Documentary credit
A bank's undertaking to pay the exporter against presentation of compliant documents, which substitutes the bank's risk for the buyer's, and which insurance supplements when the bank or its country itself presents a risk.
The documentary credit is the safest payment instrument in international trade. At the buyer's request, its bank, the issuing bank, irrevocably undertakes to pay the exporter provided it presents, within a set period, documents strictly complying with those specified: invoice, bill of lading, insurance certificate, certificate of origin. The exporter no longer relies on its customer's creditworthiness, but on a bank's. The International Chamber of Commerce uniform customs and practice, in the revision effective July 2007, govern most of these transactions. Two risks remain. Documentary risk, when the documents presented contain a discrepancy that lets the bank refuse to pay. And the risk of the issuing bank itself, or its country, which may default or be prevented from transferring foreign currency. The second risk is covered by the confirmation of a bank in the exporter's country, which adds its own undertaking, or by non-payment insurance bought by the confirming bank in the private credit and political risk market. The chain thus links the banking technique of trade to the insurance of sovereign risk.
Textbook case: an exporter sells 3 million dollars of machinery to a buyer in a country in a currency crisis, payable by documentary credit. It has the credit confirmed by its own bank, which in turn insures 70 percent of its commitment with private insurers against the issuing bank's default and inconvertibility: the exporter is paid on presentation of compliant documents, whatever happens in the buyer's country.
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