Chapter 4

1. DOCUMENTARY LETTER OF CREDIT

2. DOCUMENTARY COLLECTION
 UCP600

• What is UCP 600?

• Uniform Customs & Practice for Documentary Credits” is the official
publication issued by the ICC (International Chamber of Commerce).
• It determined the rules of various parties to a LC (Letter of Credit) and
between the banks involved in a transaction.
• The UCP 600 comes into effect from 1st July 2007.
• A few key changes are interpretations, Standard for Examination of
Documents, Interpretations, matters relating to Transport Documents and
Insurance Document and Coverage.
 DOCUMENTARY LETTERS OF CREDIT

• A documentary letter of credit is an undertaking of the bank, which has opened a

letter of credit on request of a buyer (applicant) to pay an amount to the seller
(beneficiary) as specified in the letter of credit upon the provision of documents by the
seller (beneficiary) that meet the conditions of the letter of credit and confirm the
shipment of commodities (the provision of services) within the prescribed time frame
• A letter from a bank guaranteeing that a buyer's payment to a seller will be received on
time and for the correct amount.
• If the buyer is unable to make payment on the purchase, the bank will be required to
cover the full or remaining amount of the purchase.
• Credit means any arrangement that is irrevocable and constitutes a definite
undertaking of the issuing bank to honor a complying presentation
 Letters of credit are used:

• if you are not certain about the solvency of your counterparty;

• if the counterparty is not certain about the proper performance of
obligations by you (in terms of the quantity and quality of
commodities or services);
• if you need a payment or trade credit;
• if you need a down payment (advance payment) for the valuables
to be supplied;
• if the counterparty insists on a settlement through letters of credit.
 PARTIES IN A LETTER OF CREDIT

1. Applicant - The importer who asks the bank to open the credit.
2. Beneficiary - The exporter who is entitled to receive payment under the credit.
3. Issuing Bank – The buyer’s bank, which establishes LC on behalf of the applicant.
4. Advising Bank - Correspondent bank (located in seller’s country), to which LC is mailed
by the issuing bank for authenticates and delivery to the beneficiary.
5. Reimbursing Bank - The paying bank makes payment to the beneficiary
6. Negotiating Bank - The bank authorized to negotiate drawing under the credit and
disburse proceeds to the beneficiary.
7. Confirming Bank - The advising bank (second bank to guarantee payment)
guaranteeing to the beneficiary that the bill will be paid accordingly.

• However, the are only four important parties involved in LC; buyer, seller, issuing bank,
and advising bank.
 ADVANTAGES OF LETTER OF CREDIT

For the seller

1. elimination of the risk of non-payment / late payment / partial payment for
goods supplied / services provided;
2. maximum reduction in the time interval between the shipment of the
commodity (the provision of services) and the receipt of proceeds;
3. possibility to get short-term funding;
4. possibility to increase supply volumes, to promote commodities (services)
in new markets, to gain competitive advantages
For the buyer
5. to secure performance of its obligations
6. the buyer may withhold payment pending documentary confirmation
7. the buyer specifies a list of documents against which payment will be
made;
8. the buyer limits the time frames for the provision of documents and goods
delivery.
 DISADVANTAGES OF LETTER OF CREDIT

• For the seller

1. Certain LC can be amended without his consent.
2. If the LC is not confirmed by local bank he may face the risk of non-
payment.

• For the buyer

1. There is additional cost to open LC.
2. Certain LC cannot be cancelled or amended
 THE FLOW OF LC
Step 1 : An importer enters into agreement by using a sale contract or proforma invoice.

Step 2:  the importer has to apply to their bank to have the letter of credit issued in favor of exporter.

Step 3: issuing bank prepares the LC in swift message format and transmit it to the exporter's bank.

Step 4: the advising bank advises the letter of credit to the beneficiary without any undertaking to honor or
negotiate

Step 5: the beneficiary should check the conditions of the credit as soon as it is received from the advising bank.
The beneficiary ships the goods in accordance with the terms and conditions stated in the credit.

Step 6:  as soon as the goods are loaded, exporter collects the shipment documents which are requested by the
credit and gives them to the advising bank.

Step 7: the advising bank dispatches the documents to the issuing bank on behalf of the beneficiary. 

Step 8:. The issuing bank checks the documents according to terms and conditions of the credit and governing
letter of credit rules. If the documents are found to be complying after the examination the issuing bank honors
its payment obligation and transmits the payment to the exporter through advising bank. 

Step 9:.On final step issuing bank transmits the documents to the importer. The applicant uses these
documents to clear the goods from the customs.
 URC522

• ICC Uniform Rules for Collections URC 522 is the title of the book that is
published by ICC to govern the documentary collection
• It is incorporated into the text of the “collection instruction".
• Collection Instruction is a written and separate document in which
exporter should supply to his bank along with the commercial and
financial documents. 
• Collection instructions are written in a cover letter format and normally
should contain below points.
1. Governing rules for the collection
2. Details of the bank from which the collection was received
3. Details of the principal, drawee, presenting bank, currency and
document supplied.
 THREE MAIN TYPES OF DOCUMENTARY CREDITS
1. Revocable credits - LC that can be modified by issuing bank at any time
without notice or consent of the beneficiary
2. Irrevocable credits - LC that cannot be amended without the seller's prior
written approval
3. Irrevocable and confirmed credits – LC that has been guaranteed by both
the buyer's and seller's banks
 FIVE SPECIAL TYPES OF LC

1. Revolving LC - established when the importer anticipates regular shipments to be made over a
period of time
2. A Red Clause Credit - contains a special clause, printed in red, whereby authorizing advising bank
give advance to the exporter to the extent of the total value of the credit before the shipment of the
goods.
3. Transferable LC - It is a sort of a documentary credit which can be used in situations where
middlemen are playing a certain role.

4. Back-to-back LC - It is also called counter LC. A middleman with limited financial resources who
undertakes to supply goods to a buyer commonly uses the LC

5. Standby LC - A standby LC is a form of guarantee, which is triggered, and activated upon failure
by the applicant to perform certain contractual requirement or activity.
 DOCUMENTARY COLLECTION

•Documentary collection is a payment security method that is similar to a letter of credit,

however, there is an important difference.

•A documentary collection is a trade transaction in which the exporter hands over the task
of collecting payment for goods supplied to his or her bank, which sends the shipping
documents to the importer's bank together with payment instructions.
• Key Characteristics :
1. Documentary collections are less complicated and less expensive than LC
2. Importers normally pay for the goods after shipment or after receive their shipment.
Such as 30 days after receipt of the goods.
3. The title of goods belong to the exporter until importer paid
4. Although banks play an essential role in documentary collections, they neither check
or verify the documents nor take any risks.
 TWO TYPES OF COLLECTION
URC 522 rules of the documentary collections defines two main types of documents; financial documents and
commercial documents.
a) Financial Documents :
Financial documents means bills of exchange, promissory notes, cheques, or other similar instruments used
for obtaining the payment of money.
b) Commercial Documents :
Commercial documents means invoices, transport documents, documents of title or other similar
documents, or any other documents whatsoever, not being financial documents

There are two types of collection namely:

a) DOCUMENTARY COLLECTION
collections of financial documents, which may have attached commercial documents,
or collections of commercial documents without financial documents.
b) CLEAN COLLECTION
whereby only the financial document (draft or bill of exchange) is sent through the banks
without a bill of lading and/or other shipping documents (which are sent separately by
the consignor to the consignee).
The Functions of Clean Collection:
 It is used for international trade settlement in two forms: documents against payment (D/P) and documents against acceptance
(D/A).

Features:
 Low costs. The banking fee is relatively lower for clean collection service.
 Safe and secure. Collecting money using the international banking network is a safer collection method as compared with direct
mailing of the draft to the drawee.
 Fast service. The collection time can be largely reduced if an "immediate credit" agreement is made between the remitting bank and
the paying/collecting bank.
 TWO METHODS OF PAYMENTS

1. Documents Against Payment (D/P):

Documents may be released only if the importer makes immediate
payment according to the contracted agreement between the exporter and
the importer. Also known as sight collection.

2. Documents Against Acceptance (D/A):

Documents may be released only if the importer accepts the accompanying
draft, thereby incurring an obligation to pay at a specified future date. In
this arrangement the exporter is exposed to the credit risk of the importer
and the political risk of the country. Also known as a term collection.
 PARTIES INVOLVED IN COLLECTION

The two non-bank parties;

1. Principal – (seller) the party entrusting the handling of a collection to a bank
2. Drawee – (buyer) the party to whom presentation is to be made in
accordance with the collection instruction.

The three bank parties are known as;

1. Remitting bank – the bank, which the principal has entrusted the handling
of collection.
2. Presenting bank - the collecting bank making presentation to the drawee.
3. Collecting bank – the bank involved in the collection process. Normally, the
presenting and collecting bank are the same bank located in buyer country.
PAYMENT RISK DIAGRAM