Documentary credit for international trade

Your needs

Your ideal scenario for doing business abroad is taking shape. You want to access untapped markets, meet new trading partners, and establish solid, trusting relationships with them. Above all, you want to be sure that you will be paid correctly and on time for your exports and that your imports will be delivered punctually.
A documentary credit can provide additional support to help you achieve this in your international trade activities.

Documentary credit characteristics

A documentary credit, also known as a letter of credit, goes a step further than a documentary collection.

First, the exporter and importer agree that the importer’s bank will open a documentary credit in favour of the exporter.

Two important steps then follow. Firstly, the exporter’s bank must send the correct trade documents agreed in the contract (such as the invoice, customs or insurance papers, transport documents and relevant certificates) to the importer’s bank. Second, the importer’s bank must confirm that these documents comply with the agreed contractual terms.

Once these two conditions have been met, the importer’s bank assumes the payment obligation from the importer. It pays the exporter’s bank, debiting the importer’s account. The exporter’s bank then pays the seller.

A documentary credit also has the advantage of including an agreed maturity date by which all payments must be made.

For the importer, a documentary credit ensures correct and timely delivery. For the exporter, it ensures correct and timely payment, which is guaranteed by the importer’s bank's irrevocable commitment.

Unlike a documentary collection, therefore, a documentary credit is not only an international payment technique. It also provides a payment guarantee. The only remaining risks to this guarantee are the insolvency of the importer’s bank or political risk in the importer’s country. However, there is a solution to these risks: the confirmation of the exporter’s bank, which guarantees that it will take over the commitment of the importer’s bank. This is known as a 'confirmed documentary credit'.

Payment conditions

A documentary credit may include different payment conditions. The three main types are:

1. Payment at sight: the exporter is paid when they present all agreed documents to their bank.
   
   
2. Deferred payment: the exporter receives a promise of payment at a later date after sending the documents.
   
   
3. Payment with a bill of exchange, for example 'against acceptance' or 'subject to negotiation'.

The risks of documentary credit

A documentary credit carries risks that are similar to those of a documentary collection. Once again, the bank’s commitment concerns the correct exchange of documents and payment. However, it does not guarantee the conformity or quality of the goods.

Advantages and disadvantages

A documentary credit has several clear advantages:

• The entire process follows international rules. All parties involved must comply with these rules, which are monitored by the banks.
• The importer receives a guarantee that the goods will be delivered on time, unless force majeure intervenes. As mentioned earlier, however, no guarantee is given regarding the conformity of the goods.
• The exporter is no longer at risk of non-payment by the importer, as this is covered by the importer’s bank's irrevocable commitment. The exporter can also mitigate the risk of the importer's bank being unable to pay by adding confirmation from their own bank.
• A confirmed documentary credit allows the exporter to benefit from advance financing from their bank.

However, a documentary credit also has disadvantages:

• It is more expensive than a documentary collection.
• It is also more complex to implement and follow up than a documentary collection.
• The importer’s bank will only open a documentary credit if a credit line is available.
• For confirmation of a documentary credit, the exporter depends on their own bank's approval, which requires the importer's bank to be deemed an acceptable risk.

You can rely on BNP Paribas Fortis

At BNP Paribas Fortis, we understand that entrepreneurs have many questions when considering foreign trade and selecting the right international payment solution. Are you planning to import or export, looking to expand your existing international activities or searching for new opportunities abroad? If so, contact your relationship manager. They will be happy to put you in touch with a specialist.