A documentary credit (also known as a letter of credit or L/C) is not only a vital tool enabling exporters to secure payment from overseas buyers, but should also provide a degree of certainty with regard to cash flow. The standard structure of the L/C includes timings for shipment and presentation, following which (assuming the bank determines that the documents comply with the terms), payment will be forthcoming….
…… or will it?
When requesting a letter of credit from an overseas buyer, it is important to understand the roles and obligations of the banks, particularly with regard to ‘honouring’ documents which comply with the terms of the credit. This will provide finance teams with a clearer picture as to when to expect final payment.
Article 2 of UCP 600 provides definitions of the role and purpose of the various banks involved in a Letter of Credit transaction.
The issuing bank is the bank that issues a credit at the request of an applicant, or on its own behalf. As of the time the letter of credit is issued, the issuing bank is obliged to honour* a complying presentation.
(*According to UCP 600 article 2 “Honour” means:
a. to pay at sight if the credit is available by sight payment.
b. to incur a deferred payment undertaking and pay at maturity if the credit is available by deferred payment.
c. to accept a bill of exchange (“draft”) drawn by the beneficiary and pay at maturity if the credit is available by acceptance).
The advising bank is the bank that advises the credit to the beneficiary at the request of the issuing bank. If this bank is not ‘nominated’ by the issuing bank, its role is merely to take reasonable care to verify the authenticity of the credit and advise the terms to the beneficiary. An advising bank in this context has no authority to honour or negotiate a complying presentation. A credit issued in this way could be stated as being “available with the issuing bank.”
A nominated bank is a bank (other than the issuing bank) with which the credit is stated to be available, or ‘any bank’ in the case of a credit which is stated to be available with any bank. A nominated bank (still referred to as an ‘advising bank’ in the credit) is usually domiciled in the same country as the beneficiary (exporter) and can choose to act upon its nomination to pay, accept, negotiate** or incur a deferred payment undertaking. It is important to note that a nominated bank is not obliged to honour or negotiate if it is not a confirming bank.
(**According to UCP 600 article 2 “Negotiation” means the purchase by the nominated bank of drafts (drawn on a bank other than the nominated bank) and/or documents under a complying presentation, by advancing or agreeing to advance funds to the beneficiary on or before the banking day on which reimbursement is due to the nominated bank)
One of the most common questions we receive from exporters relates to nominated banks refusing to act on their nomination, even in cases where the documents presented comply with the terms. In such instances, payment will not be forthcoming until the issuing bank has examined the documents. If the documents comply with the credit terms, only then will the issuing bank be obliged to honour and reimburse the advising /nominated bank either immediately (sight) or at maturity (deferred payment or acceptance). To the unwary exporter, this may result in an unexpected delay in payment of days or even weeks!
A confirming bank is the bank which adds its confirmation (an additional undertaking to that of the issuing bank) to a credit upon the issuing bank’s authorisation or request. A credit will state whether it is to be advised with or without confirmation. If the credit is to be confirmed, it usually follows that it will be stated to be “available with the confirming bank”. A confirming bank will be obliged to honour or negotiate a complying presentation. This enables the beneficiary to receive funds in a timely manner, often before the issuing bank has even examined the documents themselves!
(Note: when requesting a confirmed credit, exporters are advised to check the anticipated level of fees in advance and incorporate into the price!)
A reimbursing bank is the bank authorised by the issuing bank to reimburse the nominated / confirming bank following a presentation of documents which comply with the credit terms. A reimbursing bank will usually hold an account in the name of the issuing bank and will release funds when a claim is made by the nominated / confirming bank. A confirming bank may of course negotiate a complying presentation, advancing funds to the beneficiary (less interest) prior to receipt of funds from the reimbursing bank.
The above represents a quick guide to the roles of banks and the resulting impact with regard to timings of payment under letters of credit.
Our letter of credit and export sales training courses provide further detailed guidance and best practice for export sales and finance teams to help you get paid securely, on time and at a quantifiable cost!