In this article we will discuss about:- 1. Functions and Utility of Documentary Credit 2. Different Types of Documentary Credit 3. Process 4. Documents Used.

Functions and Utility of Documentary Credit:

Credit occupies an important place in this modern era of commerce. It has got more importance in the capitalistic economic system. That is why, it is called as heart of modern industrial system and life blood of business. Credit instruments are important in both domestic trade as well as in foreign trade.

According to Daniel Webster:

“Credit has done more- a thousand times more to enrich nation, than all the mines of the world. It has excited labour stimulated manufacturer, pushed commerce on every sea and brought every nation, every kingdom and every small tribe among the race of men to be known to all the rest.”

Documentary Credit in International Marketing:

Under this system of international payment, the bank of the importer undertakes the responsibility to pay the exporter, if the exporter presents documents regarding shipment of goods, as per instructions from the importer, within a specified time. In fact, the credit of the issuing bank is substituted for that of the buyer. In other words the written undertaking of the importer’s bank to the exporter is known as the letter of credit.


According to International Chamber of Commerce- “Documentary Credit, as any arrangement however named or described whereby a bank (the issuing bank) acting at the request and in accordance with the instruction of a customer (the applicant to the credit) is to make payment to or to the order of the third party (the beneficiary) or is to pay, accept or negotiate bills of exchange drawn by the beneficiary, authorize such payments to be made or such drafts to be paid, accepted or negotiated by another bank against stipulated documents and compliance with stipulated terms and conditions.”

According to S.K. Verghese:

“Under a banker’s letter of credit, the issuing bank gives a written undertaking on behalf of the buyer that the bank will honour the obligation of payment of acceptance, as the case may be on presentation of stipulated documents.”

This is the most popular form of payment nowadays. Under this system, the banker of the importer undertakes the responsibility to pay the exporter, under instructions from the importer, if the exporter presents certain shipment and payment documents covering the goods, within a specified period. In effect, the credit of the issuing bank is substituted for that of the buyer.

Such written undertaking of the importer’s banker to the exporter is known as Letter of Credit (L/C). In other words documentary credit means arrangement made with the bank in which bank accepts the responsibility to make payment or accept the bills on behalf of importer.

When bank prepares a letter regarding this arrangement, that document is called ‘letter of credit’ or sometimes it is also called ‘ Credit’. When bill is presented before the bank or the bank accepts the bill by sign, it means promise is given to pay the money of that bill on maturity date. Thus accepted bills are considered as ‘Bank Acceptances’.

Export of one country becomes the import of other country and in this circumstance documentary credit is the chain between both the parties.

Normally, importer makes arrangement to open credit account and its benefits go to exporter. But both the parties should accept its condition. Importer gives the instruction to bank to open credit account in the favour of exporter. Importer gives all the information to bank, such as description of goods, quality, quantity, price documents to be received, date of dispatch of the goods on steamer, type of insurance, credit approval date, whether credit is revocable or irrevocable etc.

Parties to Letter of Credit:

There are four parties to the letter of credit.

They are:

1. Importer:

In letter of credit there must be an importer and the letter of credit is opened at the initiative and request of the importer.

2. Issuing Bank of Opening Credit:

It is the bank in the importer’s country issuing the letter of credit at the request of the importer.

3. Agent Bank:

Agent bank is a bank in the exporter’s country which guarantees the credit at the request of the issuing bank.

4. Beneficiary:

Beneficiary is the party in whose favour the letter of credit is issued i.e. the exporter.

Different Types of Documentary Credit:

In accordance with the terms attached to them, documentary credit or letters of credit may be classified as:

1. Revocable and Irrevocable Letters of Credit:

In the revocable letter of credit, the issuing bank clearly states that the credit can be revoked at any time without the consent of, or notice to the exporter. Once the credit is revoked, the exporter has no other way out to recover his dues. The exporter’s interest is not protected under this type of credit and therefore, it is not very common in international trade. Revocable credits are never confirmed.

The irrevocable letter of credit, on the other hand, cannot be revoked by the issuing bank. Under irrevocable credit, the issuing bank is under an obligation to make the payment if the terms of credit are satisfied. The exporter, under this type of letter of credit feels secure that the credit cannot be cancelled or revoked without the consent of or notice to all the parties concerned.

2. Confirmed and Unconfirmed Letters of Credit:

As the importer and the exporter reside in different countries, the exporter is not familiar with the soundness of the importer’s bank, issuing the letter of credit. He, therefore, wants that a local bank in his country commits itself to make him the payment as soon as the documents are presented soon after the shipment in order to reduce his payment risk. The commitment for the payment by a local bank on behalf of the issuing bank is called confirmation of letter of credit.

3. Assignable and Non-Assignable Letters of Credit:

Letters of credit may be assignable or non-assignable. An assignable letter of credit is one which can be assigned by the beneficiary (or in whose favour it is opened) to some other party. This type of letter of credit is issued in favour of a representative of the importer/ buyer especially when he does not know who will actually be the exporter of the merchandise.

Once the representative finds a suitable person or firm (exporter) which is able and willing to ship the goods on the terms specified by the importer, he assigns the letter of credit to the party (exporter) concerned.

A non-assignable letter of credit is one which cannot be transferred to any other person by the beneficiary, i.e. in whose favour, which it is issued. Generally, it is opened in the name of the actual exporter after the order is confirmed by the exporter.

4. Ancillary Letters of Credit (Back to Back Letter of Credit):

These are assisting letters of credit based on the original letters of credit. If the exporter in whose favour the letter of credit is opened, has no funds and no line of credit with a bank, and consequently is unable to buy the merchandise ordered, he may request the negotiating bank to open its own letter of credit to third party (the seller of goods) under the identical terms contained in the original letter of credit.

If the original letter of credit is irrevocable, the bank may issue its own letter of credit known as ancillary letter of credit, honour the drafts of the seller on receipt of the shipping documents and cancel the ancillary letter of credit. The exporter presents his draft for the amount of the original letter of credit, but receives only the difference between the amount of the draft and the amount paid by the bank on the draft drawn under the ancillary letter of credit.

Process of Documentary Credit:

All the four parties perform their duties and responsibilities in the process of documentary credit. In this process the importer applies to his bank to open documentary credit in favour of exporter, after a written agreement between importer and exporter. After that application is analysed by the bank which is expected to provide credit.

After getting information from the agent’s bank, the exporter arranges the shipment of goods, writes bill and hands over all instruments to agent’s bank. After that, the agent bank sends the concerned instruments to the issuing bank after fulfilling acceptance and payment related functions. Ultimately credit provider bank informs the importer that all the instruments concerning goods have been received by it. The importer on getting such information, makes all necessary payments and takes delivery of goods with the help of instruments.  

Thus, documentary credit system is very important from commercial point of view. This system of payment is less expensive. The exporter gets assurance from the bank regarding the payment amount. Moreover, the importer remains confident that exporter will get dues only when all the conditions mentioned in credit letter are fulfilled completely by him.

Such credit is useful for both parties to the agreement and encourages international trade to a great extent.

Documents Used in a Documentary Credit:

In general the following documents are attached with the letter of credit:

1. Bill of Lading

2. Commercial Invoice

3. Insurance Policy

4. Certificate of Quality

5. Certificate of Origin

6. Letter of Hypothecation, and

7. Certificate of Weight.