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Documentary credit means the same thing than “letter of credit”. Traders and bankers in some parts of the world (US, Asia) tend to use the term “letter of credit” or the abbreviation “L/C”, while some bankers (in Europe) prefer to use “documentary credit” or “D/C”. Documentary credits facilitate international payments by providing security for both the exporter and the importer. The seller receives an advance assurance of payment upon presentation of documents conforming to the terms and conditions of the letter of credit, and the buyer is assured that the bank will not pay unless the seller has actually submitted documents strictly complying with the documentary credit. A typical procedure of a documentary credit is as follows:
- The process begins when the exporter and importer agree on a sales contract. Typically, it is the exporter that insists on payment by letter of credit because it does not want to take a credit risk, and cannot get sufficient information about the creditworthiness of the buyer to grant another form of payment.
- The importer then initiates the documentary credit mechanism by going to its bank and requesting it to open the credit.
- Subject to internal credit approval, the importer´s bank issues the credit (and is hence called the “issuing bank”), under which it agrees to pay according to the importer´s instructions. The credit is sent to the exporter or to the a bank in the exporter´s country (depending of the type of credit).
- Confirmation (optional). Commonly, under the sales contract and/or documentary credit application, the exporter´s bank (or another bank in the exporter´s country) will be requested to confirm the documentary credit, thereby committing itself to pay under the terms of the credit. Exporters may insist on confirmed credits when they want to have a trusted local payment.
- The exporter (beneficiary) is notified of the availability of the credit.
- Shipment and presentation of the documents. If the exporter agrees with the terms of the credit, it then proceeds to ship the goods. After shipment, the exporter goes to the bank nominated in the credit to effect payment an presents the documents that the importer has asked for. The exporter usually also presents a bill of exchange or draft, a document representing the bank´s payment obligation.
- Examination of documents/discrepancy/waiver. The bank examines the documents carefully to ensure that they comply with the terms of the credit. If the documents do not comply, the bank cites a documentary “discrepancy”, notifies the exporter and refuses to pay the credit. The exporter may then either correct the documents or obtain a waiver of the discrepancy from the importer.
International documentary credit practice is governed by a set of rules produced by ICC, the latest version of which is know as UCO 6000 Uniform Customs and Practice for Documentary Credits. See letter of credit. Model of Irrevocable Letter of Credit.
