out opportunities and threats that affect on Sacombank‘s international payment under letter of credit method performance

The model of SWOT then will be applied to assess the above strengths, weaknesses, opportunities and threats related to international payment by letter of credit operation and based on it to give solution for improving international payment operation by letter of credit method at Sacombank

The SWOT includes:

 Strengths: characteristics of the business or team that give it an advantage

over others in the industry

 Weaknesses: characteristics that place the firm at a disadvantage relative to

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1.5 Data source

This research is based on the secondary data which is the information: existing in the bank system, public media In this research, the secondary data will

be collected from the following sources:

 Information from the interview (face to face) with Sacombank‘s staff

at international payment department

 The recent relevant information and report of Sacombank

 Annual report from 2007 to 2011

 Website of Sacombank

 Equity research of Thang Long Securities

 International journals, articles, books, newspapers, public media are useful source for this study

 Business analysis and documentary credit process are also collected from discussion with supervisors, experts at Sacombank to achieve valuable information to support this study

 Practical experience in international payment operation is gathered from the internship time at Sacombank in international payment section

1.6 Research structure

Figure 1.2: Research structure

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1.7 Research organization

Chapter 1: Introduction - This chapter provides the research background,

research objectives, research methodology which presents and explains what method and solutions I choose to come up my research results Besides, it gives the

organization of the research

Chapter 2: Literature review – This chapter includes the theories on

international payment, documentary credit method, L/C process, parties involved in L/C, factors affecting on L/C, risk in L/C transaction

Chapter 3: Overview of situation at Sacombank – This chapter provides the

general overview and analysis about situation of the Sacombank

Chapter 4: Current situation in international payment under Letter of Credit method at Sacombank – This chapter describe the profile of Sacombank,

situation of business operations and L/C operations/ process at Sacombank and analyze L/C process Then, strengths and weaknesses of this L/C process and operations

Chapter 5: : Solutions to enhance the efficiency of the international payment operation by documentary credit method at Sacombank – From SWOT

analysis, solutions are given to enhance efficiency of Letter of Credit at Sacombank

Chapter 6: Conclusion - The summary of the vital role of international

payment under documentary credit In addition, some main problems, Sacombank

have to face and resolve them, are also discussed here

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CHAPTER 2: LITERATURE REVIEW

This chapter concentrates on literature review related to documentary credit like definition, process, risk in L/C, parties involved Furthermore, it tends to mention about definition and factors impacting on efficiency of documentary credit

2.1 The overall of international payment and the main

2.1.1 The overall international payment

2.1.1.1 Definition International payment refers to the payment between exporter and importer and both of them belong to two different countries International payment must be conducted through the bank by these definite modes of payment In particular, mode

of international payment carries out delivery and payment of import-export contracts through bank which as intermediaries

2.1.1.2 The role of international payment

 For the economy

International payment activities play a vital role in the economic development of a country The country cannot develop with closed policy, if there based on the accumulated exchange in domestic but a country have to develop comparative advantages, combining the power in the country with the international economic environment In the current context, when countries are putting external economic forefront, as the external economic activity is the essential way in the development strategy of national economic activity with the role of international payment is increasingly confirmed

International payment is an indispensable link in the chain of economic activity Besides, international payment is an important step in trading goods and services between individuals and organizations which belong to different countries Moreover, international payment operations contribute to dispose the relationship commodity currency, create a continuous production process and fully loaded cargo traffic process on an international scale If international payment operations are conducted fast, safe and well-organized which will make the circulation of goods and money between buyers and sellers become smoothly, safely

Furthermore international payment activities enhance economic relationships between countries over the world making the payment process is fast, safe, convenient and reduce costs for participants Finally, international payment activities increase the volume of cashless payments in the economy and attract a significant amount of foreign currency into Vietnam

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 For the bank

Firstly, International payment is a professional in relation to asset of the bank's balance sheet International payment operations help banks meet the diverse needs of customers for financial services related to it Because of that, international payment helps banks increase revenue, improve the bank's reputation and build customer confidence In addition, it not only helps banks to expand their scale of operation but also an advantage to create competition for bank in the market mechanism Besides, international payment activity is not just a single activity but also support activities to complement the trading activities of banks If these activities is done well it will extend credit for import-export operations, business development of foreign currency, bank guarantees in foreign trade, trade finance and other international banking activities

Secondly, international payment activity increases liquidity for banks When conducting the international payment, banks can temporarily obtain foreign funds of enterprises which have relationships with banks under form of escrow pending payment

Thirdly, international payment operations also facilitate the modernization of banking technology The banks will apply advanced technology to conduct international payment operation quickly, promptly and accurately in order to spread risk, contributing to expand scale and banking networks

Finally, international payment activities also strengthen the foreign relations

of the bank, strengthening the competitiveness of the bank, raising its prestige in the international market, thereby exploiting the funding sources of foreign banks and capital of international financial markets to meet the capital needs of banks

2.1.2 The main methods of international payment

Along with constant growth in foreign business operations, the payment facilities also become diversity In general, in the current foreign activities, some methods are primarily used as mode of payment in commercial banks:

 Remittance

It is the simplest payment, in which a client (payer, buyer, importer .) requests their bank to transfer an amount of money for beneficiary (seller, exporter, who receives money ) at a determined location in a definite time Remitting bank must transfer money through their agent in the country of beneficiary to carry out remittance profession

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 Collection of Payment

Refer to the payment method in which exporter will conduct their bank to collect money from exporter after it completed the delivered obligation and service provisions Collection bases on bill of exchange/cheque and document from the present of exporter

 Documentary Credit – Letter of Credit

A Letter of Credit (L/C) is a payment term generally used for international

sales transactions It is basically a mechanism, which allows importers/buyers to offer secure terms of payment to exporters/sellers in which a bank (or more than

one bank) gets involved The technical term for Letter of credit is “Documentary

Credit” Especially, there must be understood that Letters of credit deal in

documents, not goods In addition, setting of L/C bases on terms of commercial contract but when L/C is issued, which is independence from commercial contract

So, the bank will base on the content of L/C to carry out payment

2.2 General concepts of Letter of Credit

2.2.1 Characteristic of Letter of Credit

A L/C (as it is commonly referred to) is a payment undertaking given by a bank to the seller and is issued on behalf of the applicant (the buyer) The Buyer is the Applicant and the Seller is the Beneficiary The Bank that issues the L/C is referred to as the Issuing Bank which is generally in the country of the Buyer/ Applicant The Bank that Advises the L/C to the Seller is called the Advising Bank which is generally in the country of the Seller

The nominated bank makes the payment upon the successful presentation of the required documents by the seller within the specified time frame Note that the Bank scrutinizes the ―documents‖ and not the ―goods‖ for making payment Thus the process works both in favor of both the buyer and the seller The Seller gets assured that if documents are presented on time and in the way that they have been requested on the L/C and the payment will be made On the other hand, Buyer is assured that the bank will thoroughly examine these presented documents and ensure that they meet the terms and conditions stipulated in the LC

Recently, L/C is used almost exclusively in international trade transactions of significant value

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2.2.2 Contents of Letter of Credit

A letter of credit generally contains the following information:

 Complete and correct name and address of the beneficiary i.e., the exporter

 Complete and correct name and address of the applicant i.e., importer

 Type of the letter of credit/documentary credit

 Amount of letter of credit

 How the credit shall be available e.g., by payment, deferred payment, acceptance or negotiation

 The name of the drawee of the draft and the tenor of the draft

 Description of goods, quantity of the items and the unit price

 List of document required to be submitted by the beneficiary

 Port of discharge and the place of final destination

 Term of delivery i.e., FOB, CFR, CIF etc

 Status of transshipment i.e., whether allowed or not

 Status of partial shipment i.e., whether allowed or not

 The last date of sending shipment

 Time period for the presentation of documents for the negotiation by the beneficiary after the dispatch of the shipment

 The date and place of expiry of the letter of the credit

 Transfer of the letter of credit allowed or not

 Mode of advice of the letter of credit i.e., by mail or telegraphic transmission

2.3 Types of Letters of Credit

2.3.1 Basic Types of Letters of Credit

There are three basic features of letters of credit, each of which has two options These are described below Each letter of credit has a combination of each

of the three features

SIGHT OR TERM/USANCE

Letters of credit can permit the beneficiary to be paid immediately upon presentation of specified documents (sight letter of credit), or at a future date as established in the sales contract (term/usance letter of credit)

REVOCABLE OR IRREVOCABLE

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Letters of credit can be revocable This means that they can be cancelled or amended at any time by the issuing bank without notice to the beneficiary However, drawings negotiated before notice of cancellation or amendment must be honored by the issuing bank An irrevocable letter of credit cannot be cancelled without the consent of the beneficiary

UNCONFIRMED OR CONFIRMED

An unconfirmed letter of credit carries the obligation of the issuing bank to honor all drawings, provided that the terms and conditions of the letter of credit have been complied with A confirmed letter of credit also carries the obligation of another bank which is normally located in the beneficiary‘s country, thereby giving the beneficiary the comfort of dealing with a bank known to him

2.3.2 Special types of Letter of Credit

So far a description has been provided of the basic types of letters of credit used to cover the shipment of goods In addition to these basic types, there are various specialized formats which meet particular sets of circumstances

RED CLAUSE LETTER OF CREDIT

A red clause letter of credit incorporates a clause, traditionally written in red, which authorizes the bank acting as the negotiating or paying bank to pay the beneficiary in advance of shipment This enables the purchase and accumulation of goods from a number of different suppliers, and the arrangement of shipment in accordance with the letter of credit terms Such advances will be deducted from the amount due to be paid when the documents called for are presented under the letter

of credit If the beneficiary fails to ship the goods or cannot do so before the expiry

of the letter of credit, the issuing bank is bound to reimburse the negotiating or paying bank, recovering its payment from the applicant Variations of such credits may also require that any advances be secured by temporary warehouse receipts until shipment is affected Beneficiaries of red clause letters of credit are invariably brokers/agents of buyers in a particular field

TRANSFERABLE LETTER OF CREDIT

A transferable letter of credit allows the beneficiary to act as a middleman and transfer his rights under a letter of credit to another party or parties who may be suppliers of the goods Depending on whether the letter of credit permits partial shipments, fractional amounts may be transferred to more than one beneficiary The letter of credit however, can be transferred only once: the secondary beneficiaries cannot transfer their rights to a third party Transfer of a letter of credit can be made

The terms and conditions of the transferred letter of credit must be identical

to those of the original letter of credit with the following exceptions:

 The original beneficiary may be shown as the applicant on the transferred credit

 The amount of the letter of credit, and unit prices if any, may be less than in the original letter of credit (The difference being the original beneficiary‘s profit margin)

 The latest shipment date, if any and expiry date as shown on the original letter of credit should be shortened

 The percentage of insurance coverage, if any, should be increased to satisfy the requirements of the original letter of credit

 When a drawing takes place, the original beneficiary normally substitutes his invoices for those of the second beneficiary for up to the amount and unit prices available under the original letter of credit, and draws the difference as profit

BACK-TO-BACK LETTER OF CREDIT

―Back-to-back‖ is a term used in transactions involving two irrevocable letters of credit

Back-to-bank L/C is opened on the basis of L/C which was open by importer

to exporter to payment for suppliers Then, exporter ask for his bank to open L/C with similar content for supplier and this L/C (second L/C) refer to back-to-back L/C and first L/C is known as original L/C

Between 2 of L/C types, there is a difference:

 Number of documents be presented by back-to-back L/C which is more than original L/C

 The value of back-to-back L/C is usually smaller than original L/C

 Delivery time of back-to-back L/C is early back-to-back L/C

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DEFERRED PAYMENT LETTER OF CREDIT

Under a deferred payment letter of credit, the applicant does not pay until a future date determined in accordance with the terms of the letter of credit No drafts are called for, which avoids ―stamp duties‖ charged by some countries on bills of exchange (drafts) One reason an exporter might extend credit terms to an importer could be the competitiveness of the market and the need for the exporter to finance the importer if the exporter is to make the sale

2.3.3 Other types of Letters of Credit

The letters of credit described thus far cover the movement of goods from one destination to another There are other types of letters of credit which are not specifically related to the movement of goods The principal one is as follows:

STANDBY LETTERS OF CREDIT

Standby letters of credit may apply in general to transactions which are based

on the concept of default by the applicant in performance of a contract or obligation

In the event of default, the beneficiary is permitted to draw under the letter of credit Standby letters of credit may be used as a substitute for performance guarantees, or issued to guarantee loans granted by one firm to another, thereby securing payment

to the creditor in the event the other party fails to repay its obligation on the due date Even if the applicant claims to have performed, the bank issuing the letter of credit is obliged to make payment provided the beneficiary produces complying documents, usually a sight draft, and a written demand for payment

2.4 Advantages and Disadvantages in using Letter of Credit method

2.4.1 Advantages in using Letter of Credit

TO THE EXPOTER:

Provides packing credit - Exporters can easily collect pre-shipment finance

from the banks against letter of credit In particular, red clause letter of credit is issued to the exporter to enable him to collect pre-shipment finance from the bank

Clearance of exchange control regulations – When the opening bank

issues the letter of credit it indicates that the importer has fulfilled all provisions of exchanges control regulations in his country Transfer of funds will not create a problem for the exchange control authorities

No blocking of funds - The exporter gets immediate payment from the bank

when he submits full set of negotiable documents to the bank If the documents are

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drawn as per the terms of letter of credit the bank pays the exporter in full Therefore, the exporter does not have to block his funds

No bad debts – As the payment is guaranteed be the opening bank In case

the exporter holds a confirmed letter of credit, there is double guarantee by the opening bank and the confirming bank

No liability – In case of confirmed L/C and without Recourse clause The

liability of exporter comes to an end as soon as he hands over the relevant document

to the bank

Certainty of payment – The importer cannot refuse to take possession of

the goods and to clear the payment when the terms of payment are L/C This problem of non-possession and non-payment may arise in case of D/P & D/A

TO THE IMPORTER

Certainty of shipment of goods – The exporter cannot get any benefit under

the L/C without shipping the goods and submitting documents to the bank Thus, the importer is certain to get his supply

Delivery on time – As the exporter submits the documents in time for

negotiation it reaches the opening bank in time This enables the importer not only

to collect the documents on time but also collect the goods from the customs

Overdraft facility – when the importer falls short of payment, he can take

possession of the documents again overdraft facility

Better terms of trade – The opening bank provides credit facility to the

importer This helps the importer to obtain better terms of trade from the foreign supplier

Funds are not blocked – There is no need for the importer to block his

funds by making advance payment to the exporter

Long business associations – L/C protects the interest of both the exporter

and the importer Nothing is left to the imagination of both the parties because the L/C mentions all the terms and conditions of the business It helps the exporter and importer to have prolonged business associations

2.4.2 Disadvantages in using Letter of Credit

Short life – every L/C has validity period with short life It does not give

sufficient time to the exporters for shipment of goods and submission of documents

Problem of weight units – Weights and measures are different in each

country So, disparity often arises through misinterpretation of weight units

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Insurance problem – The L/C may indicate board coverage of marine

risk whereas underwriters may view them as less risky Hence underwriters may like to go for limited coverage of risk

Packing material consideration – When the importer places an order, he

specified in the L/C the type of packing material that the exporter should provide if the exporter can take objection

Lack of safety – Incase of revocable L/C, the opening bank can cancel or

modify the L/C without prior permission of the beneficiary This creates the problem of safety of payments

Delay payments – the exporter collects payments from the negotiating

bank no sooner he submits the documents When payment is delayed by the opening bank, the exporter has no pay heavy interest on the advances

Problem of discrepancy – If the exporter does not submit the documents

as demanded by the importer, it is called discrepancy in documents Because of discrepancy the importers either can delay of withhold payment

2.5 Process of Letter of Credit Transaction

2.5.1 Parties involved in a Letter of Credit Transaction

The following is a brief description of the parties most commonly involved

in letters of credit

Accepting Bank: The bank named in a letter of credit on whom term

drafts are drawn and who indicates acceptance of the draft by dating and signing across its face thereby incurring a legal obligation to pay the amount of the draft at maturity

Advising Bank: A branch or correspondent bank at or near the domicile

of the beneficiary, to which the issuing bank either sends the letter of credit, or a notification that a letter of credit has been issued, with instructions to notify the beneficiary The advising bank advises the beneficiary

of the letter of credit without engagement

Applicant: The buyer or the party who requests the letter of credit

to be issued

Beneficiary: The seller or the party to whom the letter of credit is

addressed

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Confirming Bank: A bank usually in the country of the beneficiary which,

at the request of the issuing bank, joins that bank in undertaking to honor drawings made by the beneficiary, provided the terms and conditions of the letter of credit have been complied with

Discounting Bank: A bank which discounts a draft for the beneficiary after

it has been accepted by an accepting bank

Drawee Bank: The bank have name in the letter of credit on whom

drafts are to be drawn

Drawer: The beneficiary of the letter of credit who will draw the

draft in accordance with the terms of the letter of credit

Issuing Bank: The bank which opens a letter of credit on behalf of the

applicant and forwards it to the advising bank for delivery to the beneficiary

Negotiating Bank: Usually the beneficiary‘s bank which, after satisfying it

that the documents conform to the letter of credit, agrees

to purchase the draft (pay the beneficiary)

Paying Bank: The bank have name in the letter of credit where drafts

are to be paid It is not necessarily the issuing bank, but often a branch of the issuing bank or its correspondent Once drafts have been paid or accepted by the paying/drawee bank, there is no recourse to the drawers

Reimbursing Bank: The bank authorized by the issuing bank to reimburse

the drawee bank or other banks submitting claims under the letter of credit

2.5.2 Steps in Letter of Credit‘s transaction

Step1: Importer and Exporter agree to conduct business The exporter wants a letter of credit to guarantee payment

Step 2: Applicant (importer) applies to his bank for a letter of credit in favor of the seller

Step 3: Issuing bank checks the L/C‘s risk of the importer, issues and forwards the L/C to Advising bank The advising bank is usually located in the same geographical location as the beneficiary (exporter)

Step 4: Advising bank will authenticate the L/C and forward the original L/C to the beneficiary

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Step 5: Beneficiary ships the goods, then verifies and develops the documentary requirements to support the letter of credit Documentary requirements may vary greatly depending on the perceived risk involved in dealing with a particular company

Step 6: Beneficiary presents the required documents to the Advising or negotiating bank to be processed for payment

Step 7: Advising bank examines the documents for compliance with the terms and conditions of the letter of credit and sends document to Issuing Bank

Step 8: Issuing bank examines documents, if documents are appropriate they will deduct money to Advising bank and carry out the following steps If not appropriate, deny payment

Step 9: Advising bank makes payment to beneficiary

Step 10: Applicant makes payment to Issuing bank

Step 11: Issuing bank release total documents to Applicant

Figure 2.1: Basic process of Letter of Credit transaction

2.6 The legal documents in L/C

In May 2003, the Banking Commission of the International Chamber of Commerce (ICC) began revising the international rules for letters of credit, known

as the Uniform Customs and Practice for Documentary Credits The process took three and a half years The ICC published the new rules in their publication number

600, commonly referred to as the ―UCP 600,‖ and set the effective date as July 1,

2007 This article describes the UCP rules and their revisions, some of the

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limitations of the UCP, what was not revised, and what managers need to know in order to avoid being tripped up by the UCP 600

2.6.1 Introduction of UCP

Firstly, it is important to establish what the UCP is, what it does, and whom

it affects, and also what the UCP is not The UCP is often thought to be a law, but it

is not On the other hand, to say it is simply a publication does not do it justice The UCP can be characterized as a rulebook that reflects practice Because the UCP is not a law, its use is voluntary The power of the UCP lies in its universal adoption

by banks all over the world and incorporation into their letters of credit Every player agrees to play by the same rules

The UCP is concerned with documentary credits, commonly referred to as

―letters of credit.‖ The UCP is focused on ―commercial‖ letters of credit, the traditional letters of credit that are used as a vehicle for payment in international trade, but the UCP is also used in the realm of standby letters of credit and bank guarantees Anyone engaged in international trade, whether selling goods, buying goods, or providing financing, should become familiar with the UCP

As it is not a law, the UCP only applies to letters of credit that actually state that they are subject to it Furthermore, individual rules provided by the UCP may

be excluded or altered by the terms of a letter of credit For example, it is not uncommon for a letter of credit to state that it is subject to the UCP 600 except for the provisions in article 35 regarding lost documents

The most important principles set down in the UCP are the independence principle and the principle that banks deal only in documents These principles have existed in every UCP over the years, and are fundamental to the nature of letters of credit A letter of credit involves three parties: the applicant for the letter of credit (the bank‘s customer—typically the buyer of goods described in the letter of credit); the beneficiary of the letter of credit (the party to be paid—typically the seller of the goods); and the issuing bank The independence principle is found in article 4 of the UCP 600, which states, ―A credit by its nature is a separate transaction from the sale

or any other contract on which it may be based.‖ Simply put, this means that a bank that has issued a letter of credit is not, and cannot, be concerned with whether or not the beneficiary has met its obligations under the underlying contract between the beneficiary and the applicant, for example, whether the seller has actually shipped the goods the buyer ordered All the bank cares about is whether the documents

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comply, which is stated in article 5: ―Banks deal with documents and not with goods, services or performance to which the documents may relate.‖

2.6.2 Executive Summary of UCP

 The UCP provides a global standard set of practices for letters of credit

 Anyone engaged in international trade, whether selling goods, buying goods, or providing financing, needs to be familiar with the UCP 600

 While the UCP is designed for use with commercial letters of credit, it

is often used for standby letters of credit, a reliable type of bank guarantee

 The most important principles of letters of credit set down in the UCP are the independence principle, and the principle that banks deal in documents, not goods

 The UCP defines the responsibilities of banks involved in handling letters of credit and provides rules for examining documents they call for; documents must strictly comply in order to trigger the issuing and confirming banks‘ payment obligation, but if documents do not strictly comply, the banks must themselves follow strict rules for refusing payment

 Parties who have used the UCP to govern their standby letters of credit and bank guarantees in the past should seriously consider using the International Standby Practices instead

 UCP 600 covers the followings :

Table 2.1: Article of UCP 600

Article 1 Application of UCP

Article 2 Definitions

Article 3 Interpretations

Article 4 Credits v Contracts

Article 5 Document v Goods, Services or Performance

Article 6 Availability, Expiry Dated and Place for Presentation

Article 7 Issuing Bank Undertaking

Article 8 Confirming Bank Undertaking

Article 9 Advising or Credits and Amendments

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Article 14 Standard for Examination of Documents

Article 15 Complying Presentation

Article 16 Discrepant Documents, Waiver and Notice

Article 17 Original Documents and Copies

Article 18 Commercial Invoice

Article 19 Transport Document Covering at Least Two different Modes of transport

Article 20 Bill of Lading

Article 21 Non-Negotiation Sea Waybill

Article 22 Charter Party Bill of Lading

Article 23 Air Transport Document

Article 24 Road, Rail or Inland Waterway Transport Documents

Article 25 Courier Reciept, Post Reciept or Certificate of Posting

Article 26 "On deck", "Shipper's Load and Count", "Said by Shipper to Contain" and Charge

Additional to Freight

Article 27 Clean Transport Document

Article 28 Insurance Document and Coverage

Article 29 Extension of Expiry Date or Last Day for Presentation

Article 30 Torrance in Credit Amount, Quantity and Unit Prices

Article 31 Partial Drawing or Shipments

Article 32 Installment Drawings or Shipments

Article 33 Hours of Presentation

Article 34 Disclaimer on Effectiveness of Documents

Article 35 Disclaimer on Transmission and Translation

Article 36 Force Majeure

Article 37 Disclaimer for Acts of Instructed Party

Article 38 Transferable Credits

Article 39 Assignment of Proceeds

Source: International payment by Tran Hoang Ngan & Nguyen Minh Kieu (2010)

2.6.3 New and Simplified Structure of UCP 600 in comparison with UCP 500

Firstly, one striking feature of the UCP 600 is its lean and simplified look The numbers of articles have been reduced from 49 in UCP 500 to 39 in UCP 600,

In particular, UCP 600 added much new definitions and explanations to clarify the meaning of the terms which had been controversial in UCP 500 For example, Article 2 "Definitions" of UCP 600 has raised a range defined as: Advising bank, Applicant, Beneficiary, Complying presentation, Confirmation, Confirming bank, Credit, Honor, Negotiation, Presentation

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Secondly, UCP 600 has clearly regulated the period of time for rejecting or approving the presented documents which is a fixed time "five banking days" (five banking days) On the other hands, in UCP 500, this period was not clearly regulated which was "Reasonable time" and " Without Delay‖ to examine the documents and report any invalid documents

Thirdly, UCP 600 issues new regulation about the address of the applicant and beneficiary in letters of credit is that they must be indicated on the document as presented in the L/C

Finally, according to UCP 600, the issuing bank may refuse documents and assign the documents for applicant when the bank receives acceptance in invalid documents

2.7 The efficiency of international payment under Letter of Credit service in commercial bank

2.7.1 Concept on the efficiency of international payment under Letter of Credit method

The efficiency of t international payments in general and international payments by documentary credits method in particular as well as other activities of commercial banks is characteristic to meet customer needs in the best possible manner with the least waste of time and effort

The degree of satisfaction just can be assessed by using of products and services This is extremely difficult because the evaluation is completely dependent

on one's own feeling

2.7.2 Criteria in the efficiency of international payment under Letter

of Credit

2.7.2.1 Qualitative criteria

 Safety and Accuracy

Most business operations of the bank require accuracy and safety, and international payment activities are no exception This is particularly important and essential in the international payment operations by means of L/C because most the involved parties only base on the documents which regardless of the actual goods

Usually, a professional international payment by L/C is involved by many parties, a variety of items, with large scale and huge value Therefore, this profession does not allow banks to get any errors which lead to risk Bank‘s staffs must have professional knowledge in processes to detect and settle correctly to avoid damage to the parties In addition, the accuracy can be reflected in many

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aspects of quantity, quality and time in payment process Not only contribute to bank‘s credibility with customers but also the accuracy ensures bank‘s services with foreign partners

Performing any transactions by L/C method, customers obviously expect to minimize risk and enhance safety levels in the payment It is important that the bank must ensure safety in every transaction for customers which show the usefulness of banks to clients

Thus, the accuracy and safety is decisive factor in evaluating the quality of international payment under L/C It also is an essential indicator which impact on performance of the service

 Fastness and promptness

Refer to the concept of the ability to satisfy needs of clients about a product

or service compared to the time requirements set out Especially in service business, speed in operation help bank to save time for customers The bank have a effective operation which means that the bank always have reasonable measures in order to save maximum time for client but not negatively affect the quality of service Implementation of international payment operations quickly and prompt not only help banks accelerate their activities but also help customers meet the demands time, enabling them to ensure the progress of business contract performance Therefore, customers will feel comfortable and trustful in bank when the bank helps them save their valuable time

2.7.2.2 Quantitative criteria Besides the qualitative indicators to assess the quality of international payment by documentary credit method, it is possible to base on the quantitative indicators rushing follows:

 Market share of international payments under L/C method of commercial banks in the area

 Turnover brought by documentary credit method

 The diversity of the international payment products

 Number of customers making international payments by L/C method

in commercial banks

2.8 The factors influencing on the efficiency of international payment

by L/C method in commercial bank

2.8.1 External factors

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 Economic - natural - social environment

Activities of commercial banks can be considered as a bridge between different areas of the economy, the stability or instability of economic - social impact on operations of bank The macro variables such as inflation, economic crisis or social situation - war, insurrection, coup will impact significantly on the quality of international payments

An economy with stable development can create a reputation and confidence with other economies around the world which will help the commercial trading activities develop rapidly International payment operations of commercial banks will be boosted and raised the quality, scale The economic crisis show that the balance of payments of the country lost its balance leading to the local currency depreciated sharply against foreign currencies and reduced the credit-worthiness of

a buyer

International payment activities are affected strongly by the natural and social environment Big instability in social life such as war, riots and natural disasters can cause damages exporters, importers and banks easily So, having no partners want to choose his partner in a country with political upheaval because they cannot get the goods (in the case of an importer) or not receive the money (in the case are exporters), there are unforeseen risks and no insurance for this type of risk

 Foreign economic policy of the country

Government plays a very important role in planning macroeconomic policies, which affects on the entire operation of the economy in general and international payments operations in particular Any changes in the external economic policies (such as opening of the economy, encouraging free trade) will create special advantages for different types of services such as international payments

The legal environment is also a factor to ensure the quality of payment In addition, the instability legal also caused difficulties for partners who take part in the international payment operations when not to react instantly to these changes All commercial banks are required to understand all their own legal to avoid risk for the customer and the bank

 Foreign currency management policy of the State

Foreign currency management policy refer to manage and control the movement of foreign exchange flows and within the country, it affects all the external economic relations with foreign currency Moreover, it has an important role in stabilizing the currency in payment If a foreign exchange management

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policy of the state consisted with supply and demand in the market it would help banks in foreign currency balance to meet the needs of international payments and international payments by credit method

Besides, the fluctuation of exchange rates directly affects on foreign trade activities of a country When the exchange rate of increase, the volume of imported goods tends to go up and the exported goods go down Besides, foreign trade transactions require more time to complete the procedure and if in this period sudden fluctuation of exchange rates occurs that lead to negative result in damage for the buyer or seller

Moreover, international payment is the final stage that completes a transaction in international trade, which is the payment and foreign currency payments between related parties The value of foreign currency earnings is influenced greatly by fluctuations in exchange rates so that in the case of exchange rate fluctuations that can encourage or restrict imported and exported activities and leading to the international payment operations of banks changes in trade

With the banks, the volatility exchange rate affects on their income from fee

of payment and foreign currency source to maintain the international payment operations which be disturbed Because of keeping prestige, banks have programs may loss mitigation in some cases

 Factors from customers

In the international payments, operation happens quickly or slowly depends

so much on the time of presenting documents as well as the perfection of the documents Thus, the level of knowledge of customers in the foreign trade business

is very important The new customers who are week about professional, the international rules, international law and law partner countries inevitably lead to the loose contract, mistake and cause damage to themselves and the bank

Furthermore, the customer's financial capacity is also a cause affecting on the quality of international payment by documentary credit method in commercial banks When the financial capacity of customers is weak, with small impact from the outside that also may affect on the business situation and the ability of delivery

or payment

Besides, the ethics of business in our customers is a problem that all banks are concerned In the international payments by means of documentary credit method which based on the documents, customers can set up fake documents to trick banks Thanks to development of technology, the establishment of fake documents in payment become more sophisticated and requires the commercial

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banks must have professional experience and good technique can detect cases which tried to fraud status of customer

2.8.2 Internal factors

 Potential finance of commercial banks

International payments in general and the method of payment by documentary credit in particular, mostly related to foreign currency funds Document credit always requires the bank to have a large amount of foreign currency to meet its solvency Thus, commercial banks have a large capital in foreign currency which will gain the advantage in the international payment operations Firstly, with strong finance resources, the bank can expand scale and enhance ability to provide variety of international products and services which also impacts strongly on range of international payment operations by L/C method in a bank Secondly, there is a way to build the reliable image for the bank in finance market Moreover, strong finance resources can handle difficulties in market more easily Due to the above reasons, the potential finance of commercial banks is a decisive factor in their own development and expansion of the settlement

 Reputation of the bank in domestic and global market

In term of financial field – monetary: the prestige and brand of commercial banks in the domestic market as well as on the international market is very important to confirm the bank‘s existence in global Especially, the bank can attract more investors, customers and cooperate with partners easily with good prestige Furthermore, bank can operate effectively when receiving the confidence and trust

of customers for products and services offered When the reputation and brand has been confirmed and dominated the global market allowing operation in general and international payment operations of banks in particular to be significantly expanded

 Correspondent banking network of the bank

International payment operations by means of documentary credits relate to many countries, territories and many different areas, so the network of agent bank

of the banks always occupy an important position The bank has a network of correspondent banks throughout the world that facilitate the implementation of international payment transactions smoothly and efficiently In contrast, if the network is limited which will make international payments business difficult to develop In particular, in document credit transaction, if the transaction was conducted in a country where banks do not have correspondent bank or relationship with foreign bank, the time and cost will increase so much to receives the

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document It leads to waste time and cost for bank and customer from which customer will come to the bank have more correspondent bank and large network

 Qualifications of the bank’s staff

In any business operation, the human element is always placed on top important in any activities of most fields which are the decisive factor to performance Especially, in the operation of commercial banks always need the good staff of professional who have a sense of responsibility and enthusiasm for the job because they are directly involved in the process of bringing products and services of the bank to customers International payment operations by means of documentary credit is a complex profession therefore perverse things about the qualifications of the staff will impact strongly on the quality of services

 Technical equipment and payment technology

Currently, all banks are interested in technological innovation by international standards to meet the needs of customers However, the unequal development of technology among banks may obstruct the professional application

in the whole industry and causing difficulty to cooperative to exploit services International payment activity is one of the business requires the participation of communication equipment and machinery support system so that banks have a good material and technical basis and high technological payment level will have favorable conditions for development and expansion activities

 Marketing activities of the bank

It is undeniable fact that the commercial banks are now trying to build their brand through communications services, marketing and public relation Marketing operations contribute to promote the image of the bank, make traditional customers confidence in products and services that banks have been offering Moreover, right marketing strategy also helps to enhance trust in old customers, partners and to attract new customers, expands markets So, the effectiveness of the marketing operations will contribute to develop the international payment operations by means

of documentary credit in commercial banks

2.9 Risks in using Letters of Credit

Fraud Risks

 The payment will be obtained for nonexistent or worthless merchandise against presentation by the beneficiary of forged or falsified documents

 Credit itself may be forged

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Sovereign and Regulatory Risks: Performance of the Documentary Credit

may be prevented by government action outside the control of the parties

Legal Risks: Possibility that performance of a Documentary Credit may be

disturbed by legal action relating directly to the parties and their rights and obligations under the Documentary Credit

Force Majeure and Frustration of Contract: Performance of a contract –

including an obligation under a Documentary Credit relationship – is prevented by external factors such as natural disasters or armed conflicts

Risks to the Applicant

Risks to the Issuing Bank

 Insolvency of the Applicant

 Fraud Risk, Sovereign and Regulatory Risk and Legal Risks

Risks to the Reimbursing Bank: No obligation to reimburse the Claiming

Bank unless it has issued a reimbursement undertaking

Risks to the Beneficiary

 Failure to Comply with Credit Conditions

 Failure of, or Delays in Payment from, the Issuing Bank

 Credit Issued by Party other than Bank

Risks to the Advising Bank: The Advising Bank‘s only obligation – if it

accepts the Issuing Bank‘s instructions – is to check the apparent authenticity of the Credit and advising it to the Beneficiary

Risks to the Nominated Bank: Nominated Bank has made a payment to the

Beneficiary against documents that comply with the terms and conditions of the Credit and is unable to obtain reimbursement from the Issuing Bank

Risks to the Confirming Bank: If Confirming Bank‘s main risk is that,

once having paid the Beneficiary, it may not be able to obtain reimbursement from the Issuing Bank because of insolvency of the Issuing Bank or refusal of the Issuing Bank to reimburse because of a dispute as to whether or not payment should have been made under the Credit

Other Risks in International Trade

 A Credit risk risk from change in the credit of an opposing business

 An Exchange risk is a risk from a change in the foreign exchange rate