Documentary Credit refers to a particular payment instrument used in foreign trade. Documentary credit is a written obligation of the bank to pay a predetermined payment for delivered goods or services, if the conditions in the letter of credit laid down by the buyer are fulfilled. There are more types of letters of credit.
Most of the world’s used letters of credit are governed by the Uniform Customs and Practice for Documentary Credits, which were created by the International Chamber of Commerce and it is one of the most important and most sophisticated payment instruments.
Letter of Credit in practice: Letter of credit is used to reduce the risks associated with foreign trade and payments abroad. It represents security (guarantee) for the seller, that he will be paid for the delivery (guarantee assumes the bank) - it is an irrevocable commitment, thus giving certainty to both parties. Enterprises use letters of credit for example when dealing with untested business partners or in situations when they just want to reduce their risks. Another advantage of a documentary credit is to obtain favorable pricing conditions.
Letter of credit is also used in domestic payments.
Types of letters of credit used in practice:
- Advised credit
- Export (buyer, supplier) Letter of Credit (LC)
- Import Letter of Credit
- Confirmed Letter of Credit
- Transferrable Letter of Credit
- Revolving Letter of Credit
- Standby Letter of Credit (SLOC)
The latest version of Uniform Customs and Practice for Documentary Credits (December 2012): UCP 600.