Documentary Credit

with Letter of Credit

Dr. A.K. Sengupta

Former Dean, Indian Institute of Foreign
Trade 1
 Documentary Credit
•An exporter is unwilling to part with his/her goods unless
she/he is assured of the receipt of the payment from the
imports
•Importer is unwilling to part with the money unless assured
of receiving the goods
•Banks play a crucial role of an intermediary – providing
assurance to both the importer and exporter
•The payment collection mechanism that allows exporters to
retain ownership of the goods or reasonably ensures their
receiving payments is known as documentary collection
•The bank acts as the exporter’s agent in a documentary
collection and regulates the timing and the sequence of
exchange of goods for value by holding the title of the
documents until the importer fulfils his/her obligation as given
in the uniform customs and practices (UCP), brought out by
ICC 2
Documentary Credit with Letter of Credit
•A documentary credit represents a commitment of a bank to
pay the seller, a certain amount provided the seller presents
stipulated documents evidencing the shipment of goods
within a specified period
•Modus operandi of Letter of Credit is shown in the diagram

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•Two principal documents used in documentary collection

Bill of Lading (issued by the shipping company)

Draft or Bill of Exchange (drawn by the exporter)

•Bill of Lading
Issued by the Shipping Company to the shipper for
accepting the merchandise
As the documents of title, it has unique significance that
only its legitimate holder is entitled to claim ownership of
the goods covered therein
The importer cannot take possession of the goods
unless the Bill of Lading is surrendered in original to the
shipping company at destination

•The Draft, commonly known as Bill of Exchange is drawn by

the exporter 4
It is used as an instrument to effect payment in
international commerce.
It is an unconditional order in writing signed by the seller
(exporter), also known as drawer addressed to the buyer
(importer) or importer’s agent, known as drawee ordering
the importer to pay on demand or at a fixed or
determinable future date the amount specified on its face
The draft, provides written evidence of a financial
obligation in clear and simple terms
Using a draft enables an exporter to employ its bank as
a collection agent

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 Port of Loading Port of discharge

Shipping company 6a Shipping company

Voyage
5

Shipment of

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Bill of lading
Bill of lading

released
Cargo

Cargo
6

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Export Contract
Exporter (Beneficiary) Importer (Applicant)
1
4
(including draft
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also confirms)

Application for
Documents

(draft and B/L)

Opening L/C
Advises (or
and B/L)

Documents
Payment

11b

Payment
L/C

11a
7

2
Delivers L/C
Corresponding advising 3
bank Issuing bank
8
Documents (including draft and B/L)

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Draft accepted and funds released
•Exporter gets in touch with importer and based on mutual
communications either by telephone, fax, or electronic
messaging and mutually agrees on terms of sale and enters
into a sales contract (1),
•The importer, also known as applicant applies to the issuing
bank located in his/her country (2),
•For opening an Letter of Credit in accordance with the terms
already agreed upon between the buyer and the seller in the
sales contract.
•The issuing bank opens the Letter of Credit and delivers it
(3)
•To the corresponding bank located in the exporter’s country
which in turn advises (4) it to the exporter also known as
beneficiary. The exporter carefully scrutinizes the L/C and
ensures that all terms and conditions agreed upon in the
sales contact are mentioned.

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•Once the exporter gets satisfied of the terms and conditions
contained in the Letter of Credit, She/He makes shipment (5).

•Soon after delivering goods to the shipping company, the Bill

of Lading are obtained, (6)
•Which serve as the cargo receipt, contract of carriage, and
the document for the title of the goods.
•The shipment procedure requires a number of documents,
•The exporter submits the complete set of documents as
mentioned in the Letter of Credit, including the Bill of Lading
along with the draft drawn by the exporter (7)
•To the advising bank, which in turn sends it to the issuing
bank (8).
•The issuing bank scrutinizes the documents and if found in
accordance with the terms and conditions contained in the
Letter of Credit,
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•It accepts the documents and in the case of sight Letter of
Credit, releases the payment (9) to the advising bank.
•The advising bank in turn makes the payment to the exporter
(10).
•However, in the case of a usance Letter of Credit, payment
is made at a later date as contained in the Letter of Credit.
•The issuing bank presents the draft to the applicant (i.e.,
importer), who releases

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the payment (11a), upon which it handovers the Bill of Lading
along with other documents (11b) to the importer, who in turn
hands over the Bill of Lading (12) to the shipping company at
the destination and takes delivery of the cargo (13)
Types of Letters of Credit
According to methods of payment, the Letters of Credit may
be of following types:
Irrevocable and Revocable Credit
• Under revocable letter of credit the importer’s bank opens
as credit in favour of the exporter, but expressly states that
the credit can be revoked at any time without the consent of
or notice to the beneficiary.
• This type of credit obviously does not protect the interest of
the exporter who may learn at the last moment or, even after
shipment, may come to know that the credit has been
revoked.
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•And once it is revoked, he has no means to recover his
dues.
•When the credit is irrevocable, this problem does not arise.
•The issuing bank in this case irrevocably commits itself to
make the payment, if the credit terms, as given in the letter of
credit, are satisfied, i.e., the required documents are
presented on or before the due date.
•The exporter can, therefore, feel secure about the payment
as this credit cannot be cancelled

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2. Confirmed and Unconfirmed Credit
•The exporter may not be familiar about the soundness of the
importer’s bank to irrevocably commit itself to make the
payment on presentation of the documents
•Again, it is easier for him to deal with a local bank.
•The system works in the following way: The importer’s bank
(issuing bank) asks its correspondent bank in the exporter’s
country to confirm the original credit as opened by it.
•The correspondent bank, while advising the exporter about
the opening of the letter of credit, adds a clause to the effect
that:

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•The above credit is confirmed by us and we hereby
undertake to honour the drafts drawn under this credit on
presentation provided that all the terms and conditions of the
credit are duly satisfied.
•When the advising bank adds its confirmation to the
irrevocable credit issued by the importer’s bank, the credit
becomes confirmed and irrevocable.
•The advantage of such credit, so far as the exporter is
concerned, is that the payment risk becomes localised, i.e.,
can secure payment from the local bank.
•The disadvantage to the importer is that the credit becomes
costlier, because the advising bank will ask for confirmation
charges from the issuing bank which in turn will recover the
same from the importer.
•This is the basic reason why many importers would like to
open only irrevocable but not confirmed letters of credit.
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•When the letter of credit is irrevocable but not confirmed, the
issuing bank asks the correspondent bank to advise about the
letter of credit without any confirmation of the latter.
•In such a case, the advice of the correspondent bank will
contain a clause that:
•This credit is irrevocable on the part of the issuing bank but
is not confirmed by us and therefore it does not involve any
undertaking on our part.
•If the issuing bank is well known and of good standing, the
exporter need not worry too much about the confirmation.

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