Banking 1 documentary credit

The banks’ main functions in foreign trade are:

 Handling of shipping documents;

 Collection of payments;

 Observance of buyers’ conditions of purchase;

 Discounting bills of exchange;

 Loans to exporters;

 Acting as agents for foreign banks and their customers.

PAYMENT INSTRUMENTS IN FOREIGN TRADE

The two principal instruments offered by the banks for executing and securing payments in international trade are documentary credits and documentary collections.

DOCUMENTARY CREDIT PART I

Documentary credit is an undertaking made by a bank at the request of the applicant for the credit to pay a specified amount in an agreed currency to a beneficiary, on condition that the beneficiary presents stipulated documents within a prescribed time limit.

The buyer asks his bank to “issue” or open a letter of credit. The issuing bank asks its corresponding bank – usually in the seller’s country – to advise (and confirm) the credit. The advising bank informs the seller that the credit has been issued. As soon as the seller receives the credit, he checks it and if he can meet its requirements, the seller ships the goods. At the same time the seller sends the documents, which prove shipment of the goods to the bank where the credit is available. The bank checks the documents against credit. If the documents comply with the requirements of the credit, then the bank will make payment. The bank, which made payment to the seller, sends the documents to the issuing bank for reimbursement. The issuing bank after checking the documents reimburses the bank that has paid. The documents are then released to the buyer upon payment.

- 2 -

Thus the bank acts as an intermediary between the buyer and the seller. Settlement is effected through the bank by means of a direct exchange: the beneficiary presents the required documents to the bank and receives in return the amount specified in the credit (in the form of cash, an accepted bill of exchange or an undertaking to pay, depending on the terms of the credit). With a documentary credit, the beneficiary is no longer dependent on the buyer’s ability or willingness to pay. Moreover, he can obtain liquid funds shortly after dispatching the goods.

It is not essential that a letter of credit (L/C) be paid to the seller immediately upon execution of the order. If agreed between the seller and the buyer, the arrangement could be for the agent bank (the corresponding bank) to accept a bill of exchange (B/E) drawn by the seller on the agent bank. This gives the buyer credit and is, of course, absolutely safe for the seller, who can discount the bill for ready cash if he needs it.

Documentary credits go a long way towards reconciling the conflicting interests of the buyer and the seller:

 The seller wants to be sure that the price of the goods will be paid in the correct currency and as soon as possible.

 The buyer does not want to pay for the goods before they have actually been dispatched.

- 3 -

APPLICANT

(IMPORTER)

Specific advantages of documentary credits:

 Can be used in transactions with virtually every country in the world;

 Rapid access to funds for the seller;

 Flexible terms of payment with no impairment of security;

 Suitable as an instrument for short-term financing;

 Rapid and convenient settlement, often enabling the seller to offer attractive discounts;

 High degree of legal security throughout the world.

Here is the scheme of the documentary credit procedure:

ISSUING

BANK

There are two types of documentary credits: revocable, i.e. those that can be cancelled, and irrevocable, i.e. those that cannot be cancelled. Irrevocable credits can be confirmed and unconfirmed.

- 4 -

Importer

(Applicant)

LEGAL RELATIONS IN THE CASE OF

A CONFIRMED IRREVOCABLE CREDIT

WITH PAYMENT AT SIGHT

Confirming bank (exporter's bank)

- 5 -

Example of an irrevocable letter of credit.

Barclays Bank PLC International division

23, High Street

London C.W. 25

Date of expiry

Date of issue…

Applicant Beneficiary

Agropharm Limited Medex, Russia

Advising Bank Amount: USD 40,000.00

Moscow Narodny Bank Ltd. CIF

(US dollars – forty thousand only) CIF

Ref. No. ___

Partial shipment allowed

Transhipment allowed

Shipment from Russian Sea Port Not later than …

to Hull

Dear Sirs,

We hereby issue in your favour this Irrevocable Documentary Credit as per details stated above, available by negotiation of your drafts at sight drawn on the applicant for full invoice value of shipment purporting to be 20000 kg, accompanied by the following signed documents…

- 6 -

STAGES IN A DOCUMENTARYCREDIT OPERATION

STAGE 1

Offer

The exporter makes an offer to a prospective buyer.

Establishing the credit terms

During negotiations on the contract, the exporter and the buyer agree on the requirements of the documentary credit.

STAGE 2

Order

The importer places an order with the exporter or signs a contract of sale.

Opening the credit

The importer instructs his bank to issue the credit.

STAGE 3

Delivery

The exporter delivers the goods.

Utilizing the credit

The exporter obtains payment from the bank by presenting the documents stipulated in the credit.