A Report On: How To Open Letter Of Credit

Prepared For: Sir Mumtaz Hassan

Prepared By: Muhammad Waseem

Roll No: 1204136

DATED: 8th, April, 2015

TABLE OF CONTENTS
S.No Topic Page No
01 Executive summary

02 Introduction

03 Letter of credit

04 Types of L/C

05 How to open L/C

06 Availability

07 Documents call for under L/C

08 Standard form of documentation

09 Intr. Trade payment methods

10 Risk in L/C transaction

11 Conclusion

13 Appendix (A)

14 Appendix (B)

15 Bibliography

16 Index
 EXECUTIVE SUMMARY
Whatever sector you might be located, you may have to open a letter of credit
throughout your professional career one day.

A letter of credit is a method of securing payment to a vendor. When a seller

asks a buyer to obtain a letter of credit, it means the seller would like to ensure
payment for a product he sells to that customer. Typically letters of credit are
issued by a bank. The most common forms are standby letters of credit for
domestic transactions and documentary letters of credit for international
transactions.

Letter of credit is a payment method in international trade which is used by

almost all sectors from textile to machinery, food manufacturing to
construction, oil trading to customer goods. You may assume that there are
big differences exist on letter of credit application process for all these
different sectors. But this is not correct. You have to follow similar procedures
when opening a letter of credit regardless of the sector you may be located.

Two types of L/C is wideley used around the globe which is Revocable L/C and
Irrevocable L/C and the following parties are involved in letter of credit;
Applicant of L/C, L/C issuing bank, beneficiary party, advising bank, confiming
bank, negotiating bank and second beneficiary. Typically, the documents a
beneficiary has to present in order to receive payment include a commercial
invoice, bill of lading, and documents proving the shipment was insured
against loss or damage in transit. 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.
 INTRODUCTION
when you hear the phrase letter of credit, it might be natural to think it would
refer to a document verifying that you are creditworthy, but that isn't the
case. a letter of credit is a document issued by a third party that guarantees
payment for goods or services when the seller provides acceptable
documentation. letters of credit are usually issued by banks or other financial
institutions, but some creditworthy financial services companies, like
insurance companies or mutual funds, might issue letters of credit under
certain circumstances.

The purpose of this report is to get deeper knowledge of the procedure to

open letter of credit. In this regard we were advised to visit any bank and
collect the relevant information regarding Letter of Credit. We have visited
the Habib Metro Bank ( Bahudarabad Branch).The branch manager was really
co-operative and he gave us not only his precious time but also his valuable
and practical insights on Letter of credit as he has years of experience in this
feild.

This report helped us a lot and a great addition in our knowledge.Now we are
fimiliar with procedure of opening letter of credit .
 LETTER OF CREDIT
DEFINITION:

“L/C. A binding document that a buyer can request from his bank in order to
guarantee that the payment for goods will be transferred to the seller.
Basically, a letter of credit gives the seller reassurance that he will receive the
payment for the goods. In order for the payment to occur, the seller has to
present the bank with the necessary shipping documents confirming the
shipment of goods within a given time frame. It is often used in international
trade to eliminate risks such as unfamiliarity with the foreign country,
customs, or political instability.”

TYPES OF LETTER OF CREDIT

There most common types of letter of credit are:

REVOCABLE L/C:
The Revocable L.C can be amended and cancel without the exporter
permission on knowledge.

IRREVOCABLE L.C
An Irrevocable L.C cannot amended and cancel without the permission or
knowledge of the exporter.
HOW TO OPEN LETTER OF CREDIT
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, who agrees to sell the goods and give
InCosmetika 60 days to pay for them, on the condition that they are provided
with a 90-day letter of credit for the full amount. The steps to get the letter of
credit would be as follows:

 InCosmetika goes to The Commonwealth Bank and requests a $500,000

letter of credit, with ACME as the beneficiary.
 The Commonwealth Bank can issue an LC 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 LC.
 The Commonwealth Bank sends a copy of the LC 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.
 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.
 Note that banks deal only with documents required in the letter of credit
and not the underlying transaction.
 Many exporters have mistakenly assumed that the payment is guaranteed
after receiving the LC. The issuing bank is obligated to pay under the letter
of credit only when the stipulated documents are presented and the terms
and conditions of the letter of credit have been met.
 AVAILABILITY
LC being an irrevocable undertaking of the issuing bank makes available the
Proceeds, to the Beneficiary of the Credit provided, stipulated documents
strictly complying with the provisions of the LC, UCP 600 and other
international standard banking practices, are presented to the issuing bank,
then:

I. if the Credit provides for sight payment – by payment at sight against

compliant presentation
II. if the Credit provides for deferred payment – by payment on the maturity
date(s) determinable in accordance with the stipulations of the Credit; and
of course undertaking to pay on due date and confirming maturity date at
the time of compliant presentation
III. (A) if the Credit provides for acceptance by the Issuing Bank – by
acceptance of Draft(s) drawn by the Beneficiary on the Issuing Bank and
payment at maturity of such tenor draft, or

(B). if the Credit provides for acceptance by another drawee bank – by

acceptance and payment at maturity Draft(s)drawn by the Beneficiary
on the Issuing Bank in the event the drawee bank stipulated in the
Credit does not accept Draft(s) drawn on it,

IV. or by payment of Draft(s) accepted but not paid by such drawee bank at
maturity;
V. if the Credit provides for negotiation by another bank – by payment
without recourse to drawers and/or bona fide holders, Draft(s) drawn by
the Beneficiary and/or document(s) presented under the Credit, (and so
negotiated by the nominated bank )
VI. Negotiation means the giving of value for Draft(s) and/or document(s) by
the bank authorized to negotiate, viz the nominated bank. Mere
examination of the documents and forwarding the same to LC issuing bank
for reimbursement, without giving of value / agreed to give, does not
constitute a negotiation.
 SOME OF THE DOCUMENTS CALLED FOR
UNDER LC

 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 Cert ,
Phyto-sanitary 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. Pre shipment
packing list.
STANDARD FORMS OF DOCUMENTATION
When making payment for product on behalf of its customer, the issuing bank
must verify that all documents and drafts conform precisely to the terms and
conditions of the letter of credit. Although the credit can require an array of
documents, the most common documents that must accompany the draft
include:

Commercial Invoice
The billing for the goods and services. It includes a description of merchandise,
price, FOB origin, and name and address of buyer and seller. The buyer and
seller information must correspond exactly to the description in the letter of
credit. Unless the letter of credit specifically states otherwise, a generic
description of the merchandise is usually acceptable in the other
accompanying documents.

Bill of Lading
A document evidencing the receipt of goods for shipment and issued by a
freight carrier engaged in the business of forwarding or transporting goods.
The documents evidence control of goods. They also serve as a receipt for the
merchandise shipped and as evidence of the carrier's obligation to transport
the goods to their proper destination.

Warranty of Title
A warranty given by a seller to a buyer of goods that states that the title being
conveyed is good and that the transfer is rightful. This is a method of
certifying clear title to product transfer. It is generally issued to the purchaser
and issuing bank expressing an agreement to indemnify and hold both parties
harmless.

Letter of Indemnity
Specifically indemnifies the purchaser against a certain stated circumstance.
Indemnification is generally used to guaranty that shipping documents will be
provided in good order when available.
 INTERNATIONAL TRADE PAYMENT METHODS
 Advance payment (most secure for seller)
Where the buyer parts with money first and waits for the seller to forward the
goods

 Documentary Credit (more secure for seller as well as buyer)

subject to ICC's UCP 600, where the bank gives an undertaking (on behalf of
buyer and at the request of applicant ) to pay the shipper ( beneficiary ) the
value of the goods shipped if certain documents are submitted and if the
stipulated terms and conditions are strictly complied.

Here the buyer can be confident that the goods he is expecting only will be
received since it will be evidenced in the form of certain documents called for
meeting the specified terms and conditions while the supplier can be
confident that if he meets the stipulations his payment for the shipment is
guaranteed by bank, who is independent of the parties to the contract.

 Documentary collection (more secure for buyer and to a certain

extent to seller)
subject to ICC's URC 525, sight and usance, for delivery of shipping documents
against payment or acceptances of draft, where shipment happens first, then
the title documents are sent to the [collecting bank] buyer's bank by seller's
bank [remitting bank], for delivering documents against collection of
payment/acceptance

 Direct payment (most secure for buyer)

Where the supplier ships the goods and waits for the buyer to remit the bill
proceeds, on open account terms
 RISKS IN LC TRANSACTION
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

 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 Bank’s only obligation – if it accepts the Issuing Bank’s

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

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 Bank’s 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.
 CONCLUSION
Whatever sector you might be located, you may have to open a letter of credit
throughout your professional career one day.

A letter of credit is a method of securing payment to a vendor. When a seller

asks a buyer to obtain a letter of credit, it means the seller would like to ensure
payment for a product he sells to that customer. Typically letters of credit are
issued by a bank. The most common forms are standby letters of credit for
domestic transactions and documentary letters of credit for international
transactions.
 APPENDIX (A)

Bill of Lading: A detailed list of a ship's cargo in the form of a receipt

given by

cancelled unless everyone involved agrees. Irrevocable letters of credit provide

more security than revocable ones.

Commercial Invoice : A commercial invoice is a document used in

foreign trade. It is used as a customs declaration provided by the person or
corporation that is exporting an item across international borders.

Deferred Payment: temporary postponement of the payment of an

outstanding bill or debt, usually involving repayment by instalments.

Documentary collection: A process, in which the seller instructs his

bank to

Documentary Credit: The documentary credit is one of the most

secure payment methods in international trade, offering the exporter a
conditional payment guarantee from the importer's bank.

forward documents related to the export of goods to the buyer's bank with a

Irrevocable L/C: An irrevocable letter of credit cannot be changed or

Issuing Bank: The importer's bank which issued the letter of credit called
the issuing bank.

Letter of credit: A letter of credit is a document from a bank

guaranteeing that a seller will receive payment in full as long as certain
delivery conditions have been met. In the event that the buyer is unable to
make payment on the purchase, the bank will cover the outstanding amount.

Letter of Indemnity: It is the document by which two parties to a

misrepresentation against third parties settle their differences in advance
should a third party in the future make a valid claim as a result of the
misrepresentation.
request to present these documents to the buyer for payment, indicating

Revocable L/C: A revocable letter of credit can be changed or cancelled

by the bank that issued it at any time and for any reason.

Sight Payment: A payment due on demand. An at sight payment will

require the party receiving the good or service to pay a certain sum
immediately upon being presented with the bill of exchange.

the master of the ship to the person consigning the goods.

when and on what conditions these documents can be released to the buyer.
 APPENDIX (B)

BIBLIOGRAPHY
 www.businessdictionary.com

 www.investopedia.com

 www.smedia.org

 www.wikipedia.org
 INDEX
Bill of Lading

Commercial Invoice

Deferred Payment

Documentary collection

Documentary Credit:

Irrevocable L/C

Issuing Bank

Letter of credit:

Letter of Indemnity

Revocable L/C:

Sight Payment