What is a Letter of Credit (LC)
Letter of Credit is a Written Document issued by the Importer Bank on behalf of Importer Assures the seller will received his funds upon fulfillment of terms of the Trade A agreement. A guiding principle of an LC is that the issuing bank will make the payment based solely on the documents presented, and they are not required to physically ensure the shipping of the goods. If the documents presented are in accord with the terms and conditions of the LC, the bank has no reason to deny the payment
Letter of Credit Documents
- Commercial Invoice
- Packing List
- Shipping Bill of Lading
- Airway bill
- Certificate of Origin
- Insurance Certificate
- Certificate of inspection
Opening Charges, commitment fees, upfront fees, retirement charges, advise fees, confirming bank fees, bank charges, etc., Cost will be 0.25% to 2% of LC value.
Trade Agree between buyer and seller and use of LC >>> Buyer applies to Issuing bank to issue an LC in favor of the seller >>> Issuing bank sent LC to the advising bank >>> Advising bank verifies the authenticity of the LC and forward it to the seller >>> Seller Verify LC and Initiate the goods shipping process >>> After the goods are shipped, seller presents LC documents to Advising bank >>> Advising bank send LC documents to Issuing bank and the amount is paid, accepted >>> Issuing bank verify documents and obtain payment from Buyer >>> Issuing bank send documents to buyer >>> Buyer use these documents to get possession of the shipped goods.
Bank Guarantee (BG): BG is an Assurance given bank for a non-performing activity, if any activity fails, BG pays dues. BG involves three parties: Applicant, Beneficiary, and the Banker. LC is a commitment document. It Guarantees payment to the seller. Involve four parties: Buyer, Seller, issuing bank & advising bank.
Letter of Credit (LC) Types
- Revocable LC: LC can be Modified or revoked or canceled by Issuing Bank ‘or’ Buyer without any notice. The concept of a Revocable Credit was withdrawn in 2007.
- Irrevocable LC: LC Cannot be revoked or modified or canceled without the consent of issuing bank, seller, and confirming bank.
- Confirmed– Irrevocable LC: An arrangement where another Bank or Financial institution adds its Guarantee to the LC. It is used when sellers do not trust the Buyer’s bank or issuing bank.
- Unconfirmed – Irrevocable LC: No Added Guarantee as above. It involves only the Seller, Buyer, issuing bank, and Buyer bank.
- LC at Sight: Requires the advising bank or seller bank to make payment at sight, on-demand, or upon presentation of documents
- Usance LC ‘or’ Deferred Payment LC: This type of LC wherein the buyer is allowed to make the payment after the delivery, within a stipulated grace period.
- Back to Back LC: When a transaction takes place between a buyer and a seller keeping an intermediary in the loop. A broker or trader acts as an intermediary between the seller and the buyer. Instead of issuing an LC to the Seller, the buyer issues it to the intermediary. The intermediary then submits the primary LC as collateral at a bank and asks it to issue another LC to be given to the end seller in exchange for the shipment. The second LC that is issued keeping the primary LC as collateral is known as a ‘back-to-back letter of credit.
- Transferable LC: Used when there is a Middleman involved. The first beneficiary requests the bank to transfer the entire/part payment to the second beneficiary. First Beneficiary is Middleman.
- Un-transferable LC: Used when there is no Middleman involved. LC cannot be used to pay any other party.
- Standby LC (SBLC): Similar to Bank Guarantee. The seller can obtain payment from the bank even in the case the buyer fails to perform as per the agreement.
- Free Negotiable LC: This LC is not restricted to any Bank for negotiation or it can be negotiated in any bank
- Revolving LC: Single LC that covers Multiple transactions over a long period. It is used for Regular transactions of the same commodity between the same buyer & same seller.
- Red Clause LC: Seller is paid an Advance before the goods are shipped. LC acts as an aid to the seller for his working capital requirements for the Purchase of Raw materials, Packing, and processing of goods.
- Green Clause LC: Same as above (13) additions to Raw materials, packing and processing cost but also for the cost incurred for Pre-shipment, warehousing, and insurance.
Letter of Credit (LC) Parties
|Applicant||Buyer / Importer||Buyer|
|Beneficiary||Seller / Exporter||Seller|
|Issuing / Opening Bank||Buyer Bank||Buyer|
|Advising bank||Seller Bank||Seller|
|Confirming bank||Additional Guarantee to issuing bank||Buyer|
|Negotiating bank||Make payment to seller subject to the completeness of documents||Seller|
|Reimbursing bank||Bank between Issuing and negotiating bank||**|
|Second Beneficiary||One who represents the original beneficiary in their absence||**|