Letter of Credit

1
 Letter of Credit
• What is a Letter of Credit ? ICC defines a Letter of Credit as
• “ It is a promise by a bank on behalf of the buyer (importer) to
pay the seller (beneficiary/exporter) a specified sum in the
agreed currency, provided that the seller submits the required
documents by a predetermined deadline.”
• The Uniform Customs & Practice for Documentary Credits
(UCP 600) is the official publication which is issued by the
ICC . It is a body of rules on the issuance and use of a letter of
credit and applies to 175 countries
• Many banks and lenders are subject to this regulation, which
aims to standardise international trade, reduce the risks of
trading goods and services, and govern trade.

2
 Letter of Credit
• How does it work?
• There is a seller and a buyer who want to conclude a business
transaction. However, they may or may not know each other
for financial obligations.
• Because of the cargoes shipped from foreign ports to reach
their destination takes time, importers have to find a way of
guaranteeing payment to exporters before the goods are
received.
• The answer is a letter of credit – an instruction by the
importer’s bank to an overseas bank to pay the exporting
company in advance/ well in advance
• The banks naturally charge interest for this service

3
 Letter of Credit
• How does it work?......
• Buyer sets a list of terms and conditions under which he would
like to buy and ship the cargo from the seller.
• This list generally has
• Description of the goods he wants to buy from the seller
• Quantity of the goods
• Documentary requirements (bills of lading, commercial
invoice, packing list etc)
• Details of the consignee (generally the issuing bank) will be
shown as the consignee and the buyer’s bank will have control
of the cargo until such time they receive the money from the
buyer
• Details of who must be notified of the arrival of the shipment
• Latest date of shipment (for eg. on or before 30th May.)
4
 Letter of Credit
• This list generally has……
• Sometimes the buyer also nominates the shipping line that is to
be used
• which shipping (Delivery) ports are to be used
• what mode of transport for each stage is to be used
• This L/C is then issued by the buyers bank (known as issuing
bank) and is generally sent to the seller and his bank (known as
the nominated bank(Beneficiary bank).
• The seller then proceeds to prepare his goods and documents
based on the L/C..
• Once the shipment has been accomplished, the seller will
submit the copies of all the documents as per the instructions
on the L/C to his bank..
• His bank checks the veracity and correctness of the submitted
documents against the L/C specifications.
5
 PARTIES TO DOCUMENTARY CREDITS
• 1. Commercial Parties
• There are two commercial parties viz. Applicant and Beneficiary

• A. Applicant
• The applicant is normally the buyer of the goods .i.e. the importer who
request his bank to issue a letter of credit in favour of a named beneficiary
against tending of certain specified documents.
• The Role of Applicant
• Supply the bank with complete instruction.(To fill out standard application
form)
• Issue instruction for amendments if any
• Decide on discrepancies reported by the issuing bank to him.
• Arrange for fund at the payment time.

6
 PARTIES TO DOCUMENTARY CREDITS

• B. Beneficiary
• The beneficiary is normally the seller of goods who receives payment
under documentary credit if he has complied with terms and conditions
thereof.
• A credit issued in favour of the beneficiary to enable him or his agent to
obtain payment once he performed his part of contract and submitted
stipulated documents showing compliance with the terms and conditions
of letter of credit.
• In case of a transferable letter of credit, the credit is transferred to another
party,
• The original beneficiary is known as first beneficiary the person to whom
the credit is transferred is known as the second beneficiary.

7
 PARTIES TO DOCUMENTARY CREDITS

• The Role of Beneficiary

• Establish the terms of payment when sales contract is being Negotiated.
• Assess the risk of non-payment even when compliant documents are
presented in the case of unconfirmed LCs.
• Provide the draft wordings to buyers regarding LC Terms.
• Scrutinize LC on receipt form the advising bank to check whether it is in
consonance with the sales contract and whether it is otherwise workable
and acceptable to him.
• Request for LC amendments from buyers.
• Provide copy of the credit to dispatch department and cargo agent to
ensure correct documentation.

8
 PARTIES TO DOCUMENTARY CREDITS
• 2. Bankers
• Issuing Bank
• The issuing bank or the opening bank is one which issue the credit, i.e.
undertake, independent of the undertaking of the applicant, to make
payment provided the term and conditions of the credit have been
complied with.
• Advising Bank
• The advising bank advises the credit to the beneficiary thereby
authenticating the genuineness of the credit
• Confirming Bank
• A confirming bank is the one which adds its guarantee to the credit. It
undertakes the responsibility of payments/negotiation/acceptance under the
credit in addition to that of the issuing bank.

9
 PARTIES TO DOCUMENTARY CREDITS
• Nominated Bank
• A Nominated bank is the bank authorized/nominated by issuing bank to pay, to
incur a deferred payment liability, to accept drafts or to negotiate the credit.
• When exporters make a drawing under a letter of credit, the presented documents
(bill of lading, invoice, packing list, certificate of origin, etc.) should usually be
accompanied by a draft, which is basically a cheque, representing demand for
payment. The draft or Bill of Exchange is drawn and signed by the exporter
(seller). The terms of the draft are “at sight” or a number of days after sight or
after the bill of lading date
• Reimbursing Bank
• A reimbursing bank is the bank authorized to honour the reimbursement
claims in settlement of negotiation with the paying or accepting bank.
• 3. Related Parties
• Insurer
• The insurer has the prime responsibility for insuring the goods as provided
for in the credit.
• Carrier
• The carrier , i.e. the shipping company or road transport agency is
10
responsible for safe arrival of goods at the destination.
 TYPES OF DOCUMENTARY CREDIT
• A. Confirmed and Unconfirmed Documentary Credit
• 1. Confirmed Documentary Credit
• A confirmed letter of credit is a letter of credit on which at least two banks
namely the issuing bank and the confirming bank are obliged to make
payment.
• It directly creates the obligation of a financing agency doing business in
the seller's financial market to a contract of sale.
• Confirmation at the request of the Seller.
• 2. Unconfirmed Letter of Credit
• Unconfirmed Letter of Credit. A letter of credit which has not been
guaranteed or confirmed by any bank other than the bank that opened it.
• The advising bank merely informs the beneficiary of the letter of credit
terms and conditions.

11
 STAGES IN PERFORMANCE OF LETTER OF
CREDIT

• STAGES IN PERFORMANCE OF LETTER OF CREDIT

• Stage 1 Opening of letter of credit(Application for LC)
• Stage 2 Mailing of LC to Beneficiaries bank
• Stage 3 Examination of LC by Exporter
• Stage 4 Amendments to LCs
• Stage 5 Confirmation
• Stage 6 Shipment
• Stage 7 Collection of Documents by the shipper
• Stage 8 Presentation of Documents to the nominated bank
• Stage 9 Examination of Documents by Issuing Bank
• Stage 10 Handling of Discrepant Documents
• Stage 11 Settlement of Payment

12
 GENERAL DOCUMENTS UNDER
DOCUMENTARY CREDITS
• Commercial Invoice
• Packing List
• Bill of leading and other transport documents
• Certified of Origin
• Inspection Certificate
• Bill of Exchange
• Insurance Documents

13
• Step 1: Buyer and seller conclude the sales contract and agreed to use an
LC as the method of payment.

• Step 2: Buyer approaches the Issuing Bank to issue an LC on his behalf

in favour of the seller with all the terms and conditions specified.

• Step 3: Issuing Bank issues the LC and requests the advising bank to
advise or confirm the credit to the LC beneficiary (seller).

• Step 4: Advising/confirming bank authenticates the LC and sends the LC

to the LC beneficiary.
• Step 5:Seller prepares and despatches the goods to the buyers country.

• Step 6:Seller presents the draft and/or documents to the nominated bank

• Step 7: Nominated (nominated as the negotiating bank)Bank checks

documents presented against the LC terms and Conditions an seeks
instruction from seller on documentary discrepancies.

• Step 8a: Nominated Bank forward the draft and/or documents to the
issuing Bank.

• Step 8b: If documents are free from discrepancies are supposed by

sellers indemnity, nominated bank claims reimbursement from the
appointed reimbursing bank.
• Step 8c: Reimbursing bank pays the nominated bank against a valid
reimbursement authority received from the issuing bank and statement
from negotiating bank that the documents complied with LC terms.

• Step9 : Nominated Bank credits the net proceeds into the sellers account.

• Step10 : Issuing Bank checks documents presented against the LC terms

and conditions. If documents are free from discrepancies, Issuing Bank
reimburses bank.

• Step11 : Issuing Bank presents documents to the buyers for payment.

• Step12 : Once payment is received from the buyer, Issuing Bank releases
documents to the buyer for latter to collect his goods.
 THE PAYMENT STRUCTURE
• 1. Sight Credit
• In this, the payment is released to beneficiary on presentation of
documents.
• 2. Acceptance Credit
• In this, beneficiary draws the bill of exchange on issuing bank and allows
some time for acceptance.
• 3. Deferred Credit
• Is same as Acceptance Credit except there is no bill of exchange.

20
• Revocable and Irrevocable Letter of Credit
• A revocable letter of credit can be changed or cancelled by the bank that
issued it at any time and for any reason. 
• An irrevocable letter of credit cannot be changed or cancelled unless
everyone involved agrees. 
• Irrevocable letters of credit provide more security than revocable ones.
• An unconfirmed irrevocable letter of credit provides a commitment by
the issuing bank to pay, accept, or negotiate a letter of credit. An advising
bank forwards the letter of credit to the beneficiary without responsibility
or undertaking on its part but confirming its authenticity.
• Irrevocable Confirmed LC
• A letter of credit issued by a bank on behalf of
a buyer that guarantees payment for goods receive, that is also guaranteed
by the bank. This type of letter of credit provides the lowest risk for
the seller, since it cannot be cancelled by the buyer, and it is backed by
the financial resources of the issuing bank.
• Sight LC and Time /Usance LC
• A sight LC causes payment to be made immediately to the
beneficiary/seller/exporter upon presentation of the correct documents.
• Usance LC also known as Deferred Payment Letter of Credit or
Time LC or Term LC is a letter of credit payable at a predetermined
time / future date after the conforming documents are presented.
•  Red Clause Letter of Credit is a specific type of letter of credit in which
a buyer extends an unsecured loan to a seller. Red Clause Letters of Credit
permit documentary credit beneficiaries to receive funds for any
merchandise outlined in the letter of credit.
• Revolving Credit is Instead of arranging a new L/C for each separate
shipment, the buyer establishes a L/C that revolves either in value (a fixed
amount is available which is replenished when exhausted) or in time (an
amount is available in fixed installments over a period such as week,
month, or year).
• Transferable letters of credit should be issued in an irrevocable form.
A letter of credit can be transferred to the second beneficiary at the request
of the first beneficiary only if it expressly states that the letter of credit is
"transferable". A bank is not obligated to transfer a credit.
• Back-to-back letters of credit are actually made up of two distinct LCs,
one issued by the buyer's bank to the intermediary and the other issued by
the intermediary's bank to the seller.
• Because the two letters of credit are linked and dependent on one another,
they are back-to-back letters of credit. It is important to note that back-to-
back letters of credit typically mirror each other; that is, they have the same
shipping, inspection, and other terms. In this regard, the first letter of credit
becomes the collateral for the second letter of credit.
•  Standby letter of credit (SLOC) is a guarantee of payment issued by a
bank on behalf of a client that is used as "payment of last resort" should the
client fail to fulfill a contractual commitment.