Chapter 7
Methods of International Trade Settlement and
Financing
Documentary Credit
1
Parties in D/C & How It Works
Documents Required
Sight & Usance D/C
2
Types of D/C
Trade Bloc
• A trade bloc is a large free trade area formed by one
or more tax, tariff & trade agreements.
• Typical trade pacts define such a bloc specify formal
adjudication bodies, e.g. NAFTA trade panels.
• It may include even a more democratic &
participative system, as the EU & its parliament.
• Economic blocs, generally regionally based, have
been developed to promote trade between member
states.
• A trade bloc is established thru a trade pact/pacts
covering different issues of the economic integration.
Documentary letters of Credit
• Definition
• An undertaking of payment made by a
bank(on the buyer’s/importer’s behalf) to
the exporter’s bank.
• Payment would normally be against
presentation of sight bill, maturity of the
usance bill
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Continued
• Applied by importer
• Importer needs to fill in the form, submit a
copy of the insurance policy (if purchase is
on CIF terms), and import permit
• The bank’s guarantee that they will pay
the exporter in the event the importer
becoming insolvent
• Serves to facilitate smooth transactions in
IT
Mechanism Of L/C
• Parties to LC
– Importer
– L/C issuing bank
– Exporter
– Notifying bank
Cont’d
1. Sales contract
Exporter
(Beneficiary
Importer
(Applicant)
5. Shipping
2.Application
for LC
6. Negotiation 4. Advice on
For purchase Opening of LC
of bill
3. Opening of LC
Notifying (advising)
Bank
(Negotiating Bank)
7. Send BE
& shipping
Doc.
8. Presentation
Of BE,Pmt &
surrender bill
Issuing
(Opening)
Bank
(Reimbursing bank)
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Cont’d
• Steps in opening L/C
1.When sales contract is made between the
exporter & importer, both sides agree to do
business on an L/C basis
2.Importer requests the issuing bank to issue an
L/C.
Issuing bank will determine the importer’s
financial standing & if acceptable, the bank
will issue the L/C to the exporter. The bank
may request the importer to make a deposit in
order to guarantee themselves
Continued
3.The issuing bank will forward the credit to its
correspondent (advising) bank
4. The advising bank advises the exporter that
credit has been issued in his favour
5.The exporter executes the shipment according to
the conditions of the L/C
6.The exporter presents the Bill of Exchange
(Draft) based on the condition of the L/C
together with a full set of the shipping doc. &
applies for negotiation of the doc. bill at the
exporter’s bank (negotiating bank)
Continued
7. The advising bank will send the doc. To
the issuing bank for reimbursement.
8. The issuing bank will forward the doc. To
the importer for payment. On payment the
documents will be released to the
importer.
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Classification
• Revocable
– May be cancelled or amended by the issuing
bank at any time & without prior notice to the
beneficiary.
• Irrevocable
– Lc that can only be amended/ cancelled if all
parties to the credit agrees to the alteration or
cancellation
Cont’d
• Irrevocable confirmed credit
– May be used when an exporter is concerned
about the creditworthiness of the issuing bank
– The advising bank on instruction of the
issuing bank may also confirm the credit
– Cant be modified/cancelled w/out agreement
of all parties
– Provides an added securiy to the exporter
since it bears the guarantee of two banks
Payment Provision
• Sight payment
With this type of letter of credit, the
beneficiary will draw the draft (bill of
exchange) payable at sight on a bank.
• Usance payment
• The beneficiary will draw the draft payable
at some future point in time ( usually a
specified number of day after it has been
sighted)
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Cont’d
Deferred payment
• No bills of exchange will be issued, only the
required documents will be sent to the
nominated bank for inspection.
• If it is good, the documents would be
retained & passed on to the issuing bank
• The beneficiary would be paid at the time
specified in the LC (he is paid on the
deferred date)
Cont’d
• Payments under negotiation
• The bank(negotiating) will buy the doc.
That relate to a LC.
• A bank gives full immediate value to the
beneficiary under the credit
• The negotiating bank will attend to their
presentation on the drawee bank. It would
be expected that the bank would pay on
sight or on the agreed date, as
appropriate.
Types of LC
• Red-clause-LC
– Special type of LC which contain a clause printed in red
– The issuing bank (importer bank) authorizes the
negotiating bank (the exporter bank) to make advance
payment to the beneficiary (exporter) prior to shipment of
goods.
– This allows the exporter to purchase or prepare the goods
that it will export to the importer.
– Normally used by parties who have established business
relation ship
• Standby LC
– Does not provide guarantee of payment to the beneficiary
– It gives guarantee to the beneficiary against default by the
applicant.
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Cont’d
Revolving LC
– The LC that provides an element of flexibility to
an exporter
– The credit can revolve either in relation to
amount/ time and the terms & conditions of the
LC
– The amount is reinstated/renew without specific
amendments to the original LC
– When the has been utilized & paid either fully or
partially, the credit amount in that LC is
automatically restored to its original amount.
Cont’d
• Back-to-back LC
– Two or more LC issued
– Is issued by by the importer bank (LC1) in
favour of a beneficiary (exporter 1) who is
normally known as the primary beneficiary
– The credits & value is made available to
another or second beneficiary (exporter 2)
Cont’d
– Exporter1 who gets the BBLC will apply for
another LC (LC2) and use the first LC as a
security
– The exporter’s bank will issue the second LC
in favour of a second beneficiary (exporter 2)
– Smaller value than LC1
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Back to back LC
11.Doc. Presented
& reimbursement
Advising/
Issuing
Bank
Issuing
Bank
2. Issue 1st LC
(Master credit)
10.Doc. Presented
& reimbursement
Advising
Bank
6.Issue
New LC (#2)
4.Apply
credit
3. Advise
1.Apply 12.Doc. Presented
On LC
To buyer &
LC
Get paid
Applicant
5.Substitute
BE & inv.
& present
For nego.
Beneficiary 1
(Buyer)
8.Ship goods
7.Credit
advised
9.Doc.
Presented
& nego.
To buyer
Beneficiary 2
(Supplier)
Cont’d
• Transferable LC
– LC that gives the right to the beneficiary to
instruct the advising bank to pay to a second
beneficiary who is the real supplier of the
goods in the transaction.
– Normally used when the original beneficiary is
only a middleman
Transferable Credit
10.Doc. Presented
& reimbursement
Issuing
Bank
Advising/
Issuing
Bank
2. Issue LC
9.Doc. Presented
& reimbursement
Advising
Bank
5.Credit transfer
4.Substitute
BE & inv.
& present
For nego.
1.Apply 11.Doc. Presented
To buyer &
LC
Get paid
Applicant
7.Ship goods
6.Credit
advised
3. Advise
On LC &
instructio
n to
transfer
Beneficiary 1
(Buyer)
8.Doc.
Presented
& nego.
To buyer
Beneficiary 2
(Supplier)
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The Difference Between Transferable &
Back to Back LC
The buyer is aware that
the seller is only a
middleman, not the real
supplier
Only one LC is issued
Not governed by the
rules specified in the
Uniform Customs &
Practice for
Documentary Credits
The buyer is not aware
that the seller is only a
middleman, not the real
supplier
More than one LC is
issued
It is governed by the
rules specified in the
Uniform Customs &
Practice for
Documentary Credits
Documents Against Payment D/P Terms &
Documents Against Acceptance D/A
• Used when traders do business without L/C
terms, for instance:
• Buyer can’t obtain LC from his bank because of
tight regulations
• Buyer resides in a country where banks do not
issue LC at all
• Buyer is a credible leading company
• Importer’s good financial standing is very well
known to the exporter
Continued
• Two terms of settlement through
documentary collection without using LC:
– Doc. Against payment (D/P) terms
– Doc. Against acceptance (D/A) terms
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Documents Against Payment (D/P) Term
6. Remit payment
Collecting
Bank
Remitting
Bank
3. Sends B/E
7. Pay
exporter
4. Presents B/E
for payment
2. Presents B/E
for collection
5. Makes
payment
1. Ships goods
Exporter
Importer
D/P Terms
1. The exporter ships the goods w/out the
documents
2. The documents (sight bill, bill of lading)
are presented to the remitting bank
(banker of exporter
3. Then the remitting bank will remit the doc.
To its corresponding bank (collecting
bank) in the importer’s country.
Continued
4. The collecting bank will forward the doc.
to the importer & will only release the
documents once the importer makes
payment.
5.The importer pays the BE
6.The collecting bank will remit the payment
to the remitting bankbank notifies the
negotiating bank in the exporter’s country
to confirm payment from the importer
7. The remitting bank pays the exporter &
the settlement is finished
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D/A Terms
• The exporter gives a grant of deferred payment
to the importer
• The process for D/A up to the arrival of the doc.
at the reimbursing bank is similar to D/P.
• When the reimbursing bank notifies the importer
on the arrival of the documents, the importer
checks the doc & agrees on payment (promises
to pay at a later date), then the bank hands over
the doc. to the importer.
• Under D/A terms the BE is drawn on “Usance
Bill”
• Usance means the time limit for the drawee to
honour the bill (30 to 180 days later after sight)
Documents Against Payment (D/A) Term
6. Holds BE till maturity
& remits payment when buyer pays
Remitting
Bank
7. Pay
exporter
Collecting
Bank
3. Sends B/E &
Doc.
2. Forward documents
4. Presents B/E
for acceptance &
Obtains doc.
5. Makes
payment
1. Ships goods
Exporter
Importer
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