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Documentary Credits
Documentary Credits (DC)
DCs, more commonly known as letters of credit are a widely used method to effect payments in domestic and international trade. A written undertaking is issued by a bank (usually referred to as the issuing bank) on the instructions of the buyer of goods to the seller. The payment is made under conditions stated in the undertaking. Payments are always upto a stated limit and against stipulated documents.
The use of a DC provides enough safeguards for the parties involved. The seller is ensured payment, provided he complies with terms he agreed to while the buyer can include all terms and conditions within the DC that satisfy him on the quality and quantity of the goods without having to sight / inspect the goods themselves.
Since banks act as trustworthy third parties/ intermediaries, the issues relating to trust between the buyer and the seller are taken care of.
DCs can be either sight or usance depending on whether credit period is extended to the buyer by the seller.
Important aspects to check for when you receive a DC are:
- Payment terms
- Availability of the DC
- Acceptability of issuing bank
- Terms of shipment
- Feasibility of complying with terms of the DC
- Workability of the DC
- Bank charges to whose account
Confirmation to a DC enhances security under the DC and mitigates any existing issuing bank and/ or country risk since the same are taken over by the confirming bank.
The schematic below elucidates Documentary Credit transaction flow :
