Documentary credit system

Documentary credit system. The documentary credit can also be called a “commercial credit” and the system is one that is controlled by banks, which provide finance for buying and selling goods. The phrase “standby letter of credit” can also be used.

These phrases refer to any arrangement in which a person (usually the buyer) makes application to the bank far a documentary credit and furnishes precise instructions as to how and when the bank should arrange for payment to a third party generally the seller or to the seller’s order). The bank (called the “issuing bank”), can authorise another bank to make the payment to the third parry against stipulated documents, provided that the terms and conditions of the credit (generally the buyer’s instructions) are complied with. The third party is called the “beneficiary”. The other bank is called the “advising bank” because this bank will advise the beneficiary about the credit and what documents should be produced before payment. In the system, the issuing bank can also make the payment either directly or through a branch.

Either the issuing bank or the advising bank can also pay, accept or negotiate a “bill of exchange” or “draft” drawn by the beneficiary. Moreover, a third bank may enter the scene, the “confirming bank”, authorised or requested by the issuing bank to guarantee that the beneficiary will be paid, for example, if one party is in a country where there are foreign exchange restrictions. This will give the exporter confidence in the entire transaction and may be specified by him to the buyer in the contract of sale.

The documentary credit system is a separate transaction from the sale of the goods and also separate from the contract of carriage. However, the system influences the bill of lading, which is used in the contract of carriage.

In the sale of goods, whether domestic or international, sellers may hesitate to release their goods before receiving payment and buyers may prefer to receive the goods (for example, to inspect that the goods match the description) or have control over them (for example, to sell them to another party) before making payment. However, matching payment with physical delivery is not always possible. A compromise is agreed whereby payment will be made when documents representing the goods are handed over. This handing over of the documents is called “constructive delivery”. The documents include “transport documents” which include marine bills of lading. The documents transfer title to the goods to the person who may eventually be the buyer. The holder of the documents then has some control over them.

The credit can be either a “revocable letter of credit” or an “irrevocable letter of credit”. If the instructions to the issuing bank do not specify the type of credit, it is presumed to be revocable. The revocable credit may be amended or cancelled by the issuing bank at any time and without notice to the beneficiary. This is one reason why this form of credit is unattractive in international trade and not very common. The irrevocable credit is a definite undertaking by the issuing bank to pay or that payment will be made provided that the terms and conditions of the credit are complied with by the seller and the stipulated documents are presented.

The documents are “transport documents”, “insurance documents”, a “commercial invoice” and other specified documents, for example, a certificate of weight. The entire documentary credit system is therefore concerned with payment for documents rather than payment for physical goods. The documents come to represent the goods and rights attached to the ownership of the goods.


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Documentary fraud