What do you mean by Documentary credit. What is the method of realising payments under Documents Against Payments

What do you mean by Documentary credit. What is the method of realising payments under Documents Against Payments

A Documentary Credit, also known as a letter of credit, is a financial instrument used in international trade transactions to facilitate payment between a buyer and a seller.

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It is issued by a bank on behalf of the buyer (importer) and guarantees that the seller (exporter) will receive payment for the goods or services provided, provided they comply with the terms and conditions specified in the credit.

Here’s how it works:

1. Opening of the Documentary Credit: The buyer and seller agree to use a letter of credit as the method of payment for the transaction. The buyer’s bank (issuing bank) issues the credit at the request of the buyer, specifying the terms and conditions of the credit, including the amount, expiration date, shipping terms, documents required for payment, and any other conditions.
2. Presentation of Documents: The seller ships the goods or provides the services as per the terms of the sales contract and prepares the required documents, such as commercial invoices, bills of lading, packing lists, certificates of origin, and insurance documents. The seller presents these documents to their bank (advising bank), along with the letter of credit.
3. Examination of Documents: The advising bank reviews the documents to ensure they comply with the terms and conditions of the letter of credit. If the documents are in order, the advising bank forwards them to the issuing bank.
4. Payment or Acceptance: Upon receipt of the documents, the issuing bank examines them to verify compliance with the terms of the credit. If the documents are in order, the bank makes payment to the seller or accepts drafts drawn under the credit, as per the buyer’s instructions.
5. Release of Documents: The issuing bank releases the documents to the buyer upon payment or acceptance of drafts. The buyer can then take possession of the documents and use them to claim the goods from the carrier or customs authorities.

The method of realizing payments under Documents Against Payments (DAP) is slightly different:

1. Agreement: In a DAP transaction, the buyer and seller agree that payment will be made upon delivery of the goods or documents to a specified location.
2. Shipment and Documentation: The seller ships the goods and prepares the necessary documents, as in a regular trade transaction.
3. Delivery and Payment: The seller delivers the goods to the buyer or carrier at the agreed location and presents the documents to the buyer’s bank or directly to the buyer. The buyer makes payment to the seller upon receipt of the documents or upon delivery of the goods, depending on the terms of the agreement.
4. Verification: The buyer verifies the documents and goods to ensure they conform to the terms of the sales contract. If everything is in order, the buyer makes payment to the seller.

In summary, a Documentary Credit involves the use of a letter of credit issued by a bank to guarantee payment in an international trade transaction, while Documents Against Payments (DAP) involves payment upon delivery of documents or goods to the buyer at a specified location.