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Documentary letters of credit

V. Krishnamurthy

A DOCUMENTARY credit is frequently the agreed method of settlement for international trade. The buyer's bank reimburses the seller against presentation of documents drawn in compliance with conditions stipulated in the documentary credit by the buyer.

There are advantages to both the buyer and seller when settlement is arranged by documentary letter of credit. First, the buyer knows that payment will only be made if the documents received comply strictly with the terms and conditions of the credit as stipulated by the buyer. Second, the seller knows that payment will be received provided the terms and conditions of the credit are strictly complied with.

Documentary letter of credit

A documentary credit can be defined as a conditional undertaking of payment given by a bank. Expressed more fully, it is a written conditional undertaking issued on behalf of the importer (applicant) by the issuing bank to the exporter of goods (benefici ary) to pay for the goods or services, provided the documents submitted conform strictly to terms and conditions of the credit.

From this definition it can be seen that there are basically three parties to a documentary credit: a) the buyer/importer, who requires that a credit be issued in his favour; b) the beneficiary (the supplier of goods); and c) the issuing bank which issue s the credit at the request of the buyer or importer. The credit is usually (but not always) advised to the beneficiary through a bank in the beneficiary's country (the advising bank).

All documentary letters of credit are subject to the provisions of Uniform Customs and Practices (UCP) for Documentary Credits, Brochure No. 500 issued by International Chamber of Commerce, wherever it is incorporated into the text of the credit as such.

Types of credit

There are various types of documentary credits. A revocable credit is one, which can be amended or cancelled at any time without prior notice or warning to the seller (Art. 8(a) UCP 500). It involves risks to the beneficiary, as the credit may be amended or cancelled while the goods are in transit and before correct documents are presented. The seller of goods would then face the problem of obtaining payment directly from the buyer.

A revocable credit gives the buyer maximum flexibility, as it can be amended or cancelled without prior notice to the seller up to the moment of presentation of documents to the bank at which the issuing bank has made the credit available for payment.

An irrevocable credit cannot be amended or cancelled without the agreement of the issuing bank, the confirming bank (if the credit is confirmed) and the seller (beneficiary). An irrevocable credit gives the seller greater comfort of payment but is really only dependent upon the undertaking of a bank abroad. The buyer can request the advising bank to add its confirmation to an irrevocable credit if he is not satisfied with the assurance of the credit-issuing bank. If the advising bank agrees, the irrevoc able credit becomes a confirmed irrevocable credit. For adding confirmation, the bank will charge commission, which may have to be paid by seller.

A confirmed irrevocable credit gives the seller a double assurance of payment, since a bank in the seller's country has now added its own undertaking in addition to that of the issuing bank to pay for the documents drawn under the letter of credit, provi ded of course, the documents are drawn strictly in compliance with the terms of the credit.

Transferable credits

A transferable credit under Article 48 of the UCP is one under which the beneficiary has the right to give instructions to the bank which is authorised by the credit-issuing bank to effect payment, accept drafts or negotiate documents to make the credit available in whole or in part to one or more parties.

A letter of credit can be transferred only if it is expressly designated as transferable by the issuing bank and can be transferred once only (however, if part shipments are not prohibited, fractions of a transferable credit may be transferred to more th an one beneficiary).

When a credit is transferred to a second beneficiary or a number of second beneficiaries, it must be transferred on the terms and conditions specified in the original credit, except that: a) the amount of the credit may be reduced, b) any unit price may be reduced, c) the validity may be curtailed, d) the specified period of time after the date of shipment for presentation of documents may be curtailed, e) the latest shipment date may be curtailed, f) the name of the first beneficiary can be substituted , g) insurance cover percentage may be increased in such a way as to provide the amount of cover stipulated in the original credit, h) the first beneficiary may request that payment or negotiation be effected at the place to which the credit has been tra nsferred, up to and including the original expiry date.

Back-to-back credits

#Two types of credit, by their very nature, cause bankers considerable trouble and thought. They are back-to-back and transferable credits.

A back-to-back credit can be described as credit and counter-credit. It is a method of financing both sides of a transaction in which a middleman buys goods from one customer and sells them to another, both settlements being made under documentary credit s.

When the documents are received under back-to-back credit by the bank, they will advise the opener of the receipt of documents under the back-to-back credit. The opener substitutes his own invoices and drafts made out in the name of the foreign buyer and tenders the documents for negotiation under the export letter of credit. The bank will then negotiate both the documents and honour the documents submitted under back-to-back credit from the proceeds of the original export credit. The difference, if any , between the amount paid under the back-to-back credit and amount reimbursed from the foreign bank under the export credit will be paid to the original beneficiary, less bank charges.

Revolving credits

Revolving credits are those which renew themselves automatically. If the renewal is not automatic but subject to reinstatement instructions, the credit is not, in a true sense, a revolving credit in international usage. It is rather a credit of fixed amo unt, which has to be increased by means of amendment instructions after each drawing or, alternatively, a credit of a fixed total amount is payable by specific installments.

Under a revolving credit, the drawings made under the credit can be re-available to the beneficiary, upon receipt of instructions from the opening bank to the effect that the amount has been reinstated in the credit. A credit can be made revolving as to time or up to a maximum amount of drawing.

Red-clause credits

The object of the inclusion of the red clause in a documentary credit is to enable the beneficiary to obtain pre-finance from a bank in his country. It is called so because, historically, it was usually printed in red on the advice of credit.

The red clause in the credit enables him to borrow money from the bank to pay for the goods to be shipped. The beneficiary thus purchases the goods and effects the shipments. After shipments are made, the documents are tendered to the bank. However, the bank making payment under the red-clause credit will be reimbursed by the opening bank immediately on effecting payment to beneficiary.

There are two types of red-clause credits. One is secured and other, unsecured. Under unsecured credit, the payment in advance will be made to the beneficiary against presentation of clean drafts only, drawn on the advising bank/opening bank. Under secur ed or documentary red-clause credit, the advance will be made against warehouse receipts or similar documents and the beneficiary's undertaking to deliver the relative Bills of Lading upon shipment.

A green-clause credit is one which envisages the granting of storage facilities at the port in addition to the pre-shipment payment to the beneficiary.A standby letter of credit, while possessing all the elements of a documentary credit subject to UCP, i s often used in lieu of performance guarantee. Basically, the standby credit is intended to cover a non-performance (default) situation, as with the traditional documentary credit. The bank authorised to make payment under a standby letter of credit will affect payment on presentation of requisite documents called for in the credit to the beneficiary, although the opener may claim performance.

Credits are available for settlement by acceptance/ negotiation payment/deferred payment. The negotiation under a confirmed credit is without recourse while one under an unconfirmed credit is with recourse to drawer unless specified otherwise. Typically, a letter of credit nominated in any other currency other than that of the beneficiary will be available by `negotiation'.

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