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MBA Banking & Finance 3rd Term
Letter of Credit
There are numbers of factor involved in oversees trade. 1. 2. 3. 4. The exporters are uncertain about importer capacity of payment. The importers are unwilling to pay amount unless the goods are actually received. In case of non payment the sellers should have legal rights in foreign country. There should be an agency which should meet the seller need of finance when goods are shipped to importer.
The commercial banks here come for the help of exporter and importer. The importer bank can undertake the obligation to pay to the exporter, this is usually done through letter of credit.
What is letter of Credit?
A letter of credit is commitment on the part of buyers bank to pay or accept draft drawn upon it provided do not exceed a specified amount.
Features of L/C
Issued by the importer bank Guarantees of payment to the exporter Up to specified amount
Parties in letter of Credit
There are four parties
Buyer or importer on whose account and request the L/C is opened.
The bank which issue or open L/C on the request of Importer
Exporter or Seller.
The seller in whose favor L/C is drawn
Paying or Negotiating bank:
The paying bank in the exporter country.
Types of Letter of Credit
1. Irrevocable L/C one in which the issuing bank gives
a lasting undertaking to accept in due course to pay bills drawn upon it. It can not be altered or cancelled with out the consent of the parties.
Revocable L/C it can be cancelled with out the
consent of the beneficiary bank. Issuing bank has also right of amendment.
3. Confirmed L/C
That which has the protection of the credit standing of the importers as well as the exporter bank. The exporter bank when confirm the letter of credit take the liability of paying agent in case the issuing bank fails to make payment to exporter.
4. Unconfirmed L/C the bank through which The credit is
negotiated does not give any guarantee to the exporter that the bill drawn will be honored.
5. Documentary L/C
One which provides for bill to be accompanied by documents of title to goods such as the bill of loading, invoice, insurance etc.
6. Open L/C
When there is no conditions attached in the letter of credit is called open or clean L/C.
7. Fixed L/C
When L/C is issued for fixed amount.
Revolving L/C where both amount and time is
fixed. It is automatic. It does not need renewal during the period of validity.
That under which the beneficiary has right to request the paying bank to make the credit available in whole or in part to one or more other parties
Non -Transferable L/C
Ordinary L/C in which beneficiary does not enjoy any rights of transfer credit to any other person.
With Recourse L/C
L/C where issuing bank is under obligation to make the payment of the bill drawn on the opener of the credit, if he refuses to make payment of the bill.
The original buyer first request to his bank to issue the first documentary credit to the seller. The seller request to his bank to issue a separate documentary credit in favor of the actual supplier.
Procedure of Opening Letter of Credit
1. Application for the letter of Credit. 2. Line of the Credit. 3. Opening the Letter of Credit. 4. Handling of the Documents. 5. Payment by the importer to the banker. 6. Liability of the issuing bank.
1. Application for the letter of Credit.
An importer prepares an application on the prescribed Form available form the bank. the information which are supplied in the application are based on the contract such as the value of merchandise ,port of shipment, port of unloading, expiry date of the papers and brief description of the goods. If the bank is satisfied with the application , it will signed and acceptance agreement with the importer.
2. Line of the Credit.
Before issuing the letter of the credit ,precautions for securing its credit . The bank first examines the customers credit standing, the type of goods, the collateral offered to cover the credit , then it establish the amount i.e. the line of credit.
3. Opening the Letter of Credit.
The letter of credit can be opened by mail or by cable, when it is opened by the mail, the issuing bank send letter of credit and to carbon copies to the importer. The importer then dispatch the letter of credit to the exporter in foreign country by mail, one carbon copy is kept for the record. The second carbon copy after signing is sent to the bank by the importer, if any importer directs the banks to open letter of credit by cables the importer s bank send a cable to the corresponding bank in the foreign country with a request to notify the exporter.
4. Handling of the Documents.
When the exporter receives a letter of credit , he presents the required documents and the draft to the bank in his own country after shipping of documents if the bank is satisfied with the documents in the importing country and pay the exporter at official rate in the country of his own country.
5. Payment by the importer to the banker.
When the bank approves the application of the customer for opening letter of credit ,it does not lend money to the importer ,the bank lends the importer to use the credit standing the foreign country. the banks makes the contract with the importer bank that when the draft is send by the negotiating bank for payment of the importer will make the payments to the bank not latter then the day only the bank is to honors the obligations. In case of sight letter of credit the payment to the corresponding bank is to be made on the day the draft and documents are received ,when the time of lletter of credit is used the importer is to arranged the payment not to later then the day on which the draft is to mature.
6. Liability of the issuing bank.
The liability of the issuing bank is to examine the documents I order to confirm their validity. If the documents on face appear to be in order the payment should be released .If the any defect in found in the documents and the issuing bank honors the draft, The importer can claim damages. The banker is not responsible to see wither the merchandise confirm the sale of contract or they physically exist. the issuing bank is only responsible for the completeness and regulatory of documents relating to the letter of credit.
Documents in foreign Trade.
1. 2. 3. 4. Financial documents Transport documents Commercial documents Insurance documents
Financial documents are: Bill of exchange Promissory note Trust receipt Delivery order and ware house receipt.
Import Financing Facilities
One of the most important functions performed by the banks engaged in international banking is to finance exports and imports of the country trade with foreign countries. Just as domestic trade requires various financing methods, there are several ways of financing international trade They are cash in advance, open account, documentary collection and letter of credit. Of all of these methods the most important is letter of credit. Cash in advance involve little risk and are highly advantageous to exporter. They are not very popular as a means of financing foreign trade, because of many disadvantageous for foreign buyers(importer). The buyer is forced to have a considerable amount of working capital.
The buyer will also at the mercy of the exporters because of the possibility of the shipment of inferior merchandise, delayed shipments, and even bankruptcy of the exporter. Political unstable economic conditions can effect the shipment. Cash in advance present some disadvantageous to the foreign purchasers while open account presents similarly disadvantageous to the exporter. If the foreign purchaser is slow in payment will experience drain in working capital. The exporter does not have any negotiable instrument evidencing the obligation, which would become very important in case of dispute.
There is 3 Types of Import Financing
1. 2. 3. Import financing against document. Import financing against merchandise. Finance against trust receipts.
Payment against import documents
The supplier after effecting shipment of goods, present shipping and other documents as required under terms of credit with the buyers. Documents are forwarded with a covering letter in two sets original and duplicate in separate covers) When these documents are received by the bank, the examiner checks them against the bank copy of the letter of credit point by point. In case of any discrepancies,the examiner may reject or negotiate under an indemnity from the supplier before payment is made to the advising/negotiating bank in terms of the credit. Bank will maintain NIPAD ledger. Entry will be made NIPAD Debt (Dr) and HO a/c will be credit (Cr). NIPAD mean Non interest payment against document
Refund of margin
In order to secure the finance as prescribed by the State Bank of Pakistan reasonable margin is recovered from the importer on landed cost of consignment and all other expenses incurred in connection to the import of goods as under. 1. 2. 3. 4. 5. 6. NIPAD with up to date mark up Custom duty Sales tax Extra surcharge Import surcharge Warehouse, clearing agent charges income tax etc.etc In case of financing against documents bank will pass entry for refund of margin debiting sundry deposits margin a/c on L/C And crediting NIPAD a/c.
Reversal of liability
Bankers liability on L/C is debited while customer liability on L/C is credited. Then the memo of cost is prepared on form-1 mean the form showing complete details of Import goods to state bank of Pakistan i.e. NTR, income tax circle, Id card No, place and date of issue, Name and address of authorized dealer, name and address of beneficiary goods, quantity, port of shipment, date of shipment, License NO., Invoices value in foreign currency, registration no. with state bank, importer name etc. After the completion of procedure the documents are kept in separate envelope mentioning following particulars. NIPAD, LC number, Amount, and Importer name. description of goods, quantity, port of shipment, date of shipment,
License NO., Invoices value in foreign currency, registration no. with state bank, importer name etc. After the completion of procedure the documents are kept in separate envelope mentioning following particulars. NIPAD, LC number, Amount, and Importer name.
Retirement of NIPAD
At the time of retirement of documents following vouchers are passed. Amount of NIPAD, including mark up on NIPAD, postage charges, commission on NIPAD, service charges, etc. After the amount is debited to party account draft/bill of exchange are endorsed in favor of the importer, where certificate regarding foreign exchange is given on the copy of invoice.
Finance against merchandise
Any bank who establishes a documentary letter of credit is bound to honor its commitments for the importer bills at the time of payment if otherwise in order. A. retirement by importer. B. by authoring finance at the request of the importer against the security of imported merchandise. C. Forced (FIM) finance against imported merchandise. When documents are not retired by the importer, the bank in order to save its interest, clearing the goods by debiting FIM A/C which is known as a forced FIM. Force FIM: In case the importer does not come forward to retire the goods so in order to save the interest of the bank all the charges are debited to FIM A/C. The goods after clearance stored with bank godowns, the importer should be pressed to take delivery of the goods..
In case of refusal goods should be auctioned to adjust outstanding FIM A/C.
Retirement of documents through FIM A/C
Under this loan the importer applies for a regular sanction limit from the bank and following documents are executed by the importer IB-6A . Agreement of finance for working capital on marked up basis Form IB 12-DP Note Form IB-26 letter of pledge Resolution by the board of directors, if applicable Insurance policy Other relevant documents for collateral security if any
Letter of request from the importer if desires to avoid loan facility under this agreement. The bill of lading is to be indorsed by the importers fever to get relies of the consignment from the shipping co. Bill of exchange is marked with paid stamp duly signed by the bank official and delivered to the importer. The bank is to secure more by obtaining collateral securities in the shape of equitable mortgage of property with personnel guarantee.
Financed against Trust Receipts.
This type of facility is provided to most valuable clients of the bank though it is very risky because the bank has no control over the goods. In this case the approval of the competent authority is obtained and following documents are executed. Application TR financing is allowed on documentary bill draw under letter of credit (Foreign or inland). The facility is allowed only to those parties who have been allowed by competent authority.
Documents required in case of TR Bill of exchange duly signed by the party. D.P.Note Letter of trust Collateral if any Mark up agreement. Invoice. After obtaining the documents, the shipping documents are delivered to importer on trust
And understanding that the bill amount along with the mark up will be deposited by importer with in the approved period after selling the goods whichever is earlier. Mark up is charged 50 paisa per 1000 on daily product basis and paid when importer pays the entire finance. Transportation Bond: These bonds are issued where the customer has undertaken to transport capital equipment (imported by the employer for the project) from the harbor to the worksite. Retention money bond(RMBs) These are issued to avoid retention of money (usually)ten percent )by the employer from each progress payment due to the customer
In order to cover hither to untraceable mistakes or faults in the completed construction work, until usually one following final completion o\f the project. Working capital replenishment bond: (WCRG) These are issued by the bank in favor the employer who advance funds to the contractor to bridge financial payment delays on receivable due by himself. Maintenance bond: These are issued at the end of construction period remain outstanding un till the end of maintenance period. This is usually one year. The purpose of this bond is to prevent the contractor from leaving the construction site after the construction is completed and the last progress payment received. Completion Bond: in many cases construction companies and turn-key contractors are committed not only to
Construct but also to operate more importantly, to operate successfully during a previously agreed period of time. Custom bond These are often requested to be issued in connection with imported equipment which are subsequently re-exported upon completion of the project. By giving such a bond, exemption is obtained from paying import duties and sale tax to the custom authorities of the country involved. Deferred payment guarantee: Issued on behalf of an importer customer to cover deferred payment terms agreed upon between him and the supplier of plant and machinery.
Risks for the Bank
1. The bank under takes great risk by advancing loans on sureties. The guarantor may lose his property during the period of loan contract. If the debtor fails to pay the debt, the bank can not recover the amount from the two parties. In case the debtor fails to repay the loan, the bank may not be able to get back the money even by suing the debtor and the guarantor. The case may fail on technical grounds. 3. If at any time the bank has to change the constitution or it has to amalgamate with other banks, the guarantee is terminated unless otherwise stated.
Precautions: Greater need for analysis of financial standing and for ascertaining the performance ability of the customer.
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