A documentary credit—also called a letter of credit—is a conditional guarantee of payment in which an overseas bank takes responsibility for paying you after you ship your goods, provided you present all the required documents (such as documents of title, insurance policies, commercial invoices and regulatory documents).
A documentary credit is a separate contract from an export contract. The parties to
a documentary credit deal with documents, not the goods that the documents
relate to.
Documentary credits are a common method of
payment in the international trade of goods as they offer some protection to both you and your buyer.
The advantages of a Documentary Credit:
For the Exporter/Seller:
1. The seller has the obligation of buyer's bank's to pay for the shipped goods;
2. Reducing the production risk, if the buyer cancels or changes his order
3. The opportunity to get financing in the period between the shipment of
the goods and
receipt of payment (especially, in case of
deferred payment).
4. The seller is able to calculate the payment date for the goods.
5. The buyer will not be able to refuse to pay due to a complaint about the goods
For The Importer/Buyer:
1. The bank will pay the seller for the goods, on condition that
the latter presents to the bank the determined documents in line with the terms of the letter of credit;
2. The buyer can control the time period for shipping of the goods;
3. By a letter of credit, the buyer demonstrates his solvency;
4.
In the case of
issuing a letter of credit providing for delayed payment, the seller grants a credit to the buyer.
5. Providing a letter of
credit allows the buyer to avoid or reduce pre-payment.