Elements of Foreign Exchange: A Foreign Exchange Primer

by Franklin Escher

Form of Bailee Receipt

Such difference of opinion exists among foreign exchange men as to the goodness of the trust receipt system that the author refrains from making comment on it, confining himself strictly to description of what the system is. As will be seen from the accompanying reprint of the trust receipt used by one of the largest issuers of commercial credits in the country, the document is simply a pledge on the part of the importer to hold the merchandise in trust for the banker, and, as the merchandise is sold, to hand over the proceeds to apply against the draft drawn by the shipper of the goods. The theory of the thing is that by the time all the merchandise has been sold more than enough money will have been handed over to the New York banker to take care of the draft accepted by his London correspondent, the excess constituting the importer's profit.

The kind of trust receipt under which bankers are willing to give over the merchandise (the only collateral they have) naturally varies according to the standing of the house in question. In the case of some importers the bankers would be willing to let the bill of lading pass out of their hands on almost any kind of a receipt; in the case of others a very strict and binding contract is invariably signed. But whatever the form of the contract, it is to be borne in mind that when the banker issuing the credit hands over the bill of lading to the importer on trust receipt, he is allowing the only security he has to pass out of his hands, and is putting himself in the position of having made an unsecured loan to the importer.

Returning now to the particular transaction in question, the point has been reached where the silk is in the importer's hands, that result having been accomplished without the importer having put up a cent of money. Moreover, for nearly four months to come there will be no necessity of the importer's putting up any money (unless he should sell some of the silk, in which case he is bound to turn over the money to the New York banker as a "prepayment"). But in the ordinary course of events the importer of the silk has nearly the four full months in which to fabricate the goods and sell them. At the end of that time the draft drawn by the firm in Canton and accepted by the Guaranty Trust Co., London, will be coming due, and the silk importer will be under the necessity of remitting funds to meet it. Twelve days before the actual maturity of the £1,000 draft in London, the New York banker will send to the manufacturer in Paterson a memorandum for £1,000 at, say, 4.86 (whatever is the current rate) plus commission. The silk firm pays in dollars; the New York banker uses the dollars to buy a demand draft for £1,000; a day or two before the four months' sight draft comes due in London this demand draft ("cover") is received in London from New York, and the whole operation is closed.

It has been deemed advisable to set forth the whole course of one of these import-financing transactions, in order that each successive step may be clearly understood. The question of just why this credit business is worked as it is will now be taken up.

The whole purpose of the business, it is plain enough, is to give the importer here a chance to bring in goods without putting up any actual money—‌in other words, of letting him use a larger capital than he is actually possessed of. There are persons so conservative as to consider this in itself a wrong idea, but with business carried on along the lines on which it is actually done nowadays, bank credits play so important a part that conservatism of this order has little place. Theory and practice prove that there is no reason why a silk importer, for instance, with a capital of $100,000 should not be able to use safely a credit of as much more than that, the standing and credit of the firm being always the prime consideration. Granted that a manufacturer stands well and is doing a safe, non-speculative business on the basis of $100,000 capital, there is no reason why he should not be able to secure an import credit for an additional £20,000. Not only is there no reason why he should not get it, but there are any number of good banking concerns only too glad to furnish it to him.

So much for the transaction from the importer's standpoint—‌what does the seller of the goods get out of it? Payment for his goods as soon as he is ready to ship them. No waiting for a remittance, no drawing of a dollar-draft on an obscure firm in Paterson, N.J., which no Canton bank will be willing to buy at any price. The credit constitutes authority for the shipper to draw in pounds sterling on London—‌the one kind of draft which he can always be sure of turning at once into local currency and at the most favorable rate of exchange. He ships the goods, he draws the draft, he sells the draft, he has his money, and he is out of it. From the shipper's standpoint, surely a most satisfactory arrangement and one which will induce him to quote the very best price for merchandise.

As to the banker's part in the transaction, the whole question is one of commission. The London banker on whom the credit is issued gets a commission from the American banker for "accepting" the drafts, and the American banker, of course, gets a substantial commission from the party to whom the credit is issued. Sometimes the banker in New York and the banker in London work on joint-account, in which case both risk and commissions are equally divided. But more often, perhaps, the London bank gets such-and-such a fixed commission for accepting drafts drawn under credits, and the New York banker keeps the rest of what he makes out of the importer.

Before proceeding with discussion of what commissions amount to, it is well to note the fact that in those commercial credit transactions neither banker is ever under the necessity of putting up a cent of actual money. As in the case of foreign loans previously described, the banker's credit and the banker's credit only is the basis of the whole operation. The London bank never pays out any actual cash—‌it merely "accepts" a four months' sight draft, knowing that before the draft comes due and is presented at its wicket for payment, "cover" will have been provided from New York. The New York banker, on the other hand, merely sends over on account of the maturing draft in London the money he receives from the importer. He is under an obligation to the London banker to see that the whole £1,000 is paid off before the four months are over, but he knows the party to whom he issued the credit, and knows that before that time all the silk will have been manufactured and sold and the proceeds turned over to him. At no time is he out of any actual cash.

That being the case, the amount of commission he charges is really very moderate—‌one-quarter of one per cent. for each thirty days of the life of drafts drawn under credits being the "full rate." Under such an arrangement an importer taking a credit stipulating that the drafts are to be drawn at thirty days' sight would have to pay one-quarter of one per cent.; at sixty days' sight, one-half of one per cent.; at ninety days' sight, three-quarters of one per cent., etc. Such commission to be collected at the time the drafts drawn under the credits fall due.