Documentary Credits – the latest developments
Irish exports are expanding at unprecedented levels. The traditional reliance on the United Kingdom and other nearby European markets for export revenues is fast becoming part of our history. Companies in Ireland have grasped the export opportunity and are venturing into high payment risk markets with considerable success.
The professional credit manager has played a key role in this export expansion. As the risk of delayed or payment default increases with new market development the credit manager must apply credit risk management techniques not peculiar to the domestic Irish market. The Documentary Credit remains the cornerstone secure payment product providing assurance of payment and a means of finance for the higher risk markets currently being explored. Why, you may ask?
First, the Documentary Credit provides the credit manager in an exporting company with a bank undertaking of payment, even before goods are shipped. Second, if there is concern about payment from a foreign bank or due to some political uncertainty, then the credit manager can insist on a confirmed Documentary Credit. Confirmation provides an additional undertaking of payment from a local Irish bank.
Third, payment will be made provided documents are presented as specified in the Credit. Should a contractual dispute arise with the buyer, the exporter will still be paid for correct documents presented. Fourth, a Documentary Credit allows the credit manager to grant extended credit terms to a buyer while at the same gain access to off-balance sheet finance, often at preferential rates of interest.
The use of Documentary Credits also provides the buyer or importer with significant benefits. The importer can increase control of delivery dates by specifying a latest shipment date in the Credit. The importer can specify presentation of specific documents, such as inspection certificates which verify the quality of the merchandise, a valuable feature when dealing with a new supplier. Finally, the importer can be confident that payment will not be made unless documents are presented which evidence that goods have been shipped on time as ordered.
Sounds too good to be true. Perhaps it is. The positive features illustrated are indeed attributable to the Documentary Credit but it is a matter of commercial fact that Documentary Credits are cumbersome and prone to difficulty in administration and management. For the larger exporter dealing in significant levels of Credits it is possible through training to develop in-house procedures which streamline the process. However, even in times of export expansion most export credit managers find they are only involved in shipments to high risk markets requiring Documentary Credits on an occasional basis.
Statistics from banks indicate that somewhere between 60% and 70% of documents presented to banks do not comply on first presentation. When documents do not comply it is unfortunate that the key benefit of a Documentary Credit, the bank undertaking of payment is relinquished. In most cases the exporter still gets paid, but delay is common and until payment is finally received the exporter faces the worry of the the full commercial, bank and country risk, the avoidance of which was the main reason for using a Documentary Credit in the first place.
However, developments in the marketplace point to a bright future for the Documentary Credit as a secure payment and finance instrument, though perhaps not in it’s traditional form. For instance, the use of the Standby Documentary Credit, a slimmed down default version of the traditional Documentary Credit, originally developed in the United States is evolving as a powerful instrument to secure the risk of default in cross border trade.
The introduction of ISP98 by the Institute of International Banking Law & Practice as the standard rules for Standby Credits and their endorsement by the International Chamber of Commerce has greatly enhanced the status of the Standby Credit as an international credit management tool. Credit managers must be familiar with ISP98 as their incorporation into a one page Standby Credit can provide the credit manager with a highly effective and independent credit management and payment default solution.