Risk Management Manual of Examination Policies - FDIC

INTERNATIONAL BANKING Section 11.1
The importance of documentation is paramount in all letter
of credit transactions. The bank is required to examine all
documents with care to determine that they conform to all
of the terms and conditions of the letter of credit. Many
letters of credit are part of continuous transactions evolving
from letters of credit to sight drafts or acceptances or to
notes and advances, collaterized by trust receipts or
warehouse receipts. Letters of credit negotiations rarely
occur without document discrepancies. Banks actually
charge a fee to resolve the discrepancies. Ultimate
repayment often depends upon the eventual sale of the
goods involved. Although the transaction passes through
various sections of the international department, the proper
handling and accuracy of the documents required under the
letter of credit is of primary concern.
All commercial documentary letters of credit are
contingent liabilities and are included as such in Reports of
Condition. Banks should also monitor the volume
outstanding through a general ledger memorandum account
or contra accounts.
Standby letter of credits guarantee payment to the
beneficiary by the issuing bank in the event of default or
nonperformance by the account party (the bank's
customer). Whereas a commercial documentary letter of
credit is normally payable against the presentation of
documents conveying or securing title to goods, such as a
bill of lading, a standby letter of credit is normally
unsecured and payable against a simple statement of
default or nonperformance. Some of the most common
purposes for which this instrument may be used are listed
below.
• Standby credit for the account party’s performance
under a contract award. In this case the beneficiary
would present to the issuing bank a draft accompanied
by a statement to the effect that the contract bidder
(account party) did not perform under an awarded
contract. The issuing bank would be obliged to pay
the beneficiary and then look to the account party
(customer) for reimbursement.
• Standby credit for the account party's borrowing or
advances from another bank. This arrangement calls
for the issuing bank to reimburse the lending bank if
the account party (customer) does not repay his loan.
• Standby credit to back commercial paper or other
obligations of the bank's customers.
A standby letter of credit transaction involves a higher
potential risk for the issuing bank than a commercial
documentary letter of credit. Unless the transaction is fully
secured, the issuer of this instrument retains nothing of
value to protect it against loss. A commercial documentary
letter of credit provides the bank with title to the goods
being shipped. Therefore, to reduce the unsecured credit
risk of standby letters of credit, the issuing bank's credit
analysis of the account party or customer should be
equivalent to that applicable to a borrower in an ordinary
loan. Unsecured standby letters of credit are included,
along with loans, within a bank's unsecured legal lending
limit to one borrower.
For reporting purposes, standby letters of credit are
reflected as contingent liabilities in the issuer's Report of
Condition. Once drawn upon, the amount of the standby
letter of credit becomes a direct liability of the issuing
bank.
Other direct liabilities by a bank may arise during the
course of business. Court cases and interpretive rulings
have held that banks may issue enforceable guarantees
when a direct interest of the bank is served. An instance in
which this authority is exercised is in the issuance of
steamship guarantees and airway releases. These
instruments request a transportation carrier to release
merchandise shipped under a letter of credit, but before a
bill of lading has been received, and provides indemnity
protection against future liability. All such guarantees are
to be combined with standby letters of credit for the
purpose of determining a customer’s legal lending limit.
Bankers’ acceptances are a common method of financing
international trade. These are used to finance all of the
successive stages of the movement of goods through the
channels of trade from the point of origin to the final
destination.
A bankers’ acceptance is an order in the form of a time
draft (also referred to as a bill of exchange or an issuance
draft) drawn by one party (the drawer) in favor of itself or
another party (the payee), addressed to (drawn on) a bank
(the drawee) and accepted by that bank to pay the holder a
certain sum on or before a specified date. The bank's
acceptance of this order from the drawer, by stamping
across the face of the draft "ACCEPTED" and dating and
signing the stamp, is a formal acknowledgment of the
obligation and constitutes an unconditional promise by that
bank to honor the time draft at maturity. The drawee bank
creating the acceptance is primarily liable for the
instrument, while the payee, as first endorser, is
secondarily liable for paying the holder in due course. If
the drawee (acceptor) is other than a bank, the instrument
is a trade acceptance, not a bankers’ acceptance.
Most bankers’ acceptances are used to finance trade
transactions. Accordingly, acceptances are most often
created in connection with letters of credit, although they
may arise in connection with collection or open account
International Banking (12-04) 11.1-8 DSC Risk Management Manual of Examination Policies
Federal Deposit Insurance Corporation