NAME: UNEEB WASEEM

REG NO. : 2143243

ASSIGNMENT NO. 04
MONEY & BANKING
SUBMITTED TO: MAA’M NEHA ZAIB

TOPIC: IMPORTANCE OF LETTER OF CREDIT IN INTERNATIONAL TRADE

Definition

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 credit worthy financial services companies, like insurance companies or
mutual funds, might issue letters of credit under certain circumstances.

Participants

A letter of credit generally has three participants.

1. First, there is the beneficiary, the person or company who will be paid.

2. Next, there is the buyer or applicant of the goods or services. This is the one who needs the letter
of credit.
3. Finally, there is the issuing bank, the institution issuing the letter of credit.

In addition, the beneficiary may request payment to an advising bank, which is a bank where the
beneficiary is a client, rather than directly to the beneficiary. This might be done, for example, if the
advising bank financed the transaction for the beneficiary until payment was received.

Documentation Requirements

In order to receive payment, the beneficiary must present documentation of completion of their part in
the transaction to the issuing bank. The documents that the issuing bank will accept are specified in the
letter of credit, but may often include:

 Bills of exchange

 Invoices

 Government documents such as licenses, certificates of origin, inspection certificates,

embassy legalizations

 Shipping and transport documents such as bills of lading and airway bills

 Insurance policies or certificates, except cover notes

Importance of Letter of Credit in International Trade
Letters of credit are important assurances or guarantees to sellers that they will be paid for a large
transaction, particularly with international exchanges. Think of them as a form of payment insurance from
financial institutions or another accredited party to the transaction.

How a Letter Of Credit Helps International Trade

More and more businesses are interested in expanding their horizons. International trade allows
businesses to buy supplies from other countries and sell their products abroad.

The upside of international trade is that if a business decides to either import or export products or
supplies the risks may be minimized. There are many risks to international trade. The advantage is that if a
company is not successful in entering new markets it can take suspends operations and continue in the
country of origin.

There are different legal documents and methods that allow companies to increase their working capital
and increase the accountability of their foreign transactions. We are talking about factoring, bank
guarantees, and letters of credit.

A letter of credit is one of many methods to provide protection to both parties involved in international
transactions.

The letter of credit is a crucial part of the recipe when it comes to trade done outside borders. These
documents have many useful features that make imports and exports easier and more reliable. The letter
of credit is grounded on international trade practices and regulations. It establishes what the parties are
expected to do, what documents are required for the transactions, and the terms both exporter and
importer agree beforehand. A letter of credit works as a guarantee that the transaction will be done as
agreed.

The Letter of Credit is the promise given by a bank (Issuing Bank), acting on instructions from its customer
(payer) to pay certain sum of money to a person or company (Recipient), through one of its
correspondents Bank (Notifier), provided that certain requirements are met, such a rule, are the delivery
of documents within a stipulated date.
This type of credit document is beneficial for the party paying for the merchandise, because payments can
only be done upon presentation of the letter of credit.
A letter of credit will provide the formality and legal structure sufficient for transactions to be done
properly. It evidences that the merchandise arrive in the conditions expected.

This type of credit document creates a link between the exporter and the importer and works as a
mechanism for payments that involves banks.

Letter of credit advantages for the seller

 The seller has the obligation of buyer's banks to pay for the shipped goods;

 Reducing the production risk, if the buyer cancels or changes his order

 The opportunity to get financing in the period between the shipment of the goods and receipt
of payment (especially, in case of deferred payment).

 The seller is able to calculate the payment date for the goods.

 The buyer will not be able to refuse to pay due to a complaint about the goods

Letter of credit advantages for the buyer

 The bank will pay the seller for the goods, on condition that the latter presents to the bank
the determined documents in line with the terms of the letter of credit;

 The buyer can control the time period for shipping of the goods;

 By a letter of credit, the buyer demonstrates his solvency;

 In the case of issuing a letter of credit providing for delayed payment, the seller grants a
credit to the buyer.

 Providing a letter of credit allows the buyer to avoid or reduce pre-payment.