What is Documentary Collection?
Documentary collection is a transaction via which an importer pays the exporter for their goods after both parties’ banks exchange the necessary documents. It allows for the easing and enablement of import and export procedures. Moreover, this transaction allows importers to avoid advance payment.
In the case of this payment method, the exporter gets paid by the importer in return for the shipping documents, which include a packing list, insurance certificate, certificate of origin, and commercial invoice. These documents are necessary for importers to clear the merchandise via customs and take delivery. Documentary collection is of two types — documents against acceptance and documents against payment.
Table of contents
- Documentary collection definition refers to a transaction that involves shipping merchandise and transferring necessary documents to the exporter’s bank with instructions of receiving payment in the importer’s bank. It enables easier import and export.
- There are differences between a documentary collection and a letter of credit. For example, the former has a lower issuing cost than the latter. Also, the former is not legally binding, unlike the latter.
- There are various advantages of documentary collection. For example, the procedure is straightforward and ensures that the exporter receives payment quickly.
Documentary Collection Process Explained
The Documentary collection definition refers to a transaction wherein an exporter entrusts payment collection to its bank or the remitting bank, which sends the documents and payment-related instructions to the collecting or importer’s bank. Typically, a request accompanies the instructions. They include terms and conditions which dictate when the buyer can avail the documents.
Let us look at how the documentary collection procedure works by looking at the steps involved.
- The sale takes when the importer and exporter agree on the shipping details and payment amount and decide that the transaction will take place via the documentary collection process. After that, the seller delivers the merchandise to a certain location or port. From there, the export takes place, typically via a freight forwarder.
- The exporter prepares the documents and sends them to the remitting bank. The exporter’s bank forwards the documents (certificate of origin, commercial invoice, packing list, etc.) to the importer’s bank.
- After receiving the documents, the collecting bank informs the importer and requests payment in exchange for the paperwork.
- After the collecting bank receives payment from the buyer or once the importer accepts the time draft, the collecting bank hands over the documents, then the importer utilizes the paperwork to collect the merchandise.
One must note that a crucial document in this transaction is the draft or bill of exchange. It is a formal payment request to the importer made by the exporter. Also, individuals must remember that in the case of these transactions, banks are the only channels for the paperwork. However, they do not guarantee the payment as they cannot debit the importer’s account without authorization.
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The two types of documentary collection in trade finance are as follows:
#1 – Documents Against Payment Collection
This transaction requires the buyer to pay the draft’s face amount on sight. To put it in another way, the importer must pay the collecting bank when the former receives the draft before the release of shipping documents. This is the more popular option than the other type as it involves a lower risk for the importer.
#2 – Documents Against Acceptance Collection
In this case, the seller offers a credit arrangement to the buyer by utilizing a time draft or bill of exchange. This means that the importer can claim the goods after signing and accepting the draft. However, once the buyer signs the time draft, they become legally obligated to make payment on a particular date. On this date, the collecting bank contacts the buyer for payment. After receiving the amount from the buyer, the collecting bank transfers the funds to the remitting bank for payment to the seller.
Let us look at a documentary collection example to understand the concept better.
Suppose an importer, ABC, and an exporter, DEF, agree on the merchandise’s payment amount and shipping details. They decide to carry out the transaction in a documentary collection arrangement. Hence, DEF ships the merchandise and gives a collection order to the remitting bank so that the bank would subsequently submit that order to ABC’s bank for payment to DEF.
After that, once ABC’s bank releases the documents to ABC, the importer becomes responsible for paying the bank. Then, the collecting bank transfers the amount paid by ABC to the remitting bank, which submits the acceptance or payment to ABC.
Advantages & Disadvantages
The advantages of documentary collection are as follows:
- Obtaining export collection becomes easier owing to the banks’ reliable assistance and safety.
- The buyer can avoid making advance payments to the seller.
- It is more affordable than a letter of credit.
- This transaction ensures faster receipt of payment.
- It ensures easier handling of paperwork.
- The process is fast and simple.
Now let us look at the disadvantages of such transactions.
- The role of the collecting banks is restricted as they cannot debit the buyer’s account without authorization. In other words, they cannot guarantee that the importer will make payment.
- In such transactions, verifying the documents’ accuracy does not occur.
- If the importer cannot or refuses to make payment, the exporter has to pay for the return transportation.
Documentary Collection vs. Letter Of Credit
Letter of credit and documentary collection in trade finance are crucial concepts that one must understand. Moreover, knowing the key differences between these two elements helps one to pick the right option for them. So, let us look at their distinct characteristics.
|Basis of Comparison||Documentary Collection||Letter Of Credit|
|Payment Guarantee||It does not guarantee payment to the seller. The buyer can refuse the shipment if they are not satisfied.||This is a legally binding document guaranteeing payment to the exporter.|
|Who Issues It?||The seller’s bank issues it.||The buyer’s bank issues it.|
|Issuing Cost||The cost of issuing it is lower.||The cost of issuing it is higher.|
|Bank’s Obligation To Pay The Seller||The bank does not have any obligation to pay the exporter.||The bank pays the seller if the buyer defaults.|
Documentary Collection vs. Clean Collection
Let us look at the key differences between documentary and clean collections.
- Sellers opting for documentary collection ship the merchandise and provide documents and the draft to the bank. That said, exporters choosing the clean collection process provide the banks with only the draft and no transfer documents.
- Clean collections involve a letter of instructions with a check drawn on a financial institution outside the clearing range of the exporter’s banking system. Such is not the case for documentary collections.
Frequently Asked Questions (FAQs)
The characteristics of this concept are as follows:
– Applicability: Experts recommend opting for the documentary collection procedure in stable export markets.
– Risk: This is riskier for the exporter than the importer. However, for the importer or seller, it is cheaper than a letter of credit.
It is vital in facilitating export and import processes by ensuring easier handling of documents and fast receipt of payments. In addition, it allows sellers and importers to avoid paying for the merchandise in advance.
In this transaction, the exporter or seller is the drawer, and the importer or buyer is the drawee.
One can opt for this transaction in the following cases:
– A long-standing relationship must exist between the seller and buyer
– The seller has faith in the economic and political stability of the buyer’s country
– One considers an open account sale to be extremely risky.
– The seller’s country does not have any limiting foreign exchange controls
This has been a guide to Documentary Collection and its definition. Here we explain Documentary Collection in detail such as its Types, Example, Advantages & Disadvantages and Documentary Collection vs. Letter of Credit & Clean Collection. You may also find some useful articles here: