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Letter of credit

A letter of credit is a document issued by a financial institution, or a similar party, assuring payment to a seller of goods and/or services provided certain documents have been presented to the bank. These are documents that essentially prove that the seller has performed his duties under an underlying contract (e.g., sale of goods contract)and the goods (or services) have been supplied as agreed. In return for these documents, the beneficiary receives payment from the financial institution that issued the letter of credit. The letter of credit serves essentially as a guarantee to the seller that it will be paid regardless of whether the buyer ultimately fails to pay. In this way, the risk that the buyer will fail to pay is transferred from the seller to the letter of credit's issuer. The letter of credit can also be used to ensure that all the agreed upon standards and quality of goods are met by the supplier, provided that these requirements are reflected in the documents described in the letter of credit. Letters of credit are used primarily in international trade for transactions between a supplier in one country and a customer in another. Most letters of credit are governed by rules promulgated by the International Chamber of Commerce known as Uniform Customs and Practice for Documentary Credits (UCP 600 being the latest version).They are also used in the land development process to ensure that approved public facilities (streets, sidewalks, storm water ponds, etc.) will be built. The parties to a letter of credit are the supplier, usually called the beneficiary, the issuing bank, of whom the buyer is a client, and sometimes an advising bank, of whom the beneficiary is a client. Almost all letters of credit are irrevocable, i.e., cannot be amended or canceled without the consent of the beneficiary, issuing bank, and confirming bank, if any. In executing a transaction, letters of credit incorporate functions common to giros and traveler's cheques.

Documents that can be presented for payment


To receive payment, an exporter or shipper must present the documents required by the letter of credit. Typically, the payee presents a document proving the goods were sent instead of showing the actual goods. The Original Bill of Lading (BOL) is normally the document accepted by banks as proof that goods have been shipped. However, the list and form of documents is open to imagination and negotiation and might contain requirements to present documents issued by a neutral third party evidencing the quality of the goods shipped, or their place of origin or place. Typical types of documents in such contracts might include:[citation needed]

Financial Documents Bill of Exchange, Co-accepted Draft

Commercial Documents Invoice, Packing list

Shipping Documents

Transport Document, Insurance Certificate, Commercial, Official or Legal Documents

Official Documents License, Embassy legalization, Origin Certificate, Inspection Certificate, Phytosanitary certificate

Transport Documents Bill of lading (ocean or multi-modal or Charter party), Airway bill, Lorry/truck receipt, railway receipt, CMC Other than Mate Receipt, Forwarder Cargo Receipt, Deliver Challan...etc

Insurance documents Insurance policy, or Certificate but not a cover note.

Different types of letters of credit

Import/export Letter of Credit

The same credit can be termed as import and export LC depending on whose perspective it is being looked upon. For the importer it is termed as Import LC and for the Exporter of goods, Export LC>

Revocable Letter of Credit

In this type of credit buyer and the bank which has established the LC, are able to manipulate the letter of credits or make any kinds of corrections without informing the seller and getting permissions from him. According to UCP 600, all LCs are Irrevocable, hence this type of LC used no more.

Irrevocable LC

In this type of LC, Any change (amendment) or cancellation of the LC (except it is expired) done by the Applicant through the issuing Bank must be authenticated by the Beneficiary of the LC. Whether to accept or reject the changes depends on the beneficiary.

Confirmed LC

An LC is said to be confirmed when another bank adds its additional confirmation (or guarantee) to honor a complying presentation at the request or authorization of the issuing bank.

Unconfirmed LC

This type of letter of credit, does not acquire the other bank's confirmation.

Transferrable LC

A Transferable Credit is the one under which the exporter has the right to make the credit available to one or more subsequent beneficiaries. Credits are made transferable when the original beneficiary is a middleman and does not supply the merchandise himself but procures goods from the suppliers and arrange them to be sent to the buyer and does not want the buyer and supplier know each other. The middleman is entitled to substitute its own invoice for the one of the supplier and acquire the difference as his profit in transferable letter of credit mechanism. Important Points of Consideration: A letter of credit can be transferred to the second beneficiary at the request of the first beneficiary only if it expressly states that the letter of credit is "transferable". A bank is not obligated to transfer a credit. A transferable letter of credit can be transferred to more than one second beneficiary as long as credit allows partial shipments. The terms and conditions of the original credit must be indicated exactly in the transferred credit. However, in order to keep the workability of the transferable letter of credit below figures can be reduced or curtailed. Letter of credit amount any unit price of the merchandise (if stated) the expiry date the presentation period or the latest shipment date or given period for shipment. The first beneficiary may demand from the transferring bank to substitute his name for that of the applicant. However, if a document other than invoice required in the transferable credit must be issued in a way to show the applicant's name, in such a case that requirement must be indicated in the transferred credit. Transferred credit cannot be transferred once again to any third beneficiary according to the request of the second beneficiary.

Untransferable LC

It is said to the credit that seller cannot give a part or completely right of assigned credit to somebody or to the persons he wants. In international commerce, it is required that the credit will be untransferable.

Usance LC

It is kind of credit that won't be paid and assigned immediately after checking the valid documents but paying and assigning it requires an indicated duration which is accepted by both

of the buyer and seller. In reality, seller will give an opportunity to the buyerto pay the required money after taking the related goods and selling them.

At Sight LC

It is a kind of credit that the announcer bank after observing the carriage documents from the seller and checking all the documents immediately pays the required money.

Red Clause LC

In this kind of credit assignment seller before sending the products can take the pre-paid and parts of the money from the bank. The first part of the credit is to attract the attention acceptor bank. The reason why it named so, is that the first time this credit is established by the assigner bank, to take the attention of the offered bank, the terms and conditions were written by red ink, from that time it became famous with that name.

Back to Back LC

This type of LC consists of two separated and different types of LC. First one is established in the benefit of the seller that is not able to provide the corresponding goods for any reasons. Because of that reason according to the credit which is opened for him, neither credit will be opened for another seller to provide the desired goods and sends it. Back-to-back L/C is a type of L/C issued in case of intermediary trade. Intermediate companies such as trading houses are sometimes required to open L/Cs by supplier and receive Export L/Cs from buyer. SMBC will issue a L/C for the intermediary company which is secured by the Export L/C (Master L/C). This L/C is called "Back-to-back L/C".

1) Revolving Letter of Credit: Revolving Letter of Credit is used when the delivery of goods is in form of partial/ multiple shipments. Revolving Letter of Credit keeps on revolving and is not restricted to a single transaction. Revolving Letter of Credit (LC) can be utilized for subsequent business transactions over a period of time on a continuous basis to the extent of limit sanctioned. The seller/buyer does not have to go to the bank for sanction of fresh limits every time he gets a new order for executing the same. 2) Back to Back Letter of Credit: A Letter of Credit (LC) is a mode of making payments for trade transactions. An Letter of Credit is a highly popular payment mode because it allows an importer or buyer to make secure payments to the exporter or seller. Back to Back Letter of Credit, one Irrevocable Letter of Credit facilitates the seller to obtain another Letter of Credit. To obtain the Back to Back Letter of Credit the permission of the Buyer or the applicant of the first Letter of Credit is not required. Back to Back Letter of Credit is generally used by the middleman or agencies to hide the identity of the real suppliers or manufacturers. The seller can utilize this Back to back

Letter of Credit as a security for his bank, to issue a back to back Letter of Credit in favour of his suppliers in order to get a very competitive rate for his purchases and increase his profit margin in the process. Thus this can very well be used by the seller to raise quick funds and complete his orders in the scheduled time.Such transactions originate when a seller receives a letter of credit covering goods which must be obtained from a third party who in turn requires a letter of credit. The second issuing bank looks to the first issuing bank for reimbursement after paying under the second letter of credit. Just4uloan help you with the list of the banks and the contact details, which provides Back to Back Letter of Credit.

3) Revocable Letter of Credit: Revocable Letter of Credit means the payment against this L/C can be revoked by the issuing bank. The buyer may either amend the Letter of Credit or cancel it without the approval of the seller. The payment against Revocable Letter of Credit is not for sure and hence this type of Letter of Credit is not commonly used. The Seller has meager chances to get loan against Revocable Letter of Credit. 4) Irrevocable Letter of Credit: Irrevocable Letter of Credit cannot be cancelled. This seller is assured of payment for his supply of goods/services provided all terms and conditions of L/C are conformed to. This mode of payment is generally used in international trade transactions. As the payment against this Irrevocable Letter of Credit is guaranteed by the issuing bank and the holder of this Irrevocable Letter of Credit (seller) can borrow short term finance from any other bank or lending institution at a very low rate of interest and within a very short time.

Some people think that Letters of Credit are used only when the buyer and seller don't have a good business relationship with each other - they don't trust each other. This is a common assumption from people who don't do business internationally, because they are don't fully understand the added risks in overseas transactions. The fact is, is that Letter of Credit can be a very useful financial tool for both the buyer/importer and the seller/exporter. While Letters of Credit are particularly well suited for high dollar transactions, here are some other advantageous for both sides: For the Exporter/Seller:

Upon presentation of the specified documents (in strict conformance) the Buyer/Exporter is guaranteed payment (the exception is if the Issuing Bank folds) Eliminates risk of the buyer canceling the order and therefore reduces production risk Makes it easier for the Buyer/Exporter to secure order/production financing-pre-export financing Easier to secure receivable financing (in case where the L/C is not payable At Sight) Buyer cannot refuse payment by raising a complaint about the goods. Any complaints must be settled between the Buyer and Seller outside of the L/C.

For The Importer/Buyer


In most cases the Importer/Buyer avoids partial pre-payments or deposits Helps reduce the risk of non-performance of the Exporter/Seller. If the Exporter/Seller doesnt ship the goods they dont get paid. Certainty that payment will only be make to the Exporter/Seller upon presentation of documents in strict compliance with the L/C evidencing the shipment of goods. Documents are received quickly, expediting customs clearance and ultimate delivery Makes structuring an advantageous payment schedule easy Importer/Buyer will receive timely delivery or the goods because the L/C terms dictate latest acceptable shipment date.
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