International payment system 2

Question 1

What is documentary letter of credit

Answer 1

The documentary letter of credit (abbrev. L/C) is a written obligation of the bank issued at the buyer’s request (importer) to pay a certain sum after the fulfilment of the conditions determined in a letter of credit (the banks involved examine only documents, not goods or services).

Question 2

When do we use documentary letter of credit

Answer 2

The documentary letter of credit is used when the business partners don’t know each other (payment discipline is unknown), when the seller (exporter) mistrusts the buyer (importer) or when there is an unstable political or economic situation in the buyer’s country.
The documentary letter of credit is usually used by the exporter (beneficiary) in transactions where documents are to be submitted (e.g. documents which guarantee the ownership title to the goods, the quality thereof, etc.). It may also be used in cases where a bank’s undertaking for payment is required (e.g. trade with real estates, securities, share transfers, etc.).

Question 3

Main subjects of documentary letter of credit

Answer 3

buyer (applicant)
issuing bank (buyer’s bank)
seller (beneficiary)
seller’s bank (exporter’s bank): advising bank/confirming bank

Question 4

Buyer (L/C)

Answer 4

buyer (applicant) - the client of a bank who asks for issuing of the letter of credit (importer)

Question 5

Issuing bank (L/C)

Answer 5

issuing bank (buyer’s bank) - the importer’s bank which issues the letter of credit

Question 6

Seller (L/C)

Answer 6

seller (beneficiary) - a person in favour of which the letter of credit is issued (exporter)

Question 7

Advising bank (L/C)

Answer 7

advising bank it acts as the agent of the issuing bank (the function of the advising bank is to take reasonable care to verify the authenticity of credit received and then accurately transmit them to its beneficiary)

Question 8

Confirming bank (L/C)

Answer 8

confirming bank it assumes the same responsibilities as the issuing bank, including the obligation to pay against presented documents if they are in order band all of the letter of credit terms are met

Question 9

Main functions of documentary letter of credit

Answer 9

payment function
guarantee function

Question 10

Payment function (L/C)

Answer 10

the documentary letter of credit is a payment method in the international payment system

Question 11

Guarantee function (L/C)

Answer 11

for the buyer (importer) - the documentary letter of credit provides a guarantee that payment will be made after documents are in order, and all of the letter of credit terms are met
for the seller (exporter) - the documentary letter of credit provides a guarantee that he/she will get paid when he/she submits all documents

Question 12

Documentary letters according to the security level

Answer 12

a revocable letter of credit
an irrevocable letter of credit
confirmed letter of credit
unconfirmed letter of credit

Question 13

Revocable letter of credit

Answer 13

a revocable letter of credit - can be cancelled or modified by the bank at the applicant’s instructions without the prior agreement of the beneficiary

Question 14

Irrevocable letter of credit

Answer 14

an irrevocable letter of credit can’t be cancelled or modified without the consent of the beneficiary

Question 15

Confirmed letter of credit

Answer 15

confirmed letter of credit - it is confirmed by the seller’s bank (confirming bank) which is liable for performance of obligations

Question 16

Unconfirmed letter of credit

Answer 16

unconfirmed letter of credit - it is advised by the seller’s bank (advising bank), but only the issuing bank is liable for payment of this letter of credit

Question 17

Documentary letters of credit according to the way of opening

Answer 17

disposable letter of credit
revolving letter of credit

Question 18

Disposable letter of credit

Answer 18

disposable letter of credit - it is open only for a certain time

Question 19

Revolving letter of credit

Answer 19

revolving letter of credit - it isn’t closed after the original amount has been used (the initial amount is returned to the original assignment until the sum of all payments made reaches the maximum amount provided)

Question 20

Schemes and procedures of the documentary letter of credit

Answer 20

1. the buyer agrees with the seller on the terms of a bill of sale (in this case that settlement will be made under an L/C payable in connection to shipment),
2. the buyer applies for the L/C to his/her bank (issuing bank) which issues the L/C and sends it to the advising bank,
3. the advising bank advises the L/C to the seller,
4. the seller delivers the goods and presents the documentation,
5. the advising bank sends the documents to the issuing bank which releases them to the buyer against payment,
6. the issuing bank sends payment to the advising bank which pays the seller in accordance with the structure of the L/C.

Question 21

According to what do banks handle the documentary letter of credit ?

Answer 21

The banks involved handle the L/C subject to the Uniform Customs and Practice for Documentary Credits published by the International Chamber of Commerce.

Question 22

Advantages for the buyer

Answer 22

elimination of the risk of losing money,
payments are made after fulfilment of the seller’s contractual obligations

Question 23

Advantages for the seller

Answer 23

guarantee of payment independency of the buyer,
the possibility of payment before handing the goods over to the buyer

Question 24

Disadvantages for the buyer

Answer 24

it has an expiration date to which attention must be paid,
it can be misused to take advantage of the applicant;

Question 25

Disadvantages for the seller

Answer 25

it is only as good as the bank that issues it,
it is sometimes difficult to terminate or cancel.

Question 26

What is documentary collection ?

Answer 26

The documentary collection (abbrev. DC) is a type of documentary payment mostly used with foreign countries, where documents are released to the buyer only upon the fulfilment of the collection conditions. The buyer may be asked to pay for the goods in advance or to pay part of the goods in advance. Apart from the risk of never receiving any goods, the buyer also needs to finance this advance payment and that’s why he/she uses the documentary collection.

Question 27

When is documentary collection used ?

Answer 27

The documentary collection is used when the business partners know each other well when the buyer (importer) has the better position at the market, when the seller (exporter) insurance the goods or when there is a stable political or economic situation in the buyer’s country.

Question 28

Main subjects of documentary collection

Answer 28

seller (principial)
remitting bank (seller’s bank)
buyer (drawee)
collecting bank (buyer’s bank)

Question 29

Seller (DC)

Answer 29

seller (principial) - the client of a bank who asks for issuing of the collection (exporter),

Question 30

Remitting bank (DC)

Answer 30

remitting bank (seller’s bank) - the exporter’s bank which issues the collection,

Question 31

Buyer (DC)

Answer 31

buyer (drawee) - a person in favour of which the documents are sent (importer),

Question 32

Collecting bank (DC)

Answer 32

collecting bank (buyer’s bank) - a bank which submits the documents to the buyer.

Question 33

Main functions of documentary collection

Answer 33

payment function
guarantee function

Question 34

Payment function (DC)

Answer 34

the documentary collection is a payment method in the international payment system

Question 35

Guarantee function (DC)

Answer 35

for the buyer (importer) - the documentary collection provides a guarantee that
the documents will be issued after the payment will be made,
for the seller (exporter) - the documentary collection provides a guarantee that he/she will receive all documents along with the payment.

Question 36

Schemes and procedures of documentary collection

Answer 36

1. the buyer and the seller agree on the terms of a bill of sale (in this case the settlement will
   be made under a sight collection),
2. the seller ships the goods and sends the documentation to his/her bank,
3. the remitting bank forwards the documents to the collecting bank,
4. the remitting bank advises the seller of the collection,
5. the buyer gains access to the documents upon payment or acceptance to pay on a future
   date,
   6.the collecting bank sends payment to the remitting bank at sight or at the maturity date
6. the remitting bank pays the seller.

Question 37

According to what do banks handle documentary collection ?

Answer 37

The banks involved handle the collection subject to the Uniform Rules for Documentary Collections published by the International Chamber of Commerce.

Question 38

What is bank guarantee

Answer 38

The bank guarantee is a written declaration of the bank by which the bank irrevocably undertakes to pay to the creditor (guarantee beneficiary) a certain sum according to the content of the letter of guarantee in the case the debtor (the client/guarantee applicant) fails to fulfil his/her obligation secured by a bank guarantee.