Documentary credit can be paid in three different forms:
Documentary credit can be paid primarily cash using funds from the issuing bank or a designated financial institution in the country of the exporter. Additionally, it can be done using a legal instrument transferring funds from the issuing bank. It can also be paid using payment overdue at a later time making adjustments to the exchange rates.
In the case of a credit notification, the exporter shall submit the documents to his banker. The latter will then resubmit the documentary credit to the banker of the importer. The payment will be done if the documents provided by the exporter are consistent with those that show where the shipment has been made in the contractual deadlines.
There are a few risks that financial institutions and importers take when using documentary credit.
Documentary credit involves taking a few risks as well. One is the complications that the documents may involve and another is the risk of not receiving a payment.
Let us talk about the first one. Banks may find discrepancies between what was written in the letter of credit, what was actually shipped, and what arrived at the port of entry. The importer too risks receiving products of a lower quality that was originally agreed with the seller. Importers also risks being involved in frauds or in finding errors in the documents.
There is a verification process that the issuer bank will perform in order to know the validity of the shipment and the product. If there is any error, the bank should learn it right there and it assumes the responsibility of verifying that the documents are correct.
There are also risks of non-payment.
The bank is also taking risks because if the buyer fails to deposit the money that will be given to the seller, it is the bank that must comply with the contract. The banks also have the risks of failure in transferring the money from one country to the other when the importer reports insolvency.
If in any case the importer failed to pay the bank, the latter can block the funds before making the payments to the exporter. Therefore, banks need to also plan ahead for any changes in foreign exchange rates.
Documentary credit can be paid primarily cash using funds from the issuing bank or a designated financial institution in the country of the exporter. Additionally, it can be done using a legal instrument transferring funds from the issuing bank. It can also be paid using payment overdue at a later time making adjustments to the exchange rates.
In the case of a credit notification, the exporter shall submit the documents to his banker. The latter will then resubmit the documentary credit to the banker of the importer. The payment will be done if the documents provided by the exporter are consistent with those that show where the shipment has been made in the contractual deadlines.
There are a few risks that financial institutions and importers take when using documentary credit.
Documentary credit involves taking a few risks as well. One is the complications that the documents may involve and another is the risk of not receiving a payment.
Let us talk about the first one. Banks may find discrepancies between what was written in the letter of credit, what was actually shipped, and what arrived at the port of entry. The importer too risks receiving products of a lower quality that was originally agreed with the seller. Importers also risks being involved in frauds or in finding errors in the documents.
There is a verification process that the issuer bank will perform in order to know the validity of the shipment and the product. If there is any error, the bank should learn it right there and it assumes the responsibility of verifying that the documents are correct.
There are also risks of non-payment.
The bank is also taking risks because if the buyer fails to deposit the money that will be given to the seller, it is the bank that must comply with the contract. The banks also have the risks of failure in transferring the money from one country to the other when the importer reports insolvency.
If in any case the importer failed to pay the bank, the latter can block the funds before making the payments to the exporter. Therefore, banks need to also plan ahead for any changes in foreign exchange rates.
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Wade Henderson - recognized Professional - 15 yrs in the Business Finance Field - strong reputation for getting the deal done. IMMFinancial.com Letter Draft LC Advance
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