Q: What do you mean by Documentary credit. What is the method of realising payments under Documents Against Payments
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Documentary Credit
Documentary Credit, often referred to as a Letter of Credit (LC), is a financial instrument used in international trade to provide a guarantee of payment from a buyer’s bank to a seller’s bank. It is a secure way to facilitate transactions between parties who may not know each other well, particularly in cross-border trade. The buyer applies for a letter of credit from their bank, which then promises to pay the seller upon the presentation of specified documents.
Key Features of Documentary Credit:
- Security for Seller: The seller is assured of payment as long as they meet the terms specified in the documentary credit.
- Risk Mitigation: It mitigates the risk of non-payment and provides a layer of security for both buyers and sellers.
- Documentation Requirement: Payment is contingent upon the presentation of specific documents, which typically include:
- Commercial invoice
- Bill of lading
- Insurance certificate
- Certificate of origin
- Any other documents specified in the LC.
Types of Documentary Credit:
- Revocable and Irrevocable: Revocable credits can be modified or canceled by the buyer without the consent of the seller, while irrevocable credits cannot be changed or canceled without agreement from all parties involved.
- Confirmed Credit: A confirmed letter of credit is backed by a second bank (usually in the seller’s country) in addition to the buyer’s bank, providing extra security to the seller.
- Sight and Usance Credit: A sight credit requires payment upon presentation of documents, while a usance credit allows for deferred payment after a specified period.
Method of Realizing Payments under Documents Against Payments (D/P)
Documents Against Payments (D/P) is a payment method used in international trade where the seller retains ownership of the goods until the buyer makes the payment. It is one of the methods to secure payment during the shipment of goods.
Process of D/P:
- Shipment of Goods: The seller ships the goods to the buyer and prepares the necessary shipping documents.
- Document Submission: The seller submits the shipping documents to their bank, which then forwards these documents to the buyer’s bank.
- Payment Request: The buyer’s bank holds the documents and informs the buyer that the documents are ready for collection. The buyer must make payment to receive the documents.
- Payment Realization:
- Payment Upon Delivery: The buyer pays the full amount specified in the sale agreement to the buyer’s bank. Once the payment is made, the buyer’s bank releases the documents to the buyer.
- Document Ownership Transfer: Upon receiving the documents, the buyer can take possession of the goods from the carrier or shipping company.
- Transfer of Funds: After the buyer’s bank releases the documents, it transfers the payment to the seller’s bank, completing the transaction.
Key Features of D/P:
- Risk to Seller: While D/P offers some security to the seller, it does not provide as much assurance as a letter of credit since the seller relies on the buyer’s willingness and ability to make the payment.
- Documentation: The buyer must provide payment before receiving the documents, which is critical for taking possession of the goods.
- Limited Control: If the buyer fails to pay, the seller must handle the logistics of reclaiming the goods, which may involve additional costs.
Conclusion
Documentary credit serves as a vital financial instrument in international trade, providing security and reducing risks associated with cross-border transactions. On the other hand, Documents Against Payments (D/P) offers a more straightforward approach to payment realization, where the buyer makes payment in exchange for the shipping documents. Each method has its own advantages and risks, and parties involved in international trade must carefully consider their specific needs and relationships when choosing a payment method.