Documentary Credit: The Preferred Method For International Transactions

Documentary Credit: The Preferred Method For International Transactions

Documentary credit is a payment technique that facilitates and secures international transactions. Concretely, a bank undertakes, on behalf of its client (the importer), to pay the price of goods or services to a beneficiary (the exporter) within a specified period; in return, the exporter sends a remittance of previously agreed and compliant documents proving the value and shipment of the goods or services.

Documentary credit, also called a credoc, is used when the amounts of the transaction are very large or when one of the parties has doubts about the morality or solvency of the other. In this way, it makes it possible to secure international transactions and constitutes a guarantee for the exporter and the importer .

Note: the documentary credit system is a separate transaction from the sale of goods and the transport contract.

Which companies are the documentary credit for?

Thanks to its worldwide use and its reliability, documentary credit has become the most widely used means of inter-professional payment in France. Created to secure international commercial transactions, it is particularly suitable:

  • companies that carry out commercial transactions with so-called “risky” countries or with new customers ;
  • companies that export tailor-made products ;
  • companies that do not have a credit insurance contract to cover their export customers. Thus, the credoc offers a high level of guarantees with the intervening banks. On the importer side, he ensures that payment is made only on condition that the seller respects his contractual commitments. For the exporter, it is guaranteed to be paid on time.

Note: the effectiveness of the payment transaction depends as much on the reliability of the banks as on compliance with formalism. Before opening a credoc, the instructions must be clearly detailed and scrupulously checked at each stage of the operation.

Documentary Credit Stakeholders

Generally, four main players are involved in a documentary credit operation: the importer (the buying client), his bank (the issuing bank), the exporter (the seller) and his bank (the advising bank). A fifth speaker can sometimes be called upon: a confirmation bank.

  1. The originator. As a buying client, it is he who initiates the credit transaction. It is also up to the importer to give the instructions for opening the documentary credit.
  2. The issuing bank. It opens the credoc at the request of the importer. In most cases, it is located in the buyer’s country and opens the documentary credit.
  3. The advising bank (of the seller therefore). It communicates with the issuing bank (of the buyer) and notifies the beneficiary of the documentary credit transaction. It is in principle located in the seller’s country without making any payment commitment to the latter. It can be the confirming bank if it confirms the documentary credit.
  4. The seller (or exporter) is the final beneficiary of the payment. It is in his favor that the documentary credit is opened.
  5. The confirmation bank . It sometimes happens that a third bank interferes in a documentary credit operation: the confirmation bank. Solicited by the issuing bank, its role is to guarantee payment to the beneficiary, that is to say to the seller. The exporter has the option of specifying this on the sales contract to reassure the buyer. This way, if one of the parties is located in a country where exchange restrictions exist for example, then the exporter will have more confidence in the transaction. By going through financial institutions as trusted third parties, the parties transfer the risk of conflicts to neutral partners.

With irrevocable and notified credit, the risk increases depending on the political or economic context of the exporting country. In a situation of force majeure (political unrest, economic or social crisis, etc.), the seller’s bank does not guarantee payment.

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