A letter of credit or LC may be a document issued by the importer’s bank (opening bank) on importer’s behalf. Through its issuance, the exporter is assured that the issuing bank will make a payment to the exporter for the international trade conducted between both the parties.
The importer is that the applicant of the LC, while the exporter is that the beneficiary. In an LC, the issuing bank promises to pay the mentioned amount as per the agreed timeline and against specified documents.
A guideline of an LC is that the issuing bank will make the payment based solely on the documents presented, and that they aren't required to physically make sure the shipping of the products . If the documents presented are in unison with the terms and conditions of the LC, the bank has no reason to deny the payment.
Importance of Letter Of Credit:
A letter of credit is useful for both the parties because it assures the vendor that he will receive his funds upon fulfillment of terms of the trade agreement and therefore the buyer can portray his creditworthiness and negotiate longer payment terms, by having a bank back the trade transaction.
Features / Characteristics of letter of credit
Negotiability
A letter of credit may be a transactional deal, under which the terms are often modified/changed at the parties assent. so as to be negotiable, a letter of credit should include an unconditional promise of payment upon demand or at a specific point in time.
Revocability
A letter of credit are often revocable or irrevocable. Since a revocable letter of credit can't be confirmed, the duty to pay are often revoked at any point of your time . In an irrevocable letter of credit, all the parties hold power, it can't be changed/modified without the agreed consent of all the people.
Transfer and Assignment
A letter of credit are often transferred, also the beneficiary has the proper to transfer/assign the LC. The LC will remain effective regardless of what percentage times the beneficiary assigns/transfers the LC.
Sight & Time Drafts
The beneficiary will only receive the payment upon maturity of letter of credit from the issuing bank when he presents all the drafts & the required documents.
Bill of Lading
Airway Bill
Commercial Invoice
Insurance Certificate
Certificate of Origin
Packing List
Certificate of Inspection
How does Letter of Credit Work?
LC is an appointment whereby the issuing bank can act on the request and instruction of the applicant (importer) or on their own behalf. Under an LC arrangement, the issuing bank can make a payment to (or to the order of) the beneficiary (that is, the exporter). Alternatively, the issuing bank can accept the bills of exchange or draft that are drawn by the exporter. The issuing bank also can authorize advising or nominated banks to pay or accept bills of exchange.
Fee and charges payable for an LC
There are various fees and reimbursements involved when it involves LC. In most cases, the payment under the letter of credit is managed by all parties. The fees charged by banks may include:
Opening charges, including the commitment fees, charged upfront, and therefore the usance fee that's charged for the agreed tenure of the LC.
Retirement charges are payable at the top of the LC period. They include an advising fee charged by the advising bank, reimbursements payable by the applicant to the bank against foreign law-related obligations, the confirming bank’s fee, and bank charges payable to the issuing bank.
Parties involved in an LC
Main parties involved:
Applicant An applicant (buyer) may be a one that requests his bank to issue a letter of credit.
Beneficiary A beneficiary is essentially the vendor who receives his payment under the method .
Issuing bank The issuing bank (also called a gap bank) is liable for issuing the letter of credit at the request of the customer .
Advising bank The advising bank is liable for the transfer of documents to the issuing bank on behalf of the exporter and is usually located within the country of the exporter.
Other parties involved in an LC arrangement:
Confirming bank The confirming bank provides a further guarantee to the undertaking of the issuing bank. It comes into the image when the exporter isn't satisfied with the reassurance of the issuing bank.
Negotiating bank The negotiating bank negotiates the documents associated with the LC submitted by the exporter. It makes payments to the exporter, subject to the completeness of the documents, and claims reimbursement under the credit.
(Note:- Negotiating bank can either be a separate bank or an advising bank)
Reimbursing bank The reimbursing bank is where the paying account is about up by the issuing bank. The reimbursing bank honors the claim that settles the negotiation/acceptance/payment coming in through the negotiating bank.
Second Beneficiary The second beneficiary is one who can represent the first beneficiary in their absence. In such an eventuality, the exporter’s credit gets transferred to the second beneficiary, subject to the terms of the transfer.
DRAFT OF A L/C TEXT
40A: Form of Documentary Credit
IRREVOCABLE, CONFIRMED, TRANSFERABLE
20: /Documentary Credit Number
31C: /Date of Issue:
31D: /Date and Place of Expiry:
51: /Applicant Bank
50: /Applicant
59: /Beneficiary:
32B: Currency Code, Amount:
UNITED STATES DOLLARS
39A: Percent Credit Amount Tolerance: 05/05
41D: /Available With .. By …:
42C: /Drafts at :
AT SIGHT
42D: Drawee:
43P: /Partial Shipment
ALLOWED
43T: /Transshipment:
PROHIBITED
44A: /Loading on Board/Dispatch/Taking in Charge At/From…Port:
44B: /For Transportation To:
ASWP
44C: /Latest Date of Shipment
(45 DAYS FROM THE DATE OF RECEIPT IN THE BENIFICIARY BANK)
45A: /Description of goods and / or Services :
TOTAL QUANTITY:
46A: /Documents Required:
DRAFT TO BE DRAWN AT SIGHT ON US BEARING THE CLAUSE DRAWN UNDER L/C
NO………………….ALONG WITH THE FOLLOWING :
1. Signed Commercial invoice in one original and Three copies quoting our L/C no. and date
2. Full set (3/3) of clean on board ocean bill of Lading made out the order of ………….and notify ………….. and marked freight pre-paid.
3. Certificate of inspection issued by Societe General De Surveillance on quality, quantity, weight and supervision of lading at load port in 3 original.
4. Certificate of Origin Issued by a chamber of commerce from the country of origin
5. Packing List in three copies
47A: /Additional Conditions :
1. PLUS/MINUS 5 PCT IN QUANTITY AND VALUE IS ACCEPTABLE
2. ONE SET OF SHIPPING DOCUMENTS IS TO BE FAXED TO L/C APPLICANT FAX NO. ………………. WITHIN 5 DAYS FROM THE DATE OF SHIPMENT
3. THIRD PARTY DOCUMENTS ACCEPTABLE
4. CHARTER PARTY B/L ACCEPTABLE
5. ONLY DRAFT & INVOICE TO BEAR L/C REFERENCE. NO. OTHER DOCUMENT SHOULD BEAR L/C NUMBER, DATE OR NAME OF BANK ISSUING L/C.
6. THE CREDIT IS SUBJECT TO ICC PUBLICATION 1993 REVISION BROCHURE NO. 500
71B: /Charges :
ALL CHARGES OUTSIDE ………… , EXCEPT L/C CONFIRMATION CHARGES ARE ON ACCOUNT OF BENEFICIARY
48: /Period for Presentation:
DRAFTS AND DOCUMENTS MUST BE PRESENTED FOR NEGOTIATION WITHIN 27 DAYS FROM B/L/DATE BUT WITHIN THE VALIDITY OF THE CREDIT
49: /Confirmation Instructions :
CONFIRM
53A: Reimbursing Bank
78: /Instructions to Paying / Accepting / Negotiating Bank :
WE AUTHORISE YOU TO CLAIM REIMBURSEMENT FROM OUR ACCOUNT NO……………… WITH ……….. BANK IN ……… (CITY)
57A: Advise through Bank
72: Sender to receiver Information
PLEASE ADVISE THIS CREDIT TO THE BENEFICIARY
Sources: DRIPCAPITAL