The Treasurer’s Guide to Trade Finance

Chapter 3 Understanding trade

exchange, so it is important to factor in the

additional cost to any pricing.

All documentation needs to be prepared

carefully, so the exporter will have to devote

sufficient resource to this process. This is

not simply to ensure that documentation

is accurate to allow for the collection of

payment, but also to minimise the risk of

goods being kept in customs, especially if

import licences are required.

On the other hand, the exporter should

be able to plan collection of the payment

• either on delivery, if a cash payment is
  agreed, or at term, if a bill of exchange is
  used (although in both cases this will depend
  on the time taken for payment to be sent from
  the collecting bank to the remitting bank). The
  circumstances will vary slightly, depending
  on whether collection against payment or
  collection against acceptance is used.

Documentary credit

A documentary credit, or letter of credit,

offers greater security still to the exporter,

compared with both open account trading

and documentary collections.

Just as with a documentary collection,

both parties to a documentary credit use their

banks as intermediaries. However, in contrast

to the documentary collection, under the

terms of a documentary credit the importer’s

bank guarantees payment to the exporter, as

long as the terms of the credit are met.

If the two parties agree to use a

documentary credit, the importer’s bank

will issue a letter of credit in respect of the

importer. The importer’s bank (the issuing

bank) will forward a copy of the letter of credit

to the exporter’s bank (the advising bank),

which will advise the exporter of its existence

and detail its terms and conditions. Assuming

that there are no discrepancies between the

terms agreed in the commercial contract and

those detailed in the documentary credit,

the exporter will then arrange shipment to

the importer in accordance with the agreed

shipment plans. At the same time, the

exporter, or its shipping agents, will prepare

the documents required under the terms

of the letter of credit, which would normally

include the bills of lading or other shipping

documents. The exporter will then present

these documents to its bank, which will

examine them and may (if compliant with

the terms of the documentary collection, and

negotiation and payment is set to be ‘at the

exporter’s bank’) pay the exporter.

The advising bank will then forward the

Documentary credit

Physical movement of goods

Movement of commercial documents

Payment or movement of financial

documents

1

8 11^1010

6 10

11

9

2

3

4

Buyer’s

Bank

Buyer

Carrier

Seller

5 7

Seller’s

Bank

1. Parties agree contract of sale


2. Buyer asks its bank to open a letter of credit


3. Buyer’s bank issues letter of credit to seller’s
   bank


4. Seller’s bank advises seller of receipt of letter
   of credit documents onto buyer’s bank


5. Seller checks detail of received letter of credit


6. Seller ships goods to buyer


7. Seller prepares required documents


8. Seller sends prepared documents to its bank


9. Seller’s bank checks received documents
   and sends them to buyer’s bank


10. Buyer’s bank checks documents and
    arranges payment


11. The buyer’s bank will then pay the seller’s
    bank