What is Documentary Letter of Credit (DLC).
A documentary letter of credit is bank’s promise to pay a seller on behalf of the buyer as long as the seller complies with precisely defined terms and conditions specified in the credit. Parties of the transaction are applicant, beneficiary and assurance of payment.
Documentary letters of credit are mostly used in international transactions, where the buyer and seller have yet to establish a strong relationship and/or operate in different countries. When concluding a deal with a buyer from a different country, the seller is exposed to risks due to the physical distance between the two parties, foreign or unknown legal systems, and lack of knowledge about the buyer. A seller may be hesitant to enter such a risk-sensitive deal without a letter of credit as financial security.
A documentary letter of credit is one of the oldest and most standard forms of payment for transactions in international trade. Foreign exporters that deal with unfamiliar companies thousands of miles away are naturally uncomfortable investing money to produce goods and ship them without any assurance of payment. Without documentary a letter of credit, exporters generally ask for substantial deposits or other payment guarantees. documentary Letters of credit allow buyers to avoid these undesirable alternatives.
A documentary letter of credit (DLC) is a promise by the bank that the beneficiary will receive the payment with the correct amount and on-time. Depending on the type, the bank may offer the facility to the applicant as confirmed, fully funded, or as a standby promise of payment.
Usually, a documentary letter of credit is irrevocable, non-transferable, and confirmed promise made by the bank. The bank requires collateral against issuing the facility and charges a fixed percentage of the DLC value as commission.
Important.
Letter of credit (Documentary Letter Of Credit (L/C, DLC) is the bank’s obligation to pay the seller of goods or services a certain amount of money in the timely submission of documents confirming shipment of goods or performance of contractual services.
How Does Documentary Letter Of Credit Work?
International trade involves complex documentation and payment procedure due to different regulatory and law requirements. An importer can contact a potential seller in a different continent, the shipment of goods may go through several jurisdictions before it reaches the final destination. A documentary letter of credit plays a crucial role in developing the trust and facilitating the payment process to both parties in the trade.
Parties involved in a documentary letter of credit:
* The buyer – Applicant of the DLC.
* The seller – Beneficiary of the DLC, or first beneficiary.
* The Issuing bank – from the applicant side.
* The confirming bank and nominated bank – from seller side and sometimes common facilitators.
A documentary letter of credit is a negotiable instrument, meaning the issuing bank will pay the nominated bank of the beneficiary. If the DLC specifically states, the issuing bank can transfer the funds to the nominated secondary beneficiary as well.
Types Of Documentary Letter Of Credit.
* Irrevocable (and Revocable) It is an undertaking that guarantees the bank’s issued payment for any services or goods purchased.
* Silent Confirmation.
* Confirmed And Non-Confirmed Letter Of Credit.
* Red & Green Clause.
* Fully Funded Documentary Letter Of Credit.
* Revolving.
* Commercial Letter Of Credit
* Transferable.
* Standby Letter of Credit.
* Back-to-Back.
1. Irrevocable (and Revocable).
A revocable letter of credit is uncommon because it can be changed or cancelled by the bank that issued it at any time and for any reason. An irrevocable letter of credit cannot be changed or cancelled unless everyone involved agrees. Irrevocable letters of credit provide more security than revocable ones.
2. Silent Confirmation.
A silent confirmation, is a confirmation, issued to the beneficiary of a letter of credit, by which the silent confirmation bank undertakes to pay the beneficiary (thereby the beneficiary gains assurance of payment if for some reason the issuing bank refuses or cannot pay under the letter of credit.
3. Confirmed And Non-Confirmed Letter Of Credit.
In an unconfirmed letter of credit, the seller requests the payment from issuing bank where there is a second bank as a mediator. In a confirmed letter of credit, the seller requests the payment from the confirming bank. Confirming bank makes the payment to the seller and in turn requests the payment from issuing bank.
4. Red & Green Clause.
A red clause letter of credit is one that authorizes the exporter to avail pre-shipment finance on the strength of the credit. … In a green clause letter of credit, in addition to pre-shipment finance, storage facilities are allowed at the port of shipment to the exporter by opening bank.
5. Fully Funded Documentary Letter Of Credit.
A fully funded documentary letter of credit (FFDLC) is a documented letter of credit that serves as a written promise of payment provided by a buyer to a seller. The seller receives payment when all of the terms of the agreement are fulfilled.
6. Revolving.
A revolving letter of credit is a special letter of credit type, which is structured in a way so that it revolves either in value or in time covering multiple-shipments over a long period of time under a single letter of credit.
7. Commercial Letter Of Credit
Also known as a trade letter of credit or documentary letter of credit, a commercial letter of credit is typically used by a buyer of goods to pay the purchase price to the seller in the ordinary course of the international sale of goods.
8. Transferable.
A transferable letter of credit is a type of financial guarantee, known as a letter of credit, that additionally allows the first beneficiary to transfer some or all of the credit to another party, which creates a secondary beneficiary. … A transferable letter of credit is an alternative option to advance payments.
9. Standby Letter of Credit.
A Standby Letter of Credit (SBLC / SLOC) is a guarantee that is made by a bank on behalf of a client, which ensures payment will be made even if their client cannot fulfill the payment. It is a payment of last resort from the bank, and ideally, is never meant to be used.
10. Back-to-Back.
Back-to-back letters of credit consist of two letters of credit (LoCs) used together to finance a transaction. A back-to-back letter of credit is usually used in a transaction involving an intermediary between the buyer and seller, such as a broker, or when a seller must purchase the goods it will sell from a supplier as part of the sale to his buyer.
Key takeaway
A Documentary Letter of Credit (DLC) normally forms of payment security or payment guarantee between a Buyer and Seller of Goods. … A Documentary Letter of Credit (DLC) is a specialist payment mechanism that is used for a specific buy and sell goods transaction, a DLC cannot be monetized by a 3rd party.
Advantages of Documentary Letter of Credit (DLC):
Documentary Letter of Credit (DLC) Benefits.
A letter of credit minimizes risk, maximizes control, and optimizes profits associated with international trade by making transactions simpler, smoother and safer for all sides.
For both buyers and sellers in a given transaction, letters of credit represent a reasonable compromise that protects both sides’ interests by assuring exporters that they will get paid once they produce and ship the goods according to certain documentary requirements that in turn protect importers’ interests.
* DLC helps in international business expansion.
* DLC provides financial security to both parties in international trade.
* It comes with several features and types making it a highly customizable instrument.
* It acts as facilitating instrument for payment, working capital, and financial security simultaneously.
* Both parties can secure their interests with different features.
* Enables businesses to plan better for large cash flow projects.
Disadvantages of Documentary letter of credit:
Expensive, tedious and time consuming in terms of absolute cost, working capital, and credit line usage. Additional need for security and collateral to satisfy bank’s coverage terms for the buyer. Lengthy and laborious claims process involving more paperwork for the seller.
1. Costly.
2. Sensitive expiration dates.
3. Require amendments if there are any changes, hence delaying the transaction.
4. Reliability of payment under the Letter of Credit is dependent on the issuing bank.
With all its benefits and flexibility of several options, it also serves some limitations to both parties.
* The bank cannot fully ensure the payment to the beneficiary, in case there is litigation or other factors in a trade dispute.
* DLC does not remove the financial currency risk for the beneficiary.
* It is a costly and sophisticated instrument that may not be accessible for small businesses easily.
* It cannot reduce the financial risks due to political, geographical, or macroeconomic factors.
Conclusion.
A documentary letter of credit is a means of financial guarantee and secure mode of payment in international trade. It comes with several features and is a highly customizable instrument. It comes with the backing of two banks as facilitators.
A Documentary Letter of Credit (DLC) or At Sight Letter of Credit (Sight LC) is a financial instrument, issued by banks or trade finance institutions through a SWIFT MT700 message, where seller/exporters receive payment from the buyer/importer, once the terms specified in the DLC are completely fulfilled.
A Bectic Finance Company Limited we value our relationships with our clients so much that ALL CLIENT DEPOSITS for a Documentary Letter of Credit (DLC) receive 2 Tiers of Protection which are:
1. Corporate Refund Undertaking
2. Non-Performance Penalty
Bectic Finance Company Limited offers Documentary Letter of Credit (DLC) from top rated banks such as: Standard Chartered Bank, HSBC Bank plc, Deutsche Bank AG, Barclays Bank PLC and many more.
Documentary Letter Of Credit at Bectic Finance Company Limited. Contact our Contract Bond experts today for consultation.
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