Understanding Documentary Credits
A documentary credit, also known as a letter of credit, is a financial instrument used in international trade transactions. It is a written commitment by a bank on behalf of the buyer (importer) to pay the seller (exporter) a specified amount of money, provided that the seller meets certain conditions outlined in the credit.
There are several types of documentary credits, including:
- Revocable: Can be cancelled or amended by the buyer without the seller's consent.
- Irrevocable: Cannot be cancelled or amended without the seller's consent.
- Confirmed: A second bank adds its confirmation to the credit, providing additional assurance to the seller.
- Unconfirmed: Only the issuing bank's commitment is involved.
- Applicant: The buyer who requests the issuance of the credit.
- Issuing Bank: The bank that issues the credit on behalf of the buyer.
- Beneficiary: The seller who will receive payment under the credit.
- Advising Bank: The bank that advises the beneficiary of the credit's issuance.
- Confirming Bank: The bank that adds its confirmation to the credit.
The seller must provide certain documents to the bank to receive payment under the credit. These documents may include:
- Commercial invoice
- Bill of lading
- Packing list
- Insurance certificate
- Inspection certificate
- Provides assurance to the seller that they will receive payment if they meet the credit's conditions.
- Reduces the risk of non-payment for the buyer.
- Facilitates international trade by providing a secure payment method.
- Can be expensive due to bank fees and charges.
- Can be time-consuming to process the required documents.
- May not provide complete protection against fraud or non-performance by the seller.