Types of Letter Of Credit

              Letter of Credit

•“ It is a promise by a bank on behalf of the buyer (importer) to pay the seller (beneficiary/exporter) a specified sum in the agreed currency, provided that the seller submits the required documents by a predetermined deadline.”

•The Uniform Customs & Practice for Documentary Credits (UCP 600) is the official publication which is issued by the ICC . It is a body of rules on the issuance and use of a letter of credit and applies to 175 countries

•Many banks and lenders are subject to this regulation, which aims to standardise international trade, reduce the risks of trading goods and services, and govern trade.

•How does it work?

•There is a seller and a buyer who want to conclude a business transaction. However, they may or may not know each other for financial obligations.

•Because of the cargoes shipped from foreign ports to reach their destination takes time, importers have to find a way of guaranteeing payment to exporters before the goods are received.

•The answer is a letter of credit – an instruction by the importer’s bank to an overseas bank to pay the exporting company in advance/ well in advance

•The banks naturally charge interest for this service.

•Buyer sets a list of terms and conditions under which he would like to buy and ship the cargo from the seller.

•This list generally has

•Description of the goods he wants to buy from the seller

•Quantity of the goods

•Documentary requirements (bills of lading, commercial invoice, packing list etc)

•Details of the consignee (generally the issuing bank) will be shown as the consignee and the buyer’s bank will have control of the cargo until such time they receive the money from the buyer

•Details of who must be notified of the arrival of the shipment

•Latest date of shipment (for eg. on or before 30th May.)

•This list generally has……

•Sometimes the buyer also nominates the shipping line that is to be used

•which shipping (Delivery) ports are to be used

•what mode of transport  for  each stage is to be used

•This L/C is then issued by the buyers bank (known as issuing bank) and is generally sent to the seller and his bank (known as the nominated bank(Beneficiary bank).

•The seller then proceeds to prepare his goods and documents based on the L/C..

•Once the shipment has been accomplished, the seller will submit the copies of all the documents as per the instructions on the L/C to his bank..

•His bank checks the veracity and correctness of the submitted documents against the L/C specifications.

PARTIES TO LETTER OF CREDITS

•. Commercial Parties

•There are two commercial parties viz. Applicant and Beneficiary

•A. Applicant

•The applicant is normally the buyer of the goods .i.e. the importer who request his bank to issue a letter of credit in favour of a named beneficiary against tending of certain specified documents.

•The Role of Applicant

•Supply the bank with complete instruction.(To fill out standard application form)

•Issue  instruction for amendments if any

•Decide on discrepancies reported by the issuing bank to him.

Arrange for fund at the payment time.

•B. Beneficiary

•The beneficiary is normally the seller of goods who receives payment under documentary credit if he has complied with terms and conditions thereof.

•A credit issued in favour of the beneficiary to enable him or his agent to obtain payment once he performed his part of contract and submitted stipulated documents showing  compliance with the terms and conditions of letter of credit.

•In case of a transferable letter of credit, the credit is transferred to another party,

•The original beneficiary is known as first beneficiary the person to whom the credit is transferred is known as the second beneficiary.

•The Role of Beneficiary

•Establish the terms of payment when sales contract is being Negotiated.

•Assess the risk of non-payment even when compliant documents are presented in the case of unconfirmed LCs.

•Provide the draft wordings to buyers regarding LC Terms.

•Scrutinize LC on receipt form the advising bank to check whether it is in consonance with the sales contract and whether it is otherwise workable and acceptable to him.

•Request for LC amendments from buyers.

Provide copy of the credit to dispatch department and cargo agent to ensure correct documentation

•2. Bankers

•Issuing Bank

•The issuing bank or the opening bank is one which issue the credit, i.e. undertake, independent of the undertaking of the applicant, to make payment provided the term and conditions of the credit have been complied with.

•Advising Bank

•The advising bank advises the credit to the beneficiary thereby authenticating the genuineness of the credit

•Confirming Bank

•A confirming bank is the one which adds its guarantee to the credit. It undertakes the responsibility of payments/negotiation/acceptance under the credit in addition to that of the issuing bank.

•Nominated Bank

•A Nominated bank is the bank authorized/nominated by issuing bank to pay, to incur a deferred payment liability, to accept drafts or to negotiate the credit.

•When exporters make a drawing under a letter of credit, the  presented documents (bill of lading, invoice, packing list, certificate  of origin, etc.) should usually be accompanied by a draft, which is  basically a cheque, representing demand for payment. The draft or Bill of Exchange is drawn and signed by the exporter (seller).  The terms of the draft are “at sight” or a number of days after sight or  after the bill of lading date

•Reimbursing Bank

•A reimbursing bank is the bank authorized to honour the reimbursement claims in settlement of negotiation with the paying or accepting bank.

•3. Related Parties

•Insurer

•The insurer has the prime responsibility for insuring the goods as provided for in the credit.

•Carrier

•The carrier , i.e. the shipping company or road transport agency is responsible for safe arrival of goods at the destination.

•TYPES OF DOCUMENTARY CREDIT

   •A. Confirmed and Unconfirmed Documentary Credit

•1. Confirmed Documentary Credit

•A confirmed letter of credit is a letter of credit on which at least two banks namely the issuing bank and the confirming bank are obliged to make payment.

•It directly creates the obligation of a financing agency doing business in the seller's financial market to a contract of sale.

•Confirmation at the request of the Seller.

•2. Unconfirmed Letter of Credit

•Unconfirmed Letter of Credit. A letter of credit which has not been guaranteed or confirmed by any bank other than the bank that opened it.

•The advising bank merely informs the beneficiary of the letter of credit terms and conditions.