ROLE OF LC IN INTERNATIONAL TRADE

GROUP MEMBERS NAMES MANASI GANDHI AMRUTA KHEDEKAR POOJA MUKHERJEE PRAGYA PATRA DHWANI VIBHAKAR ROLL NOS 70 78 84 93 110

LETTER OF CREDIT (LC)
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Typically. and political importance has been on the rise in recent centuries. In such cases the International Chamber of Commerce Uniform Customs and Practice for Documentary Credits applies. sidewalks. 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. nations would be limited to the goods and services produced within their own borders. Increasing international trade is crucial to the continuance of globalization. commercial letter of credit (LC) is a document issued mostly by a financial institution. In most countries. Industrialization. bill of lading. for deals between a supplier in one country and a customer in another. and services across international borders or territories. advanced transportation. i.) will be built. social.e. In executing a transaction. it represents a significant share of gross domestic product (GDP). The parties to a letter of credit are usually a beneficiary who is to receive the money. and documents proving the shipment was insured against loss or damage in transit. etc. cannot be amended or canceled without prior agreement of the beneficiary. Almost all letters of credit are irrevocable. globalization. its economic.. the documents a beneficiary has to present in order to receive payment include a commercial invoice. The reason is that a border typically imposes 3 . The letter of credit can also be source of payment for a transaction.A standard. However. The main difference is that international trade is typically more costly than domestic trade. and the advising bank of whom the beneficiary is a client. letters of credit incorporate functions common to giros and Traveler's cheques. storm water ponds. International trade is in principle not different from domestic trade as the motivation and the behavior of parties involved in a trade do not change fundamentally regardless of whether trade is across a border or not. INTERNATIONAL TRADE International trade is exchange of capital. goods. Without international trade. and outsourcing are all having a major impact on the international trade system. if any. While international trade has been present throughout much of history (see Silk Road). the issuing bank of whom the applicant is a client. Letters of credit are used primarily in international trade transactions of significant value. the issuing bank and the confirming bank. They are also used in the land development process to ensure that approved public facilities (streets. multinational corporations. used primarily in trade finance. which usually provides an irrevocable payment undertaking. meaning that redeeming the letter of credit will pay an exporter. or their place of origin or place.

Instead of importing Chinese labor the United States is importing goods from China that were produced with Chinese labour. PARTIES INVOLVED IN AN LC TRANSACTION Term Applicant Beneficiary Opening Bank Advising Bank Confirming Bank Paying Bank Definition Importer Exporter Importer’s Bank Exporter’s Bank Advising Bank or 3rd Party Bank Any bank as specified in L/C Activity Buy Sell Issues L/C Advises L/C Confirms L/C Pays the Draft LC TRANSACTION PROCEDURE 3 . Instead of importing a factor of production. a country can import goods that make intensive use of the factor of production and are thus embodying the respective factor. labor or other factors of production. Thus international trade is mostly restricted to trade in goods and services. Another difference between domestic and international trade is that factors of production such as capital and labour are typically more mobile within a country than across countries. and only to a lesser extent to trade in capital. time costs due to border delays and costs associated with country differences such as language. An example is the import of labor-intensive goods by the United States from China.additional costs such as tariffs. the legal system or culture. Then trade in goods and services can serve as a substitute for trade in factors of production.

The issuing bank sends the L/C to the advising bank (sellers bank) by courier. packing list. The issuing bank deducts the same amount from the buyers account and submits the documents to the buyer so that he can claim his goods from shipping company. ROLE OF LC IN INTERNATIONAL TRADE 3 . After receiving the LC. Airmail or telex. the advising bank pays the Seller before sending the documents back to the issuing bank. etc before presenting the documents to his bank. There should not be any discrepancy and if there is he should make amendments. it pays to the advising bank. Then the issuing bank checks all the documents and if everything is fine. The buyer has to fill out the application for LC and send it back to his bank. The advising bank informs seller (beneficiary) of the LC arrival. the seller compares the LC with commercial invoice and makes sure that all the terms and conditions that are mentioned in the L/C can be satisfied. The seller will ship the goods within the shipping period specifies in the LC and prepares all the documents such as invoice.LC is an application issued to the buyer by his bank upon request. Advising bank checks all the documents against the LC and if they match.

and primarily comprises of : (a) Opening Charges: This would comprise commitment charges and usance charged to be charged upfront for the period of the L/C. Usance is the credit period agreed between the buyer and the seller under the letter of credit. provided the terms of the letter of credit have been met. 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. 3 . (b)Retirement Charges • This would be payable at the time of retirement of LCs. The first category of the most common in the day to day banking. The fee charged depends on the credit of the applicant. Fees And Reimbursements The different charges/fees payable under import L/C are as follows: The issuing bank charges the applicant fees for opening the letter of credit. The fee charged by bank for the usance period is referred to as usance charges.• IMPORT OPERATIONS UNDER LC The Import Letter of Credit guarantees an exporter payment for goods or services. 1. When a trader is buying good from his own country and sell it to the another country for the purpose of merchandizing trade. and levies charges based on value of goods. LC opening bank scrutinizes the bills under the LCs according to UCPDC guidelines . 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. This may vary from 7 days usance (sight) to 90/180 days. The fee charged by the L/C opening bank during the commitment period is referred to as commitment fees. 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.

most banks have specialized unit which control the level of exposure that that the bank will assumes for each country.The advising bank charges an advising fee to the beneficiary unless stated otherwise The fees could vary depending on the country of the beneficiary. import regulations packing and storage. etc. Exporter Risk There is always the risk of exporting inferior quality goods. possible obsolescence. Risk Associated with Opening Import L/C The basic risks associated with an issuing bank while opening an import L/C are : The Financial Standing of the importer As the bank is responsible to pay the money on the behalf of the importer. Foreign exchange risk Foreign exchange risk is another most sensitive risk associated with the banks. • 2. • The applicant is bounded and liable to indemnify banks against all obligations and responsibilities imposed by foreign laws and usage. The Goods Bankers need to do a detail analysis against the risks associated with perishability of the goods. Country Risk These types of risks are mainly associated with the political and economic scenario of a country. thereby the bank should make sure that it has the proper funds to pay. the traders depend a lot on exchange rate fluctuations. • The reimbursing bank charges are to the account of the issuing bank. Price risk is the another crucial factor associated with all modes of international trade. • 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. Banks need to be protective by finding out as much possible about the exporter using status report and other confidential information. The advising bank charges may be eventually borne by the issuing bank or reimbursed from the applicant. To solve this issue. As the transaction is done in foreign currency. • EXPORT OPERATIONS UNDER L/C 3 .

For physical export of goods and services from India to a Foreign Country. 2. 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. 3. 2. 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. try to understand the underlying transaction. Such letters of credit may be received for following purpose: 1. It is also necessary for the advising bank to go through the letter of credit. 3 . 1. terms and conditions of the credit and advice the beneficiary in the matter. Banks in India associated themselves with the export letters of credit in various capacities such as advising bank. organization or project being executed in India with the aid of external agencies. In every cases 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. 4. There are no credit risks as the bank receives a onetime commission for the advising service.Export Letter of Credit is issued in for a trader for his native country for the purchase of goods and services. transferring bank and reimbursing bank. For sale of goods by Indian exporters with total procurement and supply from outside India. There are no capital adequacy needs for the advising function. Only on receipt of satisfactory information/ clarification the amendment may be advised. 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. 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. confirming bank. The main features of advising export LCs are: 1. In the process of advising the amendments the Issuing bank serializes the amendment number and also ensures that no previous amendment is missing from the list. 2. In all the above cases there would be earning of Foreign Exchange or conservation of Foreign Exchange.

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. 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. acceptance or negotiation. but also any bank nominated by the beneficiary. Negotiable instruments are passed freely from one party to another almost in the same way as money. In return. on demand or at a definite time. However. 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). Reimbursement of Export LCs Sometimes reimbursing bank. It is quite similar to a cheque facility provided by a bank. in addition to that of the issuing bank. the letter of credit must include an unconditional promise to pay. the reimbursement bank earns a commission per transaction and enjoys float income without getting involve in the checking the transaction documents. CHARACTERISTICS OF LETTER OF CREDIT Negotiability Letters of credit are usually negotiable. it can take the credit risk on the issuing bank or confirming bank. in such a situation. which undertakes the sight payment. 4. 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. on the recommendation of issuing bank allows the negotiating bank to collect the money from the reimbursing bank once the goods have been shipped. As a holder in 3 .3. The issuing bank is obligated to pay not only the beneficiary. Confirmation of Export Letters of Credit It constitutes a definite undertaking of the confirming bank. deferred payment. The nominated bank becomes a holder in due course. To be negotiable. 5.

in good faith. A draft is also called a bill of exchange. 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. without notice of any claims against it. The revocable letter of credit is not a commonly used instrument. Transfer and Assignment The beneficiary has the right to transfer or assign the right to draw. If a letter of credit is a straight negotiation it is referenced on its face by "we engage with you" or "available with ourselves". even if the credit specifies that it is nontransferable or no assignable. Credits governed by the Uniform Commercial Code (Domestic) maybe transferred an unlimited number of times. The transaction is considered a straight negotiation if the issuing bank's payment obligation extends only to the beneficiary of the credit. the confirming bank. the holder takes the letter of credit for value. it serves as the advising bank. the letter of credit cannot be revoked. Once the documents have been presented and meet the terms and conditions in the letter of credit. However. and the beneficiary. 3 . Sight and Time Drafts All letters of credit require the beneficiary to present a draft and specified documents in order to receive payment. The bank is allowed a reasonable time to review the documents before making payment. Revocability Letters of credit may be either revocable or irrevocable. If a letter of credit is irrevocable it is referenced on its face. There are two types of drafts: sight and time. and the draft is honored. payment will be made. If a letter of credit is revocable it would be referenced on its face. A holder in due course is treated favorably under the UCC. A revocable letter of credit may be revoked or modified for any reason. A draft is a written order by which the party creating it.due course. The irrevocable letter of credit may not be revoked or amended without the agreement of the issuing bank. the beneficiary may transfer their rights prior to performance of conditions of the credit. A sight draft is payable as soon as it is presented for payment. It is generally used to provide guidelines for shipment. A revocable letter of credit cannot be confirmed. at any time by the issuing bank without notification. Under these conditions the promise does not pass to a purchaser of the draft as a holder in due course. Under the Uniform Customs Practice for Documentary Credits (International) the credit may be transferred only once. If a correspondent bank is engaged in a transaction that involves a revocable letter of credit. orders another party to pay money to a third party. under a credit only when the credit states that it is transferable or assignable.

a clause is included that “any drawings negotiated against the L/C prior to notification or revocation or 3 . TYPES OF LETTER OF CREDIT Revocable A revocable letter of credit allows for amendments. Because this places the exporter at risk. modifications and cancellation of the terms outlined in the letter of credit at any time to an importer without the consent of the exporter or beneficiary. The issuing bank has a reasonable time to examine those documents.A time draft is not payable until the lapse of a particular time period stated on the draft. revocable letters of credit are not generally accepted. The issuing bank is obligated to accept drafts and pay them at maturity. The bank is required to accept the draft as soon as the documents comply with credit terms. In order to safeguard the interest of the exporter in a revocable L/C.

It may also be noted that if any bank confirms an L/C without an authorization from the issuing bank. it will continue to be unconfirmed. The advising bank. the bank can have recourse to the exporter for payment of not only the bill amount but also expenses. The direct exporters keep the original LC (received from issuing bank) with the negotiating or some other bank in India. as a security and obtains another LC in favor of domestic supplier.” The best form of L/C is therefore – “IRREVOCABLE. the exporter is bound to refund the money back to the bank which has negotiated his bills in the event of refusal by the importer to honor the bill” where the importer fails to pay after the specified period or unduly delays his payments. provided that the stipulated documents are presented and that the terms and conditions of the credit are compiled with. Irrevocable an irrevocable letter of credit requires the consent of the issuing bank. If no confirmation is added it is unconfirmed.amendment will be honored on presentation.” Back-to-Back Letters of Credit Back-to-back letters of credit is a domestic letter of credit. the branch or the correspondent through which the issuing bank routes the letter of credit. it binds itself to negotiate documents under the particular credit confirmed. CONFIRMED AND SANS RECOURSE. Confirmation constitutes a definite undertaking of such bank (confirming bank).” Still this type of L/C is of limited utility and. modification or cancellation to the original terms can be made. adds its undertaking and commitment to pay to the letter of credit. 3 . in addition to that of the issuing bank. hence. provided the documents submitted comply with the terms of the letter of credit. However. in a “without recourse L/C” the liability of the exporter ends after the bill is negotiated. the beneficiary and applicant before any amendment. Confirmed & Unconfirmed L/C: A confirmed letter of credit is when a second guarantee is added to the document by another bank. This type of letter of credit is commonly used and preferred by the exporter or beneficiary because payment is always assured. This confirmation means that the Exporter / seller / beneficiary may also look to the credit worthiness of the confirming bank for payment assurance. Irrevocable letters of credit can be both confirmed and unconfirmed. With Recourse & Sans (without) Recourse: In a “With Recourse” L/C. It is an ancillary credit created by a bank based on a confirmed export LC received by the direct exporters. not very popular. If an intermediary bank adds its confirmation.

The bank is 3 . Usually all letters of credit are non transferable unless it is expressly stated that LC can be transferred. the amount of credit is automatically renewed after the bills are negotiated. Under this credit the beneficiary has the right to draw the bills upto the specified amount within the specified period. copies of invoices. which further authorizes the negotiating bank to make advances to the beneficiary for the purpose of processing the export goods. with evidence that the customer has not performed its obligation. The beneficiary is able to draw under the credit by presenting a draft. Revolving L/C: When LC is issued for fixed amount and for a fixed period. but when the fixed amount is withdrawn. The standby letter of credit assures the beneficiary of the performance of the customer's obligation. Under revolving type. The validity of the LC gets over as soon as the bills upto the specified amount have been paid within the specified time. Non-Transferable LC: The beneficiary cannot transfer the LC to a third party. A revolving credit is a credit. which can be transferred by the beneficiary named therein in favor of another party. Thus. The commercial letter of credit is the primary payment mechanism for a transaction. the red LC enables the exporter to obtain Packing Credit Facility for the purpose of processing the goods.Through this route the domestic supplier gains direct access to a pre-shipment loan based on the receipt of domestic or back-to-back LC. 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 beneficiary. which is available for a fixed amount only for fixed period. it is called a fixed LC. The issuing bank can transfer a credit only if it is expressly designated as transferable. Thus. The parties involved with the transaction do not expect that the letter of credit will ever be drawn upon. The standby letter of credit serves as a secondary payment mechanism. Red Clause LC: The red clause LC is the usual irrevocable LC. Standby Letter of Credit The standby letter of credit serves a different function than the commercial letter of credit. the credit is renewed automatically for the same initial amount. It is called a red-clause LC because it is generally printed in red ink. Transferable LC: A transferable LC is one. a revolving credit is used to provide transactions are more or less regular and continuous atlest over a certain period of time.

the bank is given until the close of the third banking day after receipt of the documents to honor the draft ADVANTAGES OF L/C TO AN IMPORTER (BUYER) Reduce your commercial risk by ensuring that your supplier will not be paid until evidence has been provided that the goods have been dispatched. If the customer is unable to pay. If payments are made in accordance with the suppliers' terms. the seller presents a draft and copies of invoices to the bank for payment.obligated to make payment if the documents presented comply with the terms of the letter of credit. Once the exporter fulfills all the conditions of L/C and presents as per the terms and conditions of L/C. The standby letter of credit is often used to guarantee performance or to strengthen the credit worthiness of a customer. and to insure the completion of a sales contract. 3 . Standby letters of credit are issued by banks to stand behind monetary obligations. the bank that issued the L/C is obligated to pay) • No blocking of fund. to support performance and bid obligations. In the above example. the letter of credit would not be drawn on. L/C ultimately reduces the bad-debt of an exporter. • • ADVANTAGES OF AN L/C TO AN EXPORTER (SELLER) • Assure that you get paid (if the buyer doesn't pay. The seller pursues the customer for payment directly. to insure the refund of advance payment. L/Cs are pledged by exporters as security against working capital loans). The domestic standby letter of credit is governed by the Uniform Commercial Code. Under these provisions. Import L/Cs will also help you: • Conserve your company's cash flow by eliminating the need to make advance payments or deposits Demonstrate your creditworthiness to your supplier Support your supplier's access to bank credit (in many countries. The credit has an expiration date. the letter of credit is issued by the bank and held by the supplier. the exporter is entitled to receive the amount of exports. The customer is provided open account terms.

3 . The strength of L/C helps exporter to avail pre-shipment finance. which is granted by commercial banks.• L/C enables an exporter to avail pre-shipment finance.