Documentary Credit and Letters of Credit

Documentary Credit

Letter of Credit (L/C)

• A written undertaking by the bank to pay the seller a specified amount on behalf of the buyer
• Provides assurance to the seller of payment for goods or services
• Types:
  • Revocable L/C: Can be cancelled or modified by the buyer at any time
  • Irrevocable L/C: Cannot be cancelled or modified without the consent of all parties
  • Confirmed L/C: A third bank (confirming bank) adds its guarantee to the L/C

Documentary Collections

• A process where the seller instructs the bank to collect payment from the buyer
• The bank acts as an intermediary, presenting the documents to the buyer for payment
• Types:
  • Documents Against Payment (D/P): The buyer must pay the bank before receiving the documents
  • Documents Against Acceptance (D/A): The buyer accepts the documents and agrees to pay at a later date

Bills of Exchange

• A written order from the seller to the buyer to pay a specified amount
• Can be used in international trade to facilitate payment
• Types:
  • Sight Draft: Payment is due immediately
  • Time Draft: Payment is due at a specified future date
  • Clean Bill: A bill without any attachments or documents
  • Documentary Bill: A bill accompanied by documents, such as commercial invoices or bills of lading

Trade Finance

• The provision of financial services to support international trade
• Includes documentary credits, documentary collections, and other financing instruments
• Benefits:
  • Reduces risk for both buyers and sellers
  • Facilitates international trade by providing financing and payment guarantees
  • Enhances cash flow and improves liquidity

Export-Import Transactions

• Involves the sale and purchase of goods or services between countries
• Requires documentation, such as commercial invoices, bills of lading, and certificates of origin
• Payment terms:
  • Cash in Advance: Payment is made before shipment
  • Letter of Credit: Payment is made through a bank
  • Open Account: Payment is made after shipment
  • Documentary Collection: Payment is made through a bank after presentation of documents

Documentary Credit

• A bank's written undertaking to pay the seller a specified amount on behalf of the buyer
• Provides assurance to the seller of payment for goods or services
• Types of Documentary Credits:
  • Revocable: Can be cancelled or modified by the buyer at any time
  • Irrevocable: Cannot be cancelled or modified without the consent of all parties
  • Confirmed: A third bank (confirming bank) adds its guarantee to the Documentary Credit

Documentary Collections

• A process where the seller instructs the bank to collect payment from the buyer
• The bank acts as an intermediary, presenting the documents to the buyer for payment
• Types of Documentary Collections:
  • Documents Against Payment (D/P): The buyer must pay the bank before receiving the documents
  • Documents Against Acceptance (D/A): The buyer accepts the documents and agrees to pay at a later date

Bills of Exchange

• A written order from the seller to the buyer to pay a specified amount
• Can be used in international trade to facilitate payment
• Types of Bills of Exchange:
  • Sight Draft: Payment is due immediately
  • Time Draft: Payment is due at a specified future date
  • Clean Bill: A bill without any attachments or documents
  • Documentary Bill: A bill accompanied by documents, such as commercial invoices or bills of lading

Trade Finance

• The provision of financial services to support international trade
• Includes documentary credits, documentary collections, and other financing instruments
• Benefits of Trade Finance:
  • Reduces risk for both buyers and sellers
  • Facilitates international trade by providing financing and payment guarantees
  • Enhances cash flow and improves liquidity

Export-Import Transactions

• Involves the sale and purchase of goods or services between countries
• Requires documentation, such as commercial invoices, bills of lading, and certificates of origin
• Payment terms for Export-Import Transactions:
  • Cash in Advance: Payment is made before shipment
  • Letter of Credit: Payment is made through a bank
  • Open Account: Payment is made after shipment
  • Documentary Collection: Payment is made through a bank after presentation of documents

Documentary Credit

• A Letter of Credit (L/C) is a written undertaking by a bank to pay the beneficiary (seller) a certain amount upon presentation of complying documents
• There are two types of L/C:
  • Irrevocable L/C: cannot be cancelled or amended without the consent of all parties
  • Revocable L/C: can be cancelled or amended by the issuer without notice
• L/C provides a secure payment mechanism for the seller and ensures the buyer's payment obligations are fulfilled

Bills of Exchange

• A Bill of Exchange is a written order by the drawer (buyer) to the drawee (bank) to pay a certain amount to the payee (seller)
• There are two types of Bills of Exchange:
  • Sight draft: payable on presentation
  • Time draft: payable on a specified date
• Bills of Exchange provide a flexible payment mechanism for international trade and allow for financing options through discounting or negotiation

Documentary Collections

• Documentary Collections is a process where the seller's bank (remitting bank) sends documents to the buyer's bank (collecting bank) with instructions to release the documents only upon payment or acceptance
• There are two types of Documentary Collections:
  • Documentary Collections (D/C): documents are released upon payment
  • Documentary Against Acceptance (D/A): documents are released upon acceptance of the draft
• Documentary Collections provide a secure and efficient way to handle international trade transactions and allow for financing options through discounting or negotiation

Trade Finance

• Trade Finance is the provision of finance for international trade transactions
• There are two types of Trade Finance:
  • Pre-shipment finance: finance provided before the shipment of goods
  • Post-shipment finance: finance provided after the shipment of goods
• Trade Finance enables trade transactions to take place by providing necessary finance and mitigates risks associated with international trade

Export-Import Transactions

• Export-Import Transactions are international trade transactions involving the exchange of goods or services between countries
• There are two types of Export-Import Transactions:
  • Export: sale of goods or services to another country
  • Import: purchase of goods or services from another country
• Export-Import Transactions promote economic growth and development, and increase competition and efficiency in the global market

Negotiating Bank and Reimbursing Bank

• A Negotiating Bank is a bank that honors a bill of exchange or letter of credit by paying the beneficiary
• A Reimbursing Bank is a bank that reimburses the negotiating bank for the amount paid to the beneficiary
• The Negotiating Bank verifies the documents and ensures compliance with the L/C terms, and pays the beneficiary the amount specified in the L/C
• The Reimbursing Bank reimburses the negotiating bank for the amount paid to the beneficiary and ensures that the issuing bank's payment obligations are fulfilled

Documentary Credit

• A written undertaking by the bank to pay the beneficiary a specified amount on presentation of complying documents
• Types of Letter of Credit (L/C):
  • Irrevocable L/C: Cannot be cancelled or amended without the consent of all parties
  • Revocable L/C: Can be cancelled or amended by the issuing bank without notice

Key Features of Letter of Credit

• Provides payment security to the seller
• Ensures compliance with the terms and conditions of the sale
• Can be confirmed or unconfirmed

Bills of Exchange

• A written order from one party to another, directing the payment of a specified amount
• Types of Bills of Exchange:
  • Sight draft: Payment is due on presentation
  • Time draft: Payment is due at a specified future date

Key Features of Bills of Exchange

• A negotiable instrument, can be transferred to a third party
• Can be used in both domestic and international trade

Export-Import Transactions

• Involves the exchange of goods or services across national borders
• Key Risks:
  • Payment risk
  • Credit risk
  • Country risk

Key Requirements of Export-Import Transactions

• Proper documentation, including:
  • Commercial invoices
  • Bills of lading
  • Certificates of origin

Documentary Collections

• A process where the seller entrusts the buyer's payment to a bank, which collects payment on behalf of the seller
• Types of Documentary Collections:
  • Documentary against payment (D/P): Buyer pays the bank before receiving the documents
  • Documentary against acceptance (D/A): Buyer accepts the bill of exchange, promising to pay at a future date

Key Features of Documentary Collections

• Provides a degree of payment security to the seller
• Can be used in conjunction with a letter of credit

Trade Finance

• The provision of finance and risk mitigation services to support international trade
• Key Features:
  • Involves the use of various financial instruments, including:
    • Letters of credit
    • Bills of exchange
    • Documentary collections
  • Provides financing options for both exporters and importers

Key Banks Involved

• Negotiating Bank:
  • Verifies that the documents comply with the L/C terms
  • Negotiates the documents presented under a letter of credit
• Reimbursing Bank:
  • Reimburses the negotiating bank for the payment made under the L/C
  • Typically the issuing bank or a correspondent bank