LETTER OF CREDIT

M S University

Project on Letter of credit Submitted to: - Prof. Bharat Pagare

Submitted By:-

Aelis Rabara Sahil Bloch Jenish Kakadiya

Priyank Siddhavat
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LETTER OF CREDIT

Acknowledgement
Apart from the efforts of me, the success of any project depends largely on the encouragement and guidelines of many others. I take this opportunity to express my gratitude to the people who have been instrumental in the successful completion of this project. I would like to show my greatest appreciation to Prof. BHARAT PAGARE SIR AND NARSHIGANI SIR. I cant say thank you enough for his tremendous support and help. I feel motivated and encouraged every time I attend his meeting. Without his encouragement and guidance this project would not have materialized. The guidance and support received from all the members who contributed and who are contributing to this project, was vital for the success of the project. I am grateful for their constant support and help.

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PARTICULAR

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Introduction Elements of a letter of credit Types of letter of credit Different fields of letter of credit Letter of credit documents Transferable letter of credit L/C Analysis of typical L/C transaction Letter of credit processing Conclusion

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LETTER OF CREDIT
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The English name letter of credit derives from the French word accreditif, a power to do something, which in turn is derivative of the Latin word accreditivus, meaning trust. A letter of credit is basically a document issued by a bank guaranteeing a client's ability to pay for goods or services. A bank or finance company issues a letter of credit on behalf of a buyer, authorizing the seller to obtain payment within a specified timeframe once the terms and conditions outlined in the letter of credit are met. The letter of credit acts like an insurance contract for both the buyer and seller and practically eliminates the credit risk for both parties, while at the same time reducing payment delays. A letter of credit provides the seller with the greatest degree of safety when extending credit. It is useful when the buyer is not well known and when exchange restrictions exist or are possible. The LC can also be the source of payment for a transaction, meaning that a will get paid by redeeming the letter of credit. Letters of credit are used primarily in international trade transactions of significant value, for deals between a supplier in one country and a customer in another. The parties to a letter of credit are usually a beneficiary who is to receive the money, the issuing bank of whom the applicant is a client, and the advising bank of whom the beneficiary is a client. Almost all letters of credit are irrevocable, i.e., cannot be amended or canceled without prior agreement of the beneficiary, the issuing bank and the confirming bank, if any. In executing a transaction, letters of credit incorporate functions common Traveler's cheques.

LETTER OF CREDIT

FROM

ABOVE

WE

CAN

CONCLUDE

LETTER

OF

CREDIT IS
A letter of credit is a document issued mostly by financial institutions which usually provides an irrevocable payment undertaking to a beneficiary against complying documents as stated in the credit. Once the beneficiary or a presenting bank acting on his behalf, makes a presentation to the issuing bank or confirming bank, if any, within the expiry date of L/C, comprising documents complying with the terms and conditions of the L/C, the applicable UCP. And international standard banking practices. The issuing bank or confirming bank, if any, is obliged to honor irrespective of any instructions from the applicants to the contrary. Seller Bank

Buyer Bank

Buyer Carrier

After a contract s concluded between buyer and seller, buyer bank supplies a letter of credit to the seller Seller consigns goods to a carrier in exchange for a bill of lading.

Seller Bank

Buyer Bank 5

LETTER OF CREDIT

Seller Carrier

Buyer

Seller provide bill of lading to a bank in exchange for payment. Sellers bank exchanges bill of lading for payment from a buyers bank. Buyers bank exchange bill of lading for payment from buyer.

Seller Bank

Buyer Bank

Seller

Carrier

Buyer

Buyer provides bill of lading to a carrier and takes delivery of goods Buyer Seller Bank Bank

Buyer

Carrier

Elements of a Letter of Credit

A payment undertaking given by a bank (issuing bank) On behalf of a buyer (applicant) 6

LETTER OF CREDIT

To pay a seller (beneficiary) for a given amount of money On presentation of specified documents representing the supply of goods Within specified time limits Documents must conform to terms and conditions set out in the letter of credit Documents to be presented at a specified place

PARTIES TO AND ASSOCIATED WITH THE LETTER OF CREDIT 1. Applicant The applicant is the party who requests and instructs the issuing bank to open a letter of credit in favor of the beneficiary. The applicant usually is the importer or the buyer of goods and/or services. The applicant can also be another party acting on behalf of the importer, such as a confirming house. The confirming house is equivalent to a buying office, it acts as an intermediary between buyer and seller, and it can be located in a third country or in the sellers country. 2.Beneficiary The beneficiary is entitled to payment as long as he can provide the documentary evidence required by the letter of credit. The letter of credit is a distinct and separate transaction from the contract on which it is based. All parties deal in documents and not in goods. The issuing bank is not liable for performance of the underlying contract between the customers and beneficiary. The issuing bank's obligation to the buyer is to examine all documents to insure that they meet all the terms and conditions of the credit. Upon requesting demand for payment the beneficiary warrants that all conditions of the agreement have been complied with. If the beneficiary (seller) conforms to the letter of credit, the seller must be paid by the bank. 7

LETTER OF CREDIT 3. Issuing Bank The issuing bank's liability to pay and to be reimbursed from its customer becomes absolute upon the completion of the terms and conditions of the letter of credit. Under the provisions of the Uniform Customs and Practice for Documentary Credits, the bank is given a reasonable amount of time after receipt of the documents to honor the draft.The issuing banks' role is to provide a guarantee to the seller that if compliant documents are presented, the bank will pay the seller the amount due and to examine the documents, and only pay if these documents comply with the terms and conditions set out in the letter of credit.Typically the documents requested will include a commercial invoice, a transport document such as a bill of lading or airway bill and an insurance document; but there are many others. Letters of credit deal in documents, not goods. 4. Advising Bank An advising bank, usually a foreign correspondent bank of the issuing bank will advise the beneficiary. Generally, the beneficiary would want to use a local bank to insure that the letter of credit is valid. In addition, the advising bank would be responsible for sending the documents to the issuing bank. The advising bank has no other obligation under the letter of credit. If the issuing bank does not pay the beneficiary, the advising bank is not obligated to pay. 5. Confirming Bank The correspondent bank may confirm the letter of credit for the beneficiary. At the request of the issuing bank, the correspondent obligates itself to insure payment under the letter of credit. The confirming bank would not confirm the credit until it evaluated the

LETTER OF CREDIT country and bank where the letter of credit originates. The confirming bank is usually the advising bank.

TYPES OF LETTER OF CREDIT

1. Commercial and stand by L/C: Commercial letters of credit are used primarily to facilitate foreign trade. The commercial letter of credit is the primary payment mechanism for a transaction. It is a contractual agreement between a bank, known as the issuing bank, on behalf of one of its customers, authorizing another bank, known as the advising or confirming bank, to make payment to the beneficiary. The issuing bank, on the request of its customer, opens the letter of credit. The issuing bank makes a commitment to honor drawings made under the credit. The beneficiary is normally the provider of goods and/or services. Essentially, the issuing bank replaces the bank's customer as the payee The standby letter of credit serves a different function. The standby letter of credit serves as a secondary payment mechanism. The bank will issue the credit on behalf of a customer to provide assurances of his ability to perform under the terms of a contract. A bank will issue a standby letter of credit on behalf of a customer to provide assurances of his ability to perform under the terms of a contract between the beneficiaries. The parties involved with the transaction do not expect that the letter of credit will ever be drawn upon. The standby letter of credit assures the beneficiary of the performance of the customer's obligation. The beneficiary is able to draw under the credit by presenting a draft, copies of invoices, with evidence that the customer has not performed its obligation. The bank is obligated to make payment if the

LETTER OF CREDIT documents presented comply with the terms of the letter of credit. They are issued by banks to stand behind monetary

obligations, to insure the refund of advance payment, to support performance and bid obligations, and to insure the completion of a sales contract. The credit has an expiration date.The standby letter of credit is often used to guarantee performance or to strengthen the credit worthiness of a customer. In the above example, the letter of credit is issued by the bank and held by the supplier. The customer is provided open account terms. If payments are made in accordance with the suppliers' terms, the letter of credit would not be drawn on. The seller pursues the customer for payment directly. If the customer is unable to pay, the seller presents a draft and copies of invoices to the bank for payment. 2. Revocable or irrevocable letter of credit: Letters of credit may be either revocable or irrevocable. A revocable letter of credit may be revoked or modified for any reason, at any time by the issuing bank without notification. A revocable letter of credit cannot be confirmed. Once the documents have been presented and meet the terms and conditions in the letter of credit, and the draft is honored, the letter of credit cannot be revoked. The revocable letter of credit is not a commonly used instrument. If a letter of credit is revocable it would be referenced on its face.The irrevocable letter of credit may not be revoked or amended without the agreement of the issuing bank, the confirming bank, and the beneficiary. An irrevocable letter of credit from the issuing bank insures the beneficiary that if the required documents are presented and the terms and conditions are complied with, 10

LETTER OF CREDIT payment will be made. If a letter of credit is irrevocable it is referenced on its face. 3. Sight or usance letter of credit: All letters of credit require the beneficiary to present a draft and specified documents in order to receive payment. A draft is a written order by which the party creating it, orders another party to pay money to a third party. A draft is also called a bill of exchange. There are two types of drafts: sight and time. A sight draft is payable as soon as it is presented for payment. The bank is allowed a reasonable time to review the documents before making payment. A time draft is not payable until the lapse of a particular time period stated on the draft. The bank is required to accept the draft as soon as the documents comply with credit terms. The issuing bank has a reasonable time to examine those documents. The issuing bank is obligated to accept drafts and pay them at maturity. A Letter of credit is known as a Sight letter of credit if it involves payment to the seller against a Sight Draft. On the other hand, if the payment is made against a Usance Draft, then it is known as Usance letter of credit.

DIFFERENT FIELDS OF LETTER OF CREDIT

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LETTER OF CREDIT

FROM :( NAME & ADDRESS OF OPENING BANK ) This clause contains details of bank which has opened the Letter of Credit, and it works on the behalf of the buyer of goods. The opening bank plays the first step in the whole process of letter of credit. TO :( NAME & ADDRESS OF ADVISING BANK ) This clause shows the details of bank which plays the foremost role in the process of letter of credit. The advising bank belongs to the country of seller. It plays the role of middleman between the seller and the opening bank TYPE OF L/C :IRREVOCABLE This clause shows the type of L/C in which it is being made. Various types of L/Cs are Revocable, Irrevocable, Commercial, Negotiable etc. L/C Number : The clause shows a particular number for L/C and every L/C has different number so that difference can be judged between different L/Cs. DATE OF ISSUE : This clause shows that date on which the opening bank has issued the L/C. DT. & PLACE OF EXPIRY : IN INDIA This shows about the date and the place in india where the lc will get expired, means that financial institution where the L/C is send by the opening bank.

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NAME & ADDRESS OF THE: APPLICANT It contains detail about the buyer of the goods. It gives complete address of the buyer. NAME & ADDRESS OF THE: BENEFICIARY It shows details of the seller of goods, like sellers name, address, country to which he belongs. AMOUNT OF CREDIT IN : US DOLLARS /EURO/ANY OTHER FREELY EXCHANGEABLE CURRENCY (IN FIGURES & WORDS) It shows the currency in which the deal is been made, the code for that currency as well as the amount of the goods PERCENTAGE CREDIT : AS PER CONTRACT AMOUNT TOLERANCE Sometimes the amount in the letter of the credit and the exact amount of the goods does not match. There can be a difference between the both. So a specific percentage of amounts of goods specified in L/C is given as a tolerance and the exact amount of goods can be in between the minimum and maximum tolerated limits. CREDIT AVAILABLE WITH: This part shows the details of that party from where the amount can be reimburses by the seller. This states either a specified bank in India or any bank in India.

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LETTER OF CREDIT

USANCE OF THE DRAFTS : This clause shows whether the draft is payable at sight or at any date in future. DRAFTS TO BE DRAWN ON: It tells about the party which acts as a drawee. Generally the opening bank acts as a drawee PARTIAL SHIPMENT : AS PER CONTRACT This clause contains details whether the shipment of goods is allowed through one shipment or the goods can be sending through various shipments. TRANSHIPMENT : AS PER CONTRACT Transshipment means when the goods are send, SHIPMENT FROM : It tells about that place from where goods are send by the seller. SHIPMENT TO : Its that place where the goods are sending by the seller. And generally its that country where the buyer lives. LATEST SHIPMENT DATE : Its that date till which the goods should reach to the buyer. After that date, its the choice of the buyer whether he accepts the goods or not.

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DESCRIPTION OF GOODS : Description of Materials Size ( in mm) and Quantity (in MT) Specification Tolerance Quantity Quantity Tolerance Price per MT (in USD/Euro/any other freely exchangeable currency)

Letter of Credit Documents

There are many important points in a letter of credit transaction that need to be taken care of professionally. However, documentation is much more important than any other part of the letter of credit transactions. This importance stems its power from the letter of credit structure. Letters of credit transactions are related to the documents only. Let us consider ourselves as an exporter and assume that we have just shipped our order. What we have to do in order to prove that this shipment has been made. Of course, we must supply a relevant transport document. Let us consider also that the shipment term was CIF incoterms 2000, which obligate us to arrange the insurance for the shipment. Again, we must supply an insurance document, as it is demanded in the L/C in order to fulfill our responsibility. The importance of the documentation is stated in UCP 600 article 5 as follows:

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Banks deal with documents and not with goods, services or performance to which the documents may relate. In addition, every condition stated on the letter of credit form must be connected to a document. This point is also clearly indicated in UCP 600 article 14. If a credit contains a condition without stipulating the document to indicate compliance with the condition, banks will deem such condition as not stated and will disregard it.

Documents most frequently used in letters of credit transactions

Transport Documents:

Transport Document Covering at Least Two Different Modes of Transport (multimodal or combined transport document) Bill of Lading Non-Negotiable Sea Waybill Charter Party Bill of Lading Air Transport Document Road, Rail or Inland Waterway Transport Documents

Insurance Documents:

Insurance Policy Insurance Certificate Open Cover

Financial Documents:

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Bill of exchange (Draft)

Commercial Documents:

Commercial Invoice Packing List; Weight List Inspection Certificate Certificate of Analysis

Official Documents:

Certificate of Origin Health Certificate Consular Invoice, Legalized Invoice

DOCUMENTS NEED FOR L/C

Letter of credit documents are required to be arranged in the following series: By seller (duplicate documents) Bill of exchange Bill Goods lorry receipt Party acceptance letter Debit note Packing list Original letter of credit

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By sellers bank (Duplicate documents) Letter Bill of exchange Bill Goods lorry receipt Party acceptance letter Debit note Packing list Letter of credit (duplicate) By buyers bank (Original documents) Bill of exchange Bill Goods lorry receipt Party acceptance letter Debit note Packing list Letter of credit (DUPLICATE) BILL OF EXCHANGE A non- interest bearing written order used primarily in international trade that binds one party to pay a fixed sum of money to another party at a predetermined future date Its an unconditional order issued by a party or business which directs the recipient to pay a fixed sum of money to a third party at a future date. The future date may b either fixed or negotiable. A bill of exchange must be in writing and signed and dated also called draft Negotiation of letter of credit

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LETTER OF CREDIT NEGOTIABLE means the ability to be sold or transfers to another party as a form of payment. Something which is negotiable is transferable by endorsement and delivery. (When documents come back from bank ).

Export Documentary Requirements

Issuance Date of Documents A document that is dated before the issuing date of letter of credit (L/C) is acceptable, unless otherwise stipulated in the L/C. In the sample letter of credit the commercial invoice and the packing list can bear a date prior to January 26, 2001, which is the issuing date of the L/C. The Original Documents Unless otherwise stipulated in the letter of credit (L/C), a document is considered original if it is produced or appears to have been produced by reprographic (i.e., document reproduced by electronic techniques, for example photocopy), computerized systems, or as carbon copies, provided the document is marked as "Original", and appears to be signed where the signature is needed. The Copy Documents A document is considered copy if it is marked as "Copy" or there is no "original" marking, unless otherwise stipulated in the letter of credit (L/C). A copy document need not be signed. Multiple Documents

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LETTER OF CREDIT A letter of credit (L/C) that requires multiple documents, such as "five (5) copies", "quintuplicate", "five fold" and the like, is satisfied by presenting one original and the rest in copies, except where the document is marked otherwise. In the sample letter of credit the commercial invoice and the packing list both require five copies, meaning one original and four copies of each document are necessary for presentation to the bank Signing of Documents A document may be signed by means of handwriting, stamp, facsimile signature, perforated signature, or by any other electronic or mechanical means. A copy document need not be signed. Nevertheless, there is no harm in signing the copy(ies) of the commercial invoice and the packing list. In practice, the copies of these two documents are often signed. In the sample letter of credit it is stipulated "signed commercial invoice ...". Therefore, the UVW Exports must sign the original and the copies of the commercial invoice. Since such L/C did not stipulate signing of the packing list, UVW Exports does not have to sign it, but there is no harm done if it is signed.

Authentication of Documents Unless otherwise stipulated in the letter of credit (L/C), a document that is required by the L/C to be authenticated, validated, certified, legalized, visaed, or a similar requirement is called for, such condition is deemed to be complied with by any stamp, signature, seal or label on the face of such document that appears to satisfy the requirement.

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Unspecified Issuers or Contents of Documents When documents other than commercial invoices, transport documents (the bill of lading and the waybill) and insurance documents (the insurance policy and certificate) are required, unless the letter of credit (L/C) stipulates the issuing party and the wording or data content of the documents, the bank will accept them as presented, provided the data content of the documents is consistent with any other stipulated documents presented to the bank. Unspecified Documents The bank will not examine documents not stipulated in the letter of credit (L/C). If unspecified documents are presented, the bank returns them or passes them on without responsibility. If an L/C contains conditions but does not state the documents to be presented, such conditions are considered not stated and they are disregarded by the bank.

Transferable Letter of Credit L/C

A transferable documentary credit is a type of credit under which the first beneficiary which is usually a middleman may request the nominated bank to transfer credit in whole or in part to the second beneficiary.

The L/C does state clearly mentions the margins of the first beneficiary and unless it is specified the L/C cannot be treated as transferable. It can only be used when the company is selling the product of a third party and the proper care has to be taken about 21

LETTER OF CREDIT the exit policy for the money transactions that take place. This type of L/C is used in the companies that act as a middle man during the transaction but dont have large limit. In the transferable L/C there is a right to substitute the invoice and the whole value can be transferred to a second beneficiary.

The first beneficiary or middleman has rights to change the following terms and conditions of the letter of credit: 1. Reduce the amount of the credit. 2. Reduce unit price if it is stated 3. Make shorter the expiry date of the letter of credit. 4. Make shorter the last date for presentation of documents. 5. Make shorter the period for shipment of goods. 6. Increase the amount of the cover or percentage for which insurance cover must be effected. 7. Substitute the name of the applicant (the middleman) for that of the first beneficiary (the buyer). Standby Letter of Credit L/C Initially used by the banks in the United States, the standby letter of credit is very much similar in nature to a bank guarantee. The main objective of issuing such a credit is to secure bank loans. Standby credits are usually issued by the applicants bank in the applicants country and advised to the beneficiary by a bank in the beneficiarys country. Unlike a traditional letter of credit where the beneficiary obtains payment against documents evidencing performance, the standby letter of credit allow a beneficiary to obtains payment from a bank even when the applicant for the credit has failed to perform

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LETTER OF CREDIT as per bond.

A standby letter of credit is subject to "Uniform Customs and Practice for Documentary Credit" (UCP), International Chamber of Commerce Publication No 500, 1993 Revision, or "International Standby Practices" (ISP), International Chamber of Commerce Publication No 590, 1998. Import Operations under L/C The Import Letter of Credit guarantees an exporter payment for goods or services, provided the terms of the letter of credit have been met. A bank issue an import letter of credit on the behalf of an importer or buyer under the following Circumstances

When a importer is importing goods within its own country. When a trader is buying good from his own country and sells it to the country for the purpose of merchandizing trade. When an Indian exporter who is executing a contract outside his own country requires importing goods from a third country to the country where he is executing the contract.

The first category of the most common in the day to day banking Fees and Reimbursements The different charges/fees payable under import L/C is briefly as follows 1. The issuing bank charges the applicant fees for opening the letter of credit. The fee charged depends on the credit of the applicant, and primarily comprises of :

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(a) Opening Charges This would comprise commitment charges and usance charged to be charged upfront for the period of the L/C. The fee charged by the L/C opening bank during the commitment period is referred to as commitment fees. Commitment period is the period from the opening of the letter of credit until the last date of negotiation of documents under the L/C or the expiry of the L/C, whichever is later. Usance is the credit period agreed between the buyer and the seller under the letter of credit. This may vary from 7 days usance (sight) to 90/180 days. The fee charged by bank for the usance period is referred to as usance charges (b) Retirement Charges 1. This would be payable at the time of retirement of LCs. LC opening bank scrutinizes the bills under the LCs according to UCPDC guidelines , and levies charges based on value of goods. 2. The advising bank charges an advising fee to the beneficiary unless stated otherwise the fees could vary depending on the country of the beneficiary. The advising bank charges may be eventually borne by the issuing bank or reimbursed from the applicant. 3. The applicant is bounded and liable to indemnify banks against all obligations and responsibilities imposed by foreign laws and usage.

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LETTER OF CREDIT 4. The confirming bank's fee depends on the credit of the issuing bank and would be borne by the beneficiary or the issuing bank (applicant eventually) depending on the terms of contract. 5. The reimbursing bank charges are to the account of the issuing bank.

Risk Associated with Opening Imports L/Cs The basic risk associated with an issuing bank while opening an import L/C is: 1. The financial standing of the importer as the bank is responsible to pay the money on the behalf of the importer; thereby the bank should make sure that it has the proper funds to pay. 2. The goods Bankers need to do a detail analysis against the risks associated with perishability of the goods, possible obsolescence, import regulations packing and storage, etc. Price risk is the crucial factor associated with all modes of international trade. 3. Exporter Risk There is always the risk of exporting inferior quality goods. Banks need to be protective by finding out as much possible about the exporter using status report and other confidential information. 4. Country Risk these types of risks are mainly associated with the political

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LETTER OF CREDIT and economic scenario of a country. To solve this issue, most banks have specialized unit which control the level of exposure that that the bank will assumes for each country. 5. Foreign exchange risk Foreign exchange risk is another most sensitive risk associated with the banks. As the transaction is done in foreign currency, the traders depend a lot on exchange rate fluctuations.

Export Operations under L/C Export Letter of Credit is issued in for a trader for his native country for the purchase of goods and services. Such letters of credit may be received for following purpose: 1. For physical export of goods and services from India to a Foreign Country. 2. For execution of projects outside India by Indian exporters by supply of goods and services from Indian or partly from India and partly from outside India. 3. Towards deemed exports where there is no physical movements of goods from outside India But the supplies are being made to a project financed in foreign exchange by multilateral agencies, organization or project being executed in India with the aid of external agencies. 4. For sale of goods by Indian exporters with total procurement and supply from outside India. In all the above cases there would be earning of Foreign Exchange or conservation of Foreign Exchange.

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LETTER OF CREDIT Banks in India associated themselves with the export letters of credit in various capacities such as advising bank, confirming bank, transferring bank and reimbursing bank. In every case the bank will be rendering services not only to the Issuing Bank as its agent correspondent bank but also to the exporter in advising and financing his export activity. 1. Advising an Export L/C the basic responsibility of an advising bank is to advise the credit received from its overseas branch after checking the apparent genuineness of the credit recognized by the issuing bank. It is also necessary for the advising bank to go through the letter of credit, try to understand the underlying transaction, terms and conditions of the credit and advice the beneficiary in the matter. The main features of advising export LCs are: 1. There are no credit risks as the bank receives a onetime commission for the advising service. 2. There are no capital adequacy needs for the advising function.

2. Advising of Amendments to L/Cs Amendment of LCs is done for various reasons and it is necessary to fallow all the necessary the procedures outlined for advising. In the process of advising the amendments the Issuing bank serializes the amendment number and also 27

LETTER OF CREDIT ensures that no previous amendment is missing from the list. Only on receipt of satisfactory information/ clarification the amendment may be advised. 3. Confirmation of Export Letters of Credit It constitutes a definite undertaking of the confirming bank, in addition to that of the issuing bank, which undertakes the sight payment, deferred payment, acceptance or negotiation. Banks in India have the facility of covering the credit confirmation risks with ECGC under their Transfer Guarantee scheme and include both the commercial and political risk involved. 4. Discounting/Negotiation of Export LCs When the exporter requires funds before due date then he can discount or negotiate the LCs with the negotiating bank. Once the issuing bank nominates the negotiating bank, it can take the credit risk on the issuing bank or confirming bank. However, in such a situation, the negotiating bank bears the risk associated with the document that sometimes arises when the issuing bank discover discrepancies in the documents and refuses to honor its commitment on the due date. 5. Reimbursement of Export LCs Sometimes reimbursing bank, on the recommendation of issuing bank allows the negotiating bank to collect the money from the reimbursing bank once the goods have been shipped. It is quite similar to a cheque facility provided by a bank.

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LETTER OF CREDIT In return, the reimbursement bank earns a commission per transaction and enjoys float income without getting involve in the checking the transaction documents. reimbursement bank play an important role in payment on the due date ( for usance LCs) or the days on which the negotiating bank demands the same (for sight LCs) Regulatory Requirements Opening of imports LCs in India involve compliance of the following main regulation: Trade Control Requirements The movement of good in India is guided by a predefined se of rules and regulation. So, the banker needs to assure that make certain is whether the goods concerned can be physically brought in to India or not as per the current EXIM policy.

Exchange Control Requirements The main objective of a bank to open an Import LC is to effect settlement of payment due by the Indian importer to the overseas supplier, so opening of LC automatically comes under the policies of exchange control regulations. UCPDC Guidelines Uniform Customs and Practice for Documentary Credit (UCPDC) is a set of predefined rules established by the International Chamber of Commerce (ICC) on Letters of Credit. The UCPDC is used by bankers and commercial parties in more than 200 countries 29

LETTER OF CREDIT including India to facilitate trade and payment through LC. UCPDC was first published in 1933 and subsequently updating it throughout the years. In 1994, UCPDC 500 was released with only 7 chapters containing in all 49 articles. The latest revision was approved by the Banking Commission of the ICC at its meeting in Paris on 25 October 2006. This latest version, called the UCPDC600, formally commenced on 1 July 2007. It contains a total of about 39 articles covering the following areas, which can be classified as 8 sections according to their functions and operational procedures.

Serial No. 1. 2.

Article 1 to 3 4 to 12

Area General Obligations

Consisting Application, Definition and Interpretations Credit vs. Contracts, Documents vs. Goods Reimbursement, Examination of Documents, Complying, Discrepant Documents Bill of Lading, Chapter Party Bill of Lading, Air Documents, Road Rail etc. Documents, Courier, Postal etc.

3.

13 to 16

Liabilities and

responsibilities. Presentation, Handling

4.

17 to 28 Documents

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LETTER OF CREDIT Receipt. On board, Shippers' count, Clean Documents, Insurance documents Extension of dates, Tolerance in Credits, Partial Shipment and Drawings. House of Presentation Effectiveness of Document Transmission and Translation Force Majeure Acts of an Instructed Party Transferable Credits Assignment of Proceeds

5.

29 to 33

Miscellaneous Provisions

34 to 37 Disclaimer

38 & 39

Others

ISBP 2002 The widely acclaimed International Standard Banking Practice (ISBP) for the Examination of Documents under Documentary Credits was selected in 2007 by the ICCs Banking Commission. First introduced in 2002, the ISBP contains a list of guidelines that an examiner needs to check the documents presented under the Letter of Credit. Its main objective is to reduce the number of documentary credits rejected by banks. FEDAI Guidelines Foreign Exchange Dealer's Association of India (FEDAI) was established in 1958 under the Section 25 of the Companies Act (1956). It is an association of banks that deals in Indian foreign

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LETTER OF CREDIT exchange and work in coordination with the Reserve Bank of India, other organizations like FIMMDA, the Forex Association of India and various market participants. FEDAI has issued rules for import LCs which is one of the important areas of foreign currency exchanges. It has an advantage over that of the authorized dealers who are now allowed by the RBI to issue stand by letter of credits towards import of goods. As the issuance of stand by of letter of Credit including imports of goods is susceptible to some risk in the absence of evidence of shipment, therefore the importer should be advised that documentary credit under UCP 500/600 should be the preferred route for importers of goods. Below mention are some of the necessary precaution that should be taken by authorized dealers While issuing a stands by letter of credits: 1. The facility of issuing Commercial Standby shall be extended on a selective basis and to the following category of importers i. Where such standby are required by applicant who are independent power producers/importers of crude oil and petroleum products ii. Special category of importers namely export houses, trading houses, star trading houses, super star trading houses or 100% Export Oriented Units. 2. Satisfactory credit report on the overseas supplier should be obtained by the issuing banks before issuing Stands by Letter of Credit. 3. Invocation of the Commercial standby by the beneficiary is to be supported by proper evidence. The beneficiary of the

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LETTER OF CREDIT Credit should furnish a declaration to the effect that the claim is made on account of failure of the importers to abide by his contractual obligation along with the following documents. i. ii. iii. A copy of invoice. Nonnegotiable set of documents including a copy of non negotiable bill of lading/transport document. A copy of Lloyds /SGS inspection certificate wherever provided for as per the underlying contract. 4. Incorporation of suitable clauses to the effect that in the event of such invoice /shipping documents has been paid by the authorized dealers earlier, Provisions to dishonor the claim quoting the date / manner of earlier payments of such documents may be considered. 5. The applicant of a commercial stand by letter of credit shall undertake to provide evidence of imports in respect of all payments made under standby. (Bill of Entry)

Fixing limits for Commercial Stand by Letter of Credit L/c 1. Banks must assess the credit risk in relation to stand by letter of credit and explain to the importer about the inherent risk in stand by covering import of goods. 2. Discretionary powers for sanctioning standby letter of credit for import of goods should be delegated to controlling office or zonal office only. 3. A separate limit for establishing stand by letter of credit is desirable rather than permitting it under the regular documentary limit. 4. Due diligence of the importer as well as on the beneficiary is essential.

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LETTER OF CREDIT 5. Unlike documentary credit, banks do not hold original negotiable documents of titles to gods. Hence while assessing and fixing credit limits for standby letter of credits banks shall treat such limits as clean for the purpose of discretionary lending powers and compliance with various Reserve Banks of India's regulations. 6. Application cum guarantee for stand by letter of credit should be obtained from the applicant. 7. Banks can consider obtaining a suitable indemnity/undertaking from the importer that all remittances towards their import of goods as per the underlying contracts for which stand by letter of credit is issued will be made only through the same branch which has issued the credit. 8. The importer should give an undertaking that he shall not raise any dispute regarding the payments made by the bank in standby letter of credit at any point of time howsoever, and will be liable to the bank for all the amount paid therein. He importer should also indemnify the bank from any loss, claim, counter claims, damages, etc. which the bank may incur on account of making payment under the stand by letter of credit. 9. Presently, when the documentary letter of credit is established through swift, it is assumed that the documentary letter of credit is subject to the provisions of UCPDC 500/600 Accordingly whenever standby letter of credit under ISP 98 is established through SWIFT; a specific clause must appear that standby letter of credit is subject to the provision of ISP 98. 10. It should be ensured that the issuing bank, advising bank, nominated bank. etc, have all subscribed to SP 98 in case stand by letter of credit is issued under ISP 98.

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LETTER OF CREDIT 11. When payment under a stand by letter of credit is

effected, the issuing bank to report such invocation / payment to Reserve Bank of India.

Analysis of typical L/C Transaction

Though a L/C can have great many variations (please see later part of this article) - for simplicity and ease of understanding, I have made a simple step-by-step description of a typical L/C transaction.

Step 1 After successful negotiation on price, specification, quality etc, Buyer selects a seller and places order for specified goods Step 2 Seller accepts the order Step 3 Buyer and Seller agrees on terms and conditions of the sale. Buyer instructs its bank to open a L/c incorporating previously agreed terms of sale Step 4 The buyer's bank prepares a Letter of Credit (L/C), including all instructions to the seller's bank concerning the shipment and sends the L/C to the seller's bank, requesting confirmation. The seller may request confirmation from a confirming bank for added security. Note: There are often delays at above two steps for various reasons like buyer does not have sufficient funds or seller requests change in L/C terms. Amendments are issued to incorporate changes in L/C terms. Step 5 The Seller's bank prepares a letter of confirmation to forward to the seller along with the L/C. The seller reviews carefully all conditions in the L/C specially shipment schedule in consultation with his freight forwarder. Step 6 The seller arranges the goods and hand over to freight forwarder for delivery at appropriate port or airport.

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Step 7 Once goods are loaded / Shipped, the forwarder completes necessary documentation and hand them over to the seller. The seller then presents the documents to his bank, informing full compliance with terms and conditions of L/C. Step 8 The seller's bank reviews the documents. If they are in order, the documents are airmailed to the buyer's bank for review and passing necessary documents to buyer. The buyer gets the documents needed to claim the goods. Step 9 The buyer's bank returns accepted draft and informs buyer. Buyer pays bank. Step 10 The seller's bank gets payment and pays seller.

The letter of Credit Ensures that: Payment to the seller will only be made after the terms of the L/c have been met. The documents, which have been reviewed by the bank's experienced staff, are in order. The seller is assured of the buyer's ability to pay and, as a result, a better price and more advantageous terms of payment may be offered. Is Letter of Credit 100% Safe for Exporters? The answer is - yes and no. Yes, if you follow all L/C instructions. No, if you overlook certain pitfalls.

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LETTER OF CREDIT For detail discussion on potential pitfalls in L/C payment and how to secure your position as seller - please read following article published in past issue of FAIDA

Risk situations in letter-of-credit transactions

Fraud Risks

The payment will be obtained for nonexistent or worthless

merchandise against presentation by the beneficiary of forged or falsified documents.

Credit itself may be forged.

Sovereign and Regulatory Risks

Performance of the Documentary Credit may be prevented by

government action outside the control of the parties.

Legal Risks

Possibility that performance of a Documentary Credit may be

disturbed by legal action relating directly to the parties and their rights and obligations under the Documentary Credit Force Majeure and Frustration of Contract

Performance of a contract including an obligation under a

Documentary Credit relationship is prevented by external factors such as natural disasters or armed conflicts Risks to the Applicant 37

LETTER OF CREDIT

Non-delivery of Goods Short Shipment Inferior Quality Early /Late Shipment Damaged in transit Foreign exchange Failure of Bank viz Issuing bank / Collecting Bank

Risks to the Issuing Bank

Insolvency of the Applicant Fraud Risk, Sovereign and Regulatory Risk and Legal Risks

Risks to the Reimbursing Bank

No obligation to reimburse the Claiming Bank unless it has

issued a reimbursement undertaking.

Risks to the Beneficiary

Failure to Comply with Credit Conditions Failure of, or Delays in Payment from, the Issuing Bank Credit Issued by Party other than Bank

Risks to the Advising Bank

The Advising Banks only obligation if it accepts the Issuing

Banks instructions is to check the apparent authenticity of the Credit and advising it to the Beneficiary

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LETTER OF CREDIT Risks to the Nominated Bank

Nominated Bank has made a payment to the Beneficiary

against documents that comply with the terms and conditions of the Credit and is unable to obtain reimbursement from the Issuing Bank Risks to the Confirming Bank

If Confirming Banks main risk is that, once having paid the

Beneficiary, it may not be able to obtain reimbursement from the Issuing Bank because of insolvency of the Issuing Bank or refusal of the Issuing Bank to reimburse because of a dispute as to whether or not payment should have been made under the Credit

Other Risks in International Trade

A Credit risk risk from change in the credit of an opposing

business.

An Exchange risk is a risk from a change in the foreign

exchange rate.

A Force majeure risk is 1. a risk in trade incapability caused

by a change in a country's policy, and 2. a risk caused by a natural disaster.

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LETTER OF CREDIT

Other risks are mainly risks caused by a difference in law,

language or culture. In these cases, the cargo might be found late because of a dispute in import and export dealings.

Letter of Credit Processing

You can use Letter of Credit (LOC) Processing in Global Trade Services (GTS) to mitigate the financial risks involved in global trade. You can integrate this application with your import and export transactions, minimizing risk in your international trade activities while speeding up process flows at the same time. You can monitor delivery deadlines and document receipts better for legal control purposes. You can use the following functions to minimize the risks of your import and export transactions You can maintain letters of credit, which you receive from banks, in the letter of credit master. You can use the following LOC types:
o o

Revocable Irrevocable, unconfirmed

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LETTER OF CREDIT
o

Irrevocable, confirmed

You can enter all relevant delivery and document data in the header data of the letter of credit. You can also enter internal and external LOC numbers, Incoterms, company codes, addresses, and administrative data. The item data includes status data, business partner data, values, and bank data. Integrated inbound and outbound logistics lets you assign letters of credit to import and export documents. The system detects whether your import or export business partner is relevant for Letter of Credit Processing, which means you have to assign a letter of credit to that business partner. You can enter bank master data by transferring the initial data from your feeder system to the GTS system and then enrich it in business partner maintenance. You can monitor the status of your letters of credit with the following display options:
o o o

Existing letters of credit Assigned letters of credit Blocked documents

Two different users must carry out the review of the letter of credit its subsequent activation. You can print documents in accordance with the regulations for a letter of credit.

Process
Imports with Letters of Credit This scenario describes the process of importing goods to your country using a letter of credit.

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LETTER OF CREDIT Import with Letter of Credit 1. As an importer, you request a quotation from an exporter for goods that you want to purchase. The quotation could include shipping and insurance costs. 2. After you receive a quotation from the exporter, you create a purchase order based on that quotation. 3. The exporter creates a pro forma invoice and sends it to you. 4. You open a letter of credit at the opening bank in the country of destination (import country). During this transaction, you have to notify the opening bank which documents they need from the exporter. As an importer, you not only need the documents required for customs, but also the documents that other service providers need to handle your goods traffic, such as:

1. Bill of lading 2. Commercial invoice 3. Export packing list 4. Single Administrative Document (EU only) 5. Shippers Export Declaration (U.S. only) 6. Certificate of origin 7. Insurance certificates 8. Licenses (if needed) 5. You create a letter of credit in the GTS system. An import documentary credit gives your vendors a guarantee from your house bank that payment will be rendered within a defined period when the documents listed in the letter of credit are provided. For you as importer, using a letter of credit reduces the risk of having to pay for goods in advance

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LETTER OF CREDIT or having to pay for goods or services that do not match the product descriptions in the letter of credit. 6. If you use a letter of credit, the vendor dies not have to demand advance payment to safeguard the delivery; in addition, because the letter of credit guarantees the transaction, your vendor will often offer a better price. 7. The opening bank sends the letter of credit to the advising bank in the exporter's country. 8. The advising bank notifies the exporter that a letter of credit has been opened in his favor. 9. The exporter dispatches the goods in accordance with the conditions defined in the letter of credit.0 10. The exporter provides the appropriate documents to the advising bank to document that the goods were dispatched in agreement with the letter of credit conditions. 11. 12. 13. 14. The advising bank pays the exporter based on the The advising bank sends the documents to the opening The opening bank provides you (the importer) with the You calculate the import duty rates, submit the customs received documents. bank and receives payment. documents. declaration within the legally defined period, and pay the customs duties. Export with Letter of Credit This scenario describes the transaction for exporting goods and receiving payment using a letter of credit. 1. The importer requests a quotation for goods. 2. You (the exporter) send the importer a quotation for the goods. 43

LETTER OF CREDIT 3. The importer sends you a purchase order based on your quotation. 4. You create a sales order based on the purchase order and send it to the importer, together with the invoice. 5. Optional: You notify the importer of the exact delivery date and delivery quantity of the goods in an inbound delivery. 6. The importer opens a letter of credit at the opening bank in the country of destination (import country). 7. This letter of credit defines which documents are required by the customs authorities and other parties involved in handling your goods traffic, for example: 1. Bill of lading 2. Commercial invoice 3. Export packing list 4. Shippers Export Declaration (U.S. only) 5. Single Administrative Document (EU only) 6. Certificate of origin 7. Insurance certificates 8. Licenses (if needed) 8. You can create and print all the above documents for customs processing, aside from the insurance certificates. The export documentary credit guarantees that payment will be made as long as you deliver the goods within the defined time frame and submit the documents defined in the letter of credit. This helps you, the exporter, reduce payment risk. You can also demand immediate payment within the framework of the LOC conditions (assuming the documents are correct), improving your cash flow. 9. The opening bank sends the letter of credit to the advising bank in your country. 10. The advising bank notifies you that a letter of credit has been opened in your favor. 44

LETTER OF CREDIT 11. 12. You dispatch the goods in accordance with the You provide the advising bank in your country with the

conditions defined in the letter of credit. appropriate documents to document that the goods were dispatched in agreement with the letter of credit conditions. 13. 14. 15. The advising bank pays you for the goods, based on the The advising bank sends the documents to the opening The importer receives the goods, submits a customs received documents. bank and receives payment from the customer. import declaration, and pays the customs duties to the responsible authorities. 16. You submit a customs declaration for the exported goods.

CONCLUSION
Letter of credit means when a bank or finance company issues a document on behalf of a buyer, authorizing the seller to obtain payment within a specified timeframe once the terms and conditions outlined in the letter of credit are met. An irrevocable letter of credit has a definite implication. It is a mechanism of great importance in international trade. The legal frame work that governs the letter of credit has seen many cases in which fraud of company comes up in the court it is very difficult to prove the breach
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lies in part of the parties. It is only in exceptional cases that the courts will interfere with the machinery of irrevocable obligations assumed by banks. Except possibly in clear cases of fraud of which the banks have notice, the courts will leave the merchants to settle their disputes under the contracts by litigation or arbitration as available to them or stipulated in the contracts.

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