Documentary Credit Explained

Documentary credit, also known as a letter of credit (LC), is a financial instrument used in international trade to ensure that payments are made securely and according to the terms agreed upon by both parties. This arrangement involves three main parties: the importer (buyer), the exporter (seller), and a bank. The importer’s bank issues the documentary credit in favor of the exporter, guaranteeing that the payment will be made provided that the exporter meets certain conditions as specified in the credit.

Example:

1. Parties Involved:
   • Importer (Buyer): ABC Imports in Pakistan
   • Exporter (Seller): XYZ Exports in China
   • Bank of Importer: Bank of Pakistan
   • Bank of Exporter: Bank of China
2. Process:
   • Step 1: ABC Imports purchases goods from XYZ Exports and agrees to pay through a documentary credit.
   • Step 2: ABC Imports applies to Bank of Pakistan to open a documentary credit in favor of XYZ Exports.
   • Step 3: Bank of Pakistan issues the documentary credit and sends it to Bank of China.
   • Step 4: XYZ Exports ships the goods and prepares the required shipping documents (invoice, bill of lading, packing list, etc.).
   • Step 5: XYZ Exports presents the documents to Bank of China.
   • Step 6: Bank of China verifies the documents and forwards them to Bank of Pakistan.
   • Step 7: Bank of Pakistan checks the documents and releases the payment to Bank of China, which then pays XYZ Exports.

SWIFT Messages in Documentary Credit

SWIFT (Society for Worldwide Interbank Financial Telecommunication) messages are standardized messages used for secure and efficient financial communication between banks. In the context of a documentary credit, several SWIFT message types are exchanged.

Common SWIFT Messages:

1. MT 700: Issue of a Documentary Credit
   
   
   
   • This message is sent by Bank of Pakistan to Bank of China to confirm the opening of the documentary credit.
   
   
   
   

   Example Content:

   
   

   :20:12345678
   :32B:210511USD100000
   :50:ABC Imports
   :59:XYZ Exports
   :40E:90 days from sight
   

   
   
2. MT 707: Amendment to the Documentary Credit
   
   
   
   • If any changes are made to the terms of the LC, this message is sent.
   
   
   
   

   Example Content:

   
   

   :20:87654321
   :21:12345678
   :50:ABC Imports
   :59:XYZ Exports
   :40E:Increase to 120 days
   

   
   
3. MT 760: Guarantee or Standby Letter of Credit
   
   
   
   • Used for providing guarantees.
   
   
   
   

   Example Content:

   
   

   :20:abcd1234
   :29:Guarantee for shipment
   :50:ABC Imports
   :59:XYZ Exports
   

   
   
4. MT 799: Free Format Message
   
   
   
   • Used for communication between banks regarding the LC without a specific format.
   
   
   
   

   Example Content:

   
   

   :20:abc123
   :21:xyz456
   :72:Please expedite document processing.
   

   
   

These messages facilitate the smooth exchange of information and ensure that all parties involved are aligned and aware of the financial commitments and documentation requirements.