Letter of Credit ( LC)

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Definition

In a simple explanation a letter of credit is a promise to pay. Banks issue letters of credit as a way to ensure sellers that they will get paid as long as they do what they've agreed to do. Letters of credit ( LC , L/C ,LOC) are common in international trade because the bank acts as an uninterested party between buyer and seller

Definition

Component

Issuing bank

Applicants

beneficiary

Advising bank

Where it works

1- international trade : Lcs used in international trade transactions of significant value , mostly for deal between supplier in one country and customer in another. ( exporters , importers ) 2- Land development process: they also used in land development process to ensure that approved public facilities will be built ( streets , sidewalks.. contracts )

How it works

How it works

Example : The steps mentioned in the example

A business called the InCosmetika from time to time imports goods from a business called ACME, which banks with the ABC Bank. InCosmetika holds an account at the Commonwealth Bank. InCosmetika wants to buy $500,000 worth of merchandise from ACME, what steps should be taken to get a LC ?

Steps ( generally )

1-InCosmetika goes to The Commonwealth Bank and requests a $500,000 letter of credit, with ACME as the beneficiary. 2-The Commonwealth Bank can issue a letter of credit either on approval of a standard loan underwriting process or by InCosmetika funding it directly with a deposit of $500,000 plus fees which are typically between 1% and 8% of the face value of the letter of credit. 3-The Commonwealth Bank sends a copy of the letter of credit to the ABC Bank, which notifies ACME that payment is available and they can ship the merchandise InCosmetika has ordered with the full assurance of payment to them.

4-On presentation of the stipulated documents in the letter of credit and compliance with the terms and conditions of the letter of credit, the Commonwealth Bank transfers the $500,000 to the ABC Bank, which then credits the account of ACME for that amount.

Types of LC

Stand by

Documentary

Revocable Irrevocable -confirmed -non confirmed

Back to back

Special LCs

Deferred Payment (Usance) Red Clause Revolving Transferable Assignment of Proceeds

Samples