Letter of Credit vs Documentary Credit
There are a number of payment mechanisms that are used when conducting international business. Letter of credit is a prominent payment method used, particularly for import and export activities. There are a few types of letters of credit which include documentary credit and standby letters of credit. The major similarity between the two is that the seller will be guaranteed of payment as long as all documentation is provided and terms and conditions are met. The following article takes a closer looks at letters of credit and documentary credit and shows how these payment mechanisms are similar and different to one another.
What is Letter of Credit?
A letter of credit is an agreement in which the buyer’s bank guarantees to pay the seller’s bank at the time goods/services are delivered. Letters of credit are used in international payment transactions. Once the buyer and the seller have agreed to business, the buyer will request for a letter of credit from the issuing bank, to ensure a safe transaction. The issuing bank will send the Letter of credit to the advising bank once the seller ships the goods (in accordance to contract). Once goods are delivered and a request for payment (with or without documentation – depending on types of letter of credit) is made, the seller’s bank will make the payment and send documents to the issuing bank who will pay this amount to the seller’s bank. Finally, the issuing bank will obtain payment from the buyer and will release documents so that the buyer can now claim the goods from the carrier.
There are few types of letters of credit, which include documentary credit and standby letters of credit. When a standby letter of credit is used, the seller may not have to submit all documentation to receive payment, and a mere request for payment should ensure that the funds are transferred from buyer’s bank (issuing bank) to the seller’s bank.
What is Documentary Credit?
Documentary credit is very similar to a letter of credit, and facilitates international payment transactions. For the payment to be made, a number of specific documentation needs to be submitted, which could include goods purchase invoice, bill of lading, inspection documentation, insurance proof, etc. Letters of credit ensure that the seller will be able to obtain the payment for goods and services that have been shipped or delivered upon presentation of the documentation at the time of delivery. Letters of credit are beneficial to both the buyer and seller. Letters of credit give the buyer the right to inspect whether correct documentation verifies the quality of the goods, and the seller is guaranteed payment as long as all terms and conditions stated are met.
Letter of Credit vs Documentary Credit
Documentary credits are a type of Letters of credit which are international payment mechanisms that are both quite similar to one another. Letters of credit (whether documentary or otherwise) guarantee payment and are, therefore, more suited for use when the two parties are unknown. The difference between the two lies in the strict documentation and presentation requirements at delivery. Documentary credits require strict compliance and correct documentation that needs to be presented at the time the goods are delivered; failing which can result in the rejection of the goods. When using a standby letter of credit a request for payment will be sufficient, and such a request can be made with or without the presentation of documentation.
Summary:
Difference Between Letter of Credit and Documentary Credit
• There are a number of payment mechanisms that are used when conducting international business.
• A letter of credit is an agreement in which the buyer’s bank guarantees to pay the seller’s bank at the time goods/services are delivered.
• There are few types of letters of credit such as documentary credit and standby letters of credit. The difference between the two lies in the strict documentation and presentation requirements at delivery.