DOCUMENTARY CREDITS

A bill of exchange might not be honoured, or the order might be cancelled. But a letter of credit is a more binding method of payment.

Letters of credit (L/C) have been used for centuries in one form or another to enable travellers to obtain money from overseas banks. The process begins with the traveller asking his bank to open a letter of credit in his favour, i.e. for him, for a specific amount which is deb­ited to his account. The bank then drafts a letter which will allow him to draw money on overseas banks with whom the home bank has an agreement. The foreign banks will then draw on the home bank to re­cover their payments.

This method of obtaining money has now generally been replaced by Euro cheques, traveller’s cheques, and credit cards. But documen­tary credits — letters of credit accompanied by documents -are widely used in the import/export trade.

There are two types of documentary credit: revocable, i.e. those that can be cancelled, and irrevocable, i.e. those that cannot be can­celled. The second type is more common in overseas business trans­actions.

The stages in an irrevocable documentary credit transaction are as follows:

1.   The importer agrees to pay by documentary credit, and tells his bank that he will do so by completing an application form which names the exporter and states: the amount to be paid; the documents concerned; what the consignment consists of; whether the shipment is c.i.f., f.o.b., etc.; details of dispatch and any other documents in­volved, e.g. certificate of origin, consular invoice, certificate of qual­ity; and the length of time the credit will be available. The availability of the credit should take account of how much time it will take to pre­pare and ship the goods.

2.   The importer’s bank will then select a bank in the exporter’s country to act as its agent, and will notify them that the credit has been opened.

3.    The agent bank will notify the exporter that a credit has been opened, and they may add their own confirmation, i.e. they will promise to see that the conditions of payment against the documents will be fulfilled. If they confirm the letter, the L/C is known as a con­firmed credit and the agent bank as the confirming bank.

4.   The exporter ships the goods before the credit expires and sends the shipping documents (bill of lading, insurance certificate, invoice, etc.) to the agent bank who check the documents against the condi­tions and pay him; or they may have asked him to draw a bill of ex­change on them, and will discount the bill for him so that he can get his money immediately.

5.  The agent bank will then send the documents and debit the im­porter’s bank with the cost and charges, which are calculated as a per­centage of the total amount of the invoice, plus an extra charge if the letter is confirmed.

6.  The importer’s bank then checks the documents, pays the agent bank, and sends the documents to the importer so that he can claim the goods.