Here we will consider the bank in two roles:
(1) as the institution financing the importer, and
(2) as the exporter’s bank.
1. Imports under Documentary Credit (DC)
Before undertaking to establish a DC for an importer, the bank should consider: The financial standing of the importer: The bank has to look to the importer to pay the import bill drawn under the DC and therefore should be sure that the latter has or will have the funds to pay.
The goods: Trade finance is supposed to be self-liquidating and the goods must be readily saleable. Consideration should also be given to the risks associated with perishability of the goods, possible obsolescence, import regulations, packing and storage, etc.
The status of the exporter (or beneficiary of the DC): There is always the risk that an errant exporter could ship substandard goods or, worse still, complete rubbish, and one always guards against this by finding out as much possible about the exporter using status reports and other confidential information from banks and credit rating agencies such as Dun & Bradstreet. It is always wise to request a reliable third party like SGS (a firm of international cargo inspectors) to inspect the goods prior to shipment and produce a report called an inspection certificate. Such a document is often called for under a DC.
There has been many an instance where the exporter has shipped rubbish and still produced a compliant set of documents. Under the Uniform Custom and Practice for Documentary Credits (UCP), ICC publication No. 500, all parties deal in documents and a tender of compliant documents to the issuing bank means that the bank will have to pay. The only redress that is available to the importer is if he can conclusively prove fraud and get the courts to issue an injunction restraining the bank from making payment.
(Remember: the DC itself is a contract between the importer’s bank (the issuing bank) and the exporter. It makes a lot of sense to find out about the party you are contracting with prior to issuing the contract, doesn’t it?!)
One must also consider the various macro risks and it is imperative that the goods are suitably insured by & reputable insurance company. The bank should endeavor to retain control over the goods until release to the importer and this can usually be achieved with a suitable transport document like the Bill of Lading or the Air Waybill.
2. Exports under DC
One of the greatest services a bank can do for its exporter in advising the DC it receives from an overseas bank is to check carefully whether it is workable and that the exporter will be able to comply with its terms and conditions. This is called checking the workability of a DC and very often one encounters exporters finding that they cannot produce a compliant set of documents under the DC. Payment is thus delayed due to discrepancies between the documents and the DC or, worse still, not forthcoming at all.
Many exporters submit documents to their bank and request that the bank negotiate the documents, i.e. they want the bank to give value for the documents prior to reimbursement by the issuing bank. Provided bank risk and country risk considerations have been dealt with, the exporter’s bank – now termed the negotiating bank – will have to check the documents carefully against the DC and if
they are in order, i.e., no discrepancies, the bank will discount the export bill. The documents are then sent to the issuing bank, which will check the documents and then reimburse the negotiating bank. If the issuing bank finds discrepancies overlooked by the negotiating bank, they will reject the documents and if the applicant is also unwilling to take up the documents, the negotiating bank will have to turn to the exporter for reimbursement-usually not an easy task as the exporter may have already used the funds other trading activities. The situation is more serious if the negotiating bank is also the confirming bank, Here; the negotiating bank takes on the same liabilities and responsibilities of the issuing bank and therefore has no recourse to the exporter.
To mitigate the above risks of non-payment, the negotiating bank must understand the underlying transaction and be comfortable that the trading parties will honor their commitments. Very simply the importer wants the goods and the exporter wants to be paid in time. No DC, however worded, will prevent the actions of a fraudster. The operational competency and integrity of the issuing basic must be considered carefully, since it can be very trying dealing with banks who habitually reject a document and delay payments due to trivial discrepancies.