SS 14: Documentary Credit

What this standard is about

The standard covers documentary credits (letters of credit) issued by a bank, either on a client's order or for the bank's own use. A documentary credit is the bank's written promise to the seller to pay up to a set amount, within a set time, if the seller presents shipping documents that match the instructions. The standard covers all types and forms, the stages of execution, and the relationships between the buyer, the seller, and the bank.

Why it exists

International trade needs a trusted middleman. The seller wants assurance of payment. The buyer wants proof of shipment before money moves. The standard fits this practice into Shariah contracts such as agency and guarantee, so the arrangement stays free of interest.

The key rules, simply put

• The process starts with the underlying contract, usually a sale, in which the seller asks to be paid through documentary credit. It can also be a lease, an agency with commission, or another contract.
• The buyer then asks the bank to open the credit so the seller can be notified.
• The bank pays only against documents that conform to the instructions.
• The standard defines the Shariah position of each party at each stage — as agent, guarantor, or otherwise — so no party ends up in an interest-bearing loan unknowingly.

An everyday example

A Dubai importer buys machinery from Germany for €500,000. Their bank issues a letter of credit promising the German seller payment once the bill of lading and the other documents are presented and match the order.

Words to know

• Documentary credit (letter of credit) — a bank's written payment undertaking used in trade.
• Beneficiary — the seller who receives the bank's promise.
• Applicant — the buyer who asks the bank to issue the credit.
• Riba — interest; any guaranteed extra on a loan. Not allowed in Islamic finance.

Source

• AAOIFI Shariah Standard No. 14 — https://islamicmarkets.com/publications/documentary-credit-scope-of-standard