AlLs n r lager lol , to-, t02 taii

Chanter 23
hueuic y B-abr 3n E1
Tntit

Letter of Credit (LIC)

A letter of credit is a document issued by the importer's bank called the
opening bankin favour of the exporter called the beneficiary
letter w
guaranteesthe creditworthiness ofthe importer. If the importer fails to , it is
thebank which has issued the LIC that becomes liable to the exporter T
international trade, L/C is a medium otpayment and is an important documen n
trade. Banks also invest in L/Cs for the purpose of profit when the currencY
value
representing the L/C appreciates.
In practice, banks treat L/Cs in three different levels.
1. LCs issued by banks belonging todeveloped countries are purchased and
the cash is paid to the exporterimmediately. Erample:U.S.A.
2 LICs issued by banks to developingcountries that have political stability
They will be discounted according to the value of currency. Example: Egyrt
Philippines, etc.
3. LICs belonging to banks located in countries which are politically and
economically weak - The value ofL/Cs will be collected from the importer
and will be paid to the exporter. Example: Congo, Rwanda.
Parties to LCs
1. Opener: The person who is opening the L/C is nornmally the importer.
2 Beneficiary The person in whose favour the L/C is issued is invariably the
exporter.
3. Opening Banker: The bank whichissuesthe L/C is also called the iung
banker
4. Negotiating banker:Thebankthrough which the LICis negotiated bytne
exporter for the purpose of collecting the amount.
In addition to the above parties, we have confirming
bank and paying bA
Confirming bank is a branch of the importer's bank located in the exporters
1s
Country and it also endorses the LIC because of which more credibility
to the L/C. The paying bank is one which ultimately becomes liable to ma

payment on the L/C.

Types of Lc
V. 1. Clean LIC and Documentary L/C.
/ 2 Revocableand irevocable L/C
r oCfr e d i(
tLC)

232
ContimedLc
revolving
LC
and
Fixed
TranstèrableL / c

BackLIC
3ackto
Bac
and without recourse to L/C
Win th recourse
AnticipatoryLIC.

A /C
Clean LC and Documentary L/C: When an L/C does not
contain
entsoftrade such as bills, invoices etc., it is a clean LIC. In the
documents

case
AnCumentary
of L/C, documents of trade will be
documentary L/C
accompanying the L/C, ie,
uments such as bill of lading, consular invoice, certificate of origin,
marine insurance policy, etc.
invoice,
Revocable and irrevocable L/C: When an opening bank issues a revocable
LC, it clearly mentions that it can withdraw the L/C at any time
his. the letter of credit becomes less dependable. In the case and due to
UC. the issuing bank undertakes the
of irrevocable
responsibility of making payment even
inthe case of insolvency of theinmporter, which makes it quite
dependable.
Confirmed LC: The letter of credit issued by the importer's bank will have
the signature of one more bank which is
By this, the document becomes more
located in the exporter's country.
valuable and it can never be
dishonoured.
4 Fixed and revolving L/C: In the case of
fixed
fixedamount and once it is exhausted, it cannotL/C, the letter of creditis for a
case of revolving L/C, the letter of credit will bebeused
used anymore. But in the
for
as
whenever a payment is made on the letter of credit, it different amounts,
the importer instead of going for a gets revolved and
letter of credit. Thus, there is the fresh LC can continue to use the same
reimbursement and fresh renewal of L/C as
and when payment is made.
5. Transferable L/C: It is
obvious that the
trader for importing different commoditiesLIC is transferable to a different
When it cannot be transferred, it is a with the consent of
non transferable
issuing bank.
6. Back to Back L/C: letter of credit.
The exporter åfter obtaining a
receiving the L/C rom ine huge order and after
a fresh letter of credit iromprospective importer, will use the
his
country to be sent to some same for obtaining
exa if an Indian importer receives order other
country. For
tea for which LC is an
received from U.S.A, for exporting 10,00 kgs of
nracure only 5,000 Kg and 10r he
if the exporter in India is able to
remaining quantity he may have to
tea from Sri Lanka. nport
 Bankig Theory, Law andPractice
23.3

In such a the Indian exporter

case,
will use the letter of credit
om the
Practice
the Us
US
Indian bank a letter of credit to be sent to Sri
and obtain from the
backs another letter of Lanka for
importing 5,000 kgs of tea. Thus, one LC credit
which iscalled back toback L/C
7. With recourse and without
recourse to LC: In the case of with reco.

drawee of a bill drawn against

an LIC fails to make LC,
uc
when the payment, theo
drawer of the bill will be held liable.Inthecase without recourse letterthe
be made.
credit, such recourse to drawer cannot
credit when aa letter
8. Anticipatory L/C: In anticipation of aletter of letter isis issued:

from the importer's bank to theexporter's bank, requesting them to finan

theexporter for manufacturing goods against orders and on shipment afsthe
order, letter ofcredit will be issued- such a letter is called anticipatory i c
ADVANTAGES OF LETTER OF CREDIT

I. Advantages to the importer

1. It enables the importer to purchase and import goods on credit from foreien
countries.
2 The importer is in a position to repay the loan taken from the bank by
utilising the imported goods.
3. Goods which are not available in the domestic market could be imported
even without being familiar with the exporter.
4. It enables importer's bank to expand its banking business.
5. Importing country will also be benefited as it can also improve its exports
with the help of imported goods.
like machinery be
6. Even highvaluable goods such as capital goods can

imported on instalment basis.

7. It enables the importer to purchase goods at a competitive price by finding
out the cheapest market at the global level.
IL Advantages of the exporter
e nl
1. By obtaing irrevocable confirmed L/C, the importer is assured of paymen
even in the case of death or the insolvency of the importer.
ofpayment.
2 2 Asthe bank of theimporter is involved, the exporter is assured ven
the exporter ev
3.The credit worthiness of the importer is made known to
before the commencement of the trade.
another
4. Confirmed L/C provides guarantee ofthe bank- one ofopening and

of confirming to the exporter. orters need not

5. Letter of Credit' has increased international trade as

worry about the credit worthiness of the importer. It is ony uth
exportcansthe
banksthat
Letter of Credit(LC) A
are involved in negotiating L/Cs. Foreign exchange market in the ezpuurs
country is effectively activated with the presence of L/Cs since the 1/
belonging to developed countries will be purchased by bankers,
1./Underdeveloped countries will be more keen to export to developed cnuntries
as the L/Cs of these countries are purchased and payments are immediately
made to the exporter.
8.LCs enable activities such as insurance, transport and banking to flourish.
Thus, services sector improves and employment opportunities grow.
9 Forwarding and clearing agents will have more scope as L/Cs promote more
international trade.
Review Questions
Section A
1. State the purpose for which a letter of credit is issued.
2. Name the parties involved in a 'Letter of Credit'.
Section BB
What are the various types of L/C? Explain each of then.

2. State the advantages of a "Letter of Credit'.