DOCUMENTARY CREDIT

INTRODUCTION

Documentary (Letter of) Credit have been a cornerstone of international trade dating back

to the early 1900s. They continue to play a critical role in world trade today. For any

company entering the international market, Letters of Credit are an important payment

mechanism which helps eliminate certain risks.

Documentary of credit is one of the important methods of payments in international trade.

Documentary of credit operations are governed by the provisions of the uniform customs

and practice for documentary credits, a set of rules framed by the international chamber of

commerce.

Meaning of Documentary Credit

A documentary letter of credit is an arrangement

whereby a bank, at the request and in accordance

with the instructions of a customer (importer), is to

make payment to or to the order of a third party

(exporter) or is to pay, accept or negotiate bills of

exchange drawn by such third party or authorises such

payments or negotiation by another bank, against

stipulated documents, provided that the terms and

condition of the credit complied.

Parties Involved in a Documentary (Letter) of

Credit

Accepting Bank

Advising Bank

“available with” Bank

Confirming Bank

Drawee Bank

Exporter/Beneficiary/Seller

Importer/Applicant/Buyer

Issuing Bank

Reimbursing Bank

Transferring Bank

Advantages and Disadvantages of Using a Letter of

Credit

Advantages to the Importer

• Importer is assured that the Exporter will be paid

only if all terms and conditions of the Letter of Credit

have been met.

• Importer is able to negotiate more favourable trade

terms with the Exporter when payment by Letter of

Credit is offered.

Disadvantages to the Importer

A Letter of Credit does not offer protection to theImporter against the Exporter shipping inferior qualitygoods and/or a lesser quantity of goods. Consequently, itis important that the Importer performs the appropriatedue diligence to assess the reputation of the Exporter. Ifthe Exporter acts fraudulently, the only recourseavailable to the Importer is through legal proceedings.

It is necessary for the Importer to have a line of creditwith a bank before the bank is able to issue a Letter ofCredit. The amount outstanding under each Letter ofCredit issued is applied against this line of credit fromthe date of issuance until final payment.

Advantages to the Exporter

• The risk of payment relies upon the

creditworthiness of the Issuing Bank and the political

risk of the Issuing Bank’s domicile, and not the

creditworthiness of the Importer.

• Exporter agrees in advance to all requirements for

payment under the Letter of Credit. If the Letter of

Credit is not issued as agreed, the Exporter is not

obligated to ship against it.

Disadvantages to the Exporter

• Documents must be prepared and presented in

strict compliance with the requirements stipulated

in the Letter of Credit.

• Some Importers may not be able to open Letters of

Credit due to the lack of credit facilities with their

bank which consequently inhibits export growth.

Types of letter of credit

Acceptance

Negotiable Credit

Irrevocable and revocable letters of credit

Confirmed and unconfirmed letters of credit

With recourse and without recourse credits

Transferable letters of credit

Standby letters of credit

Revolving letters of credit

Back-to-back letters of credit

Red Clause L/C

Green Clause L/C

Example

A business called theInCosmetika from time totime imports goods from abusiness called ACME,which banks with the ABCBank. InCosmetika holds anaccount at theCommonwealth Bank.InCosmetika wants to buy$500,000 worth ofmerchandise from ACME,what steps should be taken toget a LC ?

1-InCosmetika goes to The Commonwealth Bank and requests a $500,000 letter of credit, with ACME as the beneficiary.

2-The Commonwealth Bank can issue a letter of credit either on approval of a standard loan underwriting process or by InCosmetika funding it directly with a deposit of $500,000 plus fees which are typically between 1% and 8% of the face value of the letter of credit.

3-The Commonwealth Bank sends a copy of the letter of credit to the ABC Bank, which notifies ACME that payment is available and they can ship the merchandise InCosmetika has ordered with the full assurance of payment to them.

4-On presentation of the stipulated documents in the letter of credit and compliance with the terms and conditions of the letter of credit, the Commonwealth Bank transfers the $500,000 to the ABC Bank, which then credits the account of ACME for that amount.

Samples

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