Foreign exchange market plays the part of a clearing house, while, similarly, banks (authorized dealers in foreign exchange) act as clearing agents for international debts. The authorized dealers buy rights to wealth from those who have them to dispose of and sell rights to wealth who wish to acquire them.
In practice, it is very much usual that when the exporter parts with his goods, either he wants money immediately or wants to be sure that it will be paid at the pre-determined date without any contestation. The importer, on the other hand, does not want to pay the goods until arrival of the carrying vessel. This two-faced problem in all cases is solved where both parties are favorable known to their own bankers. Depending upon the terms of agreement, the exporter can draw on his counterpart, the importer, or on the importer’s banks (or even on any third party) and hand the bill to his banker either for collection (i.e. proceeds are received only after realization from the importer) or he may outright sell the bill to his banker.
It is not totally impossible that the importer, at times, remits to the exporter the value of goods-maybe in advance or on receipt of advice of shipment from the exporter- through the latter’s bank. The importer may also settle his obligation by a cheque on his own bank or its correspondent either in the exporter’s country or in any other country.
The above methods of settlement of transactions arising form sale and purchase of goods are common. Nevertheless, it should be borne in mind that when an exporter (creditor) has to draw a bill of exchange on the importer (debtor) he will ordinarily draw the bill of exchange in any one of the following methods:
- On the importer (may be under a letter of credit, if any);
- On the importer’s bank under a letter of credit established by the same bank;
- On his own banks or any other banks in his own country under a letter of credit opened by the importer’s bank; or
- On a third country bank (Obviously a correspondent of the importer’s bank) under a letter of credit established by the importer’s bank.
In whatever manner the buyer and the seller of goods agree to settle the transactions, it will not be too much to say that in foreign trade payment for goods in ultimately made between one bank and another. There is also a great volume of transactions which does not result from commercial deals and the bills of exchange are not indeed the means of settlement for such transactions, viz., exchange of service, borrowing money from one another and paying interest on such borrowing, etc. These can be settled by the use of various credit instruments, the buying and selling of which are virtually the primary operations of an exchange dealer. The principal credit instruments used in international transaction settlements are:
- Telegraphic Transfers (TTs) or Cable Transfers: These are the speediest mode of effecting remittances without involving any loss of interest and the principal banking means of transferring funds in large amounts to a foreign center. The availability of sufficient funds at the other end is the criterion for such remittances and, therefore, is confined to banks and large commercial houses who maintain ample funds abroad. The rate of exchange quoted by banks for such remittances is considered to be the basic rate of exchange between two currencies.
- Mail Transfers or MTs (Air or Sea-Mail):These are the orders for payment transmitted by letter by banks, financial and large commercial houses, and disbursements are effected either by payment of cash to a third party or by credit to the account of the beneficiary/ies). Under this method, the mechanism is similar to that of TTs except that the instructions to pay to the beneficiaries are transmitted by mail (generally by air-mail) instead of cable, consequently there occurs a time lag of some days in each case before the relevant instructions are received by the paying banks and the payments are actually effected. If the paying banks does not have an account with the issuing bank the former remains out of funds until it is reimbursed by the latter’s correspondent. For that reason the rate applied by paying bank is slightly inferior to that quoted for TTs.
- Guaranteed Mail Transfer (GMT): This is a combination of the qualities of mail transfer and cable transfer. It may also be called as deferred cable transfer (or deferred TTs). Before the airmail transfers developed, this system was in use and had its utility as postal transit time was relatively more. Banks, after dispatch of mil transfer, used to advice their correspondents by cable the issuance of such instructions and on receipt of the cable they could pay on the stated value date irrespective of the date of receipt of the relevant mail transfer. The value date, if fact, used to be future or deferred date. With the development and popularity of airmail services, the guaranteed mail transfer (or deferred cable transfer) has lost much of its importance and is rarely used now as remittance facility.
- Cheque or Draft: This is another means of payment of debts abroad, or effecting remittances for any other purposes. The instruments are ordinarily drawn on their own foreign branch or correspondent. Although these instruments were widely used in the past for settlement of debts, their popularity now –a – days is on the wane as the risks of loss and delay in transit are there. The uses of cheques drawn by firms/ companies on their account and sent abroad for settlement of debts is however not totally absent. Cheques of this nature are also purchased by dealers from the selected customers with recourse to them.
- Circular Credits and Travelers Cheques: These instruments are treated at sight basis by any bank (or travel agents handing banking business) called upon to issue such instruments or to make payment (encashment) against them. The issuance of such instruments in a foreign currency is simply a sale of that currency against ready cash and until the instruments are encashed abroad or the issuer’s account abroad is debited, there is no outlay of fund. Therefor, there is a gain of interest on the amount involved in the transaction. As and when such instruments, expressed in ‘foreign currency, are encashed by a bank abroad there is an actual outlay of funds by that bank and there are also occurs a time lag to get the amount credited to its foreign currency account abroad. As a result, the paying bank has to make necessary provision for loss of interest in the rate of exchange applicable for such transactions.