What is a Documentary Letter of Credit?
A documentary letter of credit is a bank’s promise to pay a seller on behalf of the buyer as long as the seller complies with precisely defined terms and conditions specified in the credit. Parties of the transaction are the applicant, beneficiary, and assurance of payment. The applicant is the buyer of goods, the beneficiary is the seller of goods, and assurance of payment is the bank that substitutes its credit for that of the buyer. Minimum terms, conditions and information are needed to be agreed upon between the Applicant and Beneficiary for the Applicant’s bank to issue the Credit to the Beneficiary. To understand this further, we should acquaint ourselves with the documentary collection, the documentary collection process, and document payment collection.
Documentary collection is a form of trade finance in which an exporter is paid for its goods by an importer after the two parties’ banks exchange the required documents. The exporter’s bank collects funds from the importer’s bank in exchange for documents releasing title to the shipped merchandise, usually after the goods arrive at the importer’s location.
Documentary Collection Process
The following are the steps involved in a documentary collection process:
- The sale is made when the importer and exporter agree on the shipping details and payment amount and decide that the transaction will take place via the documentary collection process. After that, the seller delivers the merchandise to a certain location or port. From there, the export takes place, typically via a freight forwarder.
- The exporter prepares the documents and sends them to the remitting bank. The exporter’s bank forwards the documents (certificate of origin, commercial invoice, packing list, etc.) to the importer’s bank.
- After receiving the documents, the collecting bank informs the importer and requests payment in exchange for the paperwork.
- After the collecting bank receives payment from the buyer or once the importer accepts the time draft, the collecting bank hands over the documents, then the importer utilizes the paperwork to collect the merchandise.
Advantages of Documentary Letter Of Credit
- It gives the trading partners a chance to transact and interact with unknown people or establish new trade relationships.
- It helps in expanding and broadening their business quickly into new geographical areas.
- A letter of credit is highly effective and stable.
- Both the trading partners can put in terms and conditions as per their requirements and demands and then arrive at a mutually decided exclusive list of clauses.
- It makes the issuing bank independent of the trading partners’ obligations and any conflicts arising out of those liabilities.
- It transfers the credit-worthiness from the exporter or buyer to the issuing bank. The importer can do any number of transactions at the same time when he is backed by an established and larger institution.
- A letter of credit is safer for the exporter in case the importer goes bankrupt. Since the creditworthiness of the seller is transferred to the issuing bank, it is the bank’s obligation to pay the amount as agreed in the letter of credit. Therefore, a letter of credit implies the exporter from the importer’s business.
- A letter of credit is quick to administer. As per the initial terms and conditions, the seller has to show the proof of material type and quantity along with the documents enhancing his claim that the goods have been shipped. The advising bank will verify and judge the documents