What is a documentary credit should be known to individuals and legal entities participating in the purchase and sale of a particular product. This form of payment allows you to protect both the seller and the buyer from financial losses.
There is no definite answer to the question of what a documentary credit is. The concept can be interpreted both as a contract and as a certain method, a method of fixing a transaction between a seller and a buyer, when a third party acts as a certain guarantor of transparency and fulfillment of obligations.
What is documentary credit
The main task of trading at any level is not only to sell or buy a product, but also to eliminate the risk of financial losses. This is why there is such a type of transaction as documentary credit. This is an agreement in which three parties participate - the seller, the buyer and the guarantor of the payment, which is most often a financial institution, a bank. The letter of credit settlement scheme gives a full guarantee to the parties to the transaction that the obligations will be fulfilled by the partner. Documentary letters of credit are of several types:
- revocable and irrevocable,
- confirmed and reserve,
- covered or uncovered,
- with "red" clauses,
- revolving and circular,
- cumulative.
The bank participates in such an agreement as a third party, guarantor only if one of the parties to the transaction, usually the buyer, is its client. What the contract will be (type and conditions), in what order and in what time frame will the payment be made under it - all these nuances are determined by the bank's experts. The agreement is signed by the parties to the transaction only after all clauses of the document fully satisfy the representatives of the three parties.
Participants in documentary credit transactions
The interest in such a settlement system on the Russian market, according to financial analysts, is constantly growing. But the legal side on which such an agreement is based has not been adequately studied, which often becomes the reason for the termination of transactions or their transformation into a fraudulent scheme. A transparent and secure documentary credit transaction always involves
- the advising bank, which is not responsible for the fulfillment of the clauses of the agreement, which only takes on the functions of delivering information,
- the bank that is responsible for the payments of the amounts stipulated in the agreement,
- payer (seller) and buyer.
In some cases, a third bank assumes responsibility for payments, which is not prohibited by law and is actively practiced in international transactions. The number of subjects participating in the procedure for fulfilling the obligations of a documentary credit can be up to 5.
Advantages and disadvantages of documentary credit
A documentary credit is a convenient and flexible mechanism for settlements. But, like any other financial instrument, it has advantages and disadvantages. The advantages include the following points:
- the seller can be sure that he will receive payment for his product (service),
- for the buyer, it eliminates the need for an advance payment,
- payments are made only after the end of the transaction.
Legislation allows for individual conditions of payment to be made into a documentary credit. For example, a buyer wants to be convinced of the quality of the product, but the seller does not want to deliver it without prepayment (advance payment). A clause is added to the agreement that the money transfer will be performed only after a certain period of time or after the bank receives a notification from the purchaser of the goods about its high quality. The bank is the guarantor of the payment.
The disadvantages of such a transaction can be attributed only to the fact that both parties will have to pay for the services of the intermediary bank. But if we take into account the exclusion of the risks of financial losses, then this nuance can not be considered a disadvantage.
