Question

how can banks add the value of documentary credits?

Answer 1

Documentary Credit is a payment technique whereby a bank commits itself, on behalf of its client (the importer), to pay to a beneficiary (the exporter) within a fixed period, the price of goods / services against the delivery by the exporter of previously agreed and compliant documents proving the value and shipment of the goods / services.

The Documentary Credit is used when the transaction amounts are very high or when one party has doubts about the morality or solvency of the other. It provides security for both the exporter and the importer. The seller (the exporter) receives an advance assurance of payment upon presentation of documents listed in the agreement, and the buyer is assured that the bank will not pay unless the seller has submitted all the documents strictly complying with the documentary credit. The credit worthiness of the importer is substituted by the guaranty of a bank (usually his own bank).

Documentary Credit, also called a Letter of Credit, is subject to the Uniform Rules and Practices of the International Chamber of Commerce. The term “Letter of Credit” or the abbreviation “L/C” is predominantly used in the USA while Europeans prefer to use “Documentary Credit” or the abbreviation “D/C”.

There are many types of documentary credits. In its main forms, a documentary credit may be revocable or irrevocable, notified or confirmed.

• the revocable documentary credit: It may be amended or canceled any time by the importer without the approval of the exporter. Or the importer’s bank may cancel its commitment before the goods are shipped. Given the sums generally involved, the risk for the exporter is significant (Production of goods that he will not be able to ship because the client or his bank has retracted). This explains why this form of documentray credit is almost never used in practice.
• the irrevocable documentary credit: The bank of the importer makes a firm commitment to pay. This type of documentary credit cannot be changed or canceled without the agreement of all parties. The exporter considers the irrevocable documentary credit as an order confirmation. He can start manufacturing the goods because he is assured of being paid by the importer’s banker if he meets all his commitments.
• the notified documentary credit: Notifying a documentary credit is informing its beneficiary, the exporter, that it has been issued in its favor. This notification is made by a bank (called the notifying bank or advising bank) located in the exporter’s country. It may be the exporter’s bank, but it is not always the case. When the documentary credit is notified, only the banker of the importer is committed to pay. The notifying bank credits the exporter’s account after receipt of funds from the importer’s bank.
• the confirmed documentary credit: This type of documentary credit contains a guarantee on the part of both the issuing and the notifying banks to make the payment to the seller if the terms of the documentary credit are met. Confirmation is only added to irrevocable documentary credits. The bank that gives the second guarantee is called the confirming bank. If he wants a confirmation, the applicant (the importer) must state this expressly in his documentary credit application. The confirming bank assumes the credit risk of the issuing bank as well as the political and transfer risks of the importer’s country. The confirming bank is usually the correspondent of the importer’s bank located in the country of the exporter. Without confirmation of the documentary credit, the notifying bank just forwards it to the beneficiary without taking on its own commitment.'