Financing of Imports

Bank Guarantees and Letters of Credit

Introduction
• It is regulated by Directorate General Foreign Trade
• Opening letters of credit
• Retiring import bills received under LC
• Handling import bills on collection
• Making advance payment towards imports on behalf of their
customers.
Letter of Credit:

Letter of Credit means any arrangement, that is irrevocable and thereby

constitutes a definite undertaking of the issuing bank to honor a
complying presentation
Letter of Credit - Procedure
1. Sales Contract between Buyer and seller
2. Application submitted by the buyer ( importer) to his Bank for an LC
3. Buyer’s Bank delivers LC to Corresponding/ Advising bank
4. Advising Bank advises LC to the Exporter
5. Exporter ships goods to the buyer ( hands over goods to the
shipping company)
6. a. Bill of lading handed over to the exporter by the shipping
company
b Goods sent to the port of discharge
7. Documents including the Bill of lading handed over to the exporter bank
8. Documents sent to Importer bank by the Exporter bank
9. Draft accepted by the importer if DA. If DP, funds released by the importer
bank to exporter bank
10. Payment to exporter
11a. Documents released to the buyer against payment or against acceptance
b. Payment to issuing bank immediately if DP and after completion of usance
period if DA
12. Bill of lading to the shipping company
13 Cargo released
Parties to a letter of credit

• applicant 
• beneficiary 
• issuing bank/ reimbursing bank (bank of the applicant)
• confirming bank /advising bank, Negotiating /nominated bank  (bank
of the beneficiary)
Types of Letter of credits
• Revocable L/C , normally resorted between a parent and subsidiary where there is
hardly any risk of cancellation
• Irrevocable L/C : Most, if not all are these. Unless otherwise stipulated all LCs are
irrevocable
• Confirmed LC : confirmed by advising bank. ( no obligation to confirm amendments)-
the bank’s guarantee is available only if documents are in order. Confirmation means
a definite undertaking of the confirming bank, in addition to that of the issuing bank,
to honor or negotiate a complying presentation. Such LCs have guarantee of 2 banks
for the exporter. But all LCs are as good or as bad as the ability of the bank to pay
• Unconfirmed LC : not confirmed by advising bank
• Revolving credit : keeps rotating
Issuing bank :
Enter into correspondent arrangements with overseas banks for issue ,
reimbursing, payment etc. Issue LC with proper payment instructions. Pay
without recourse when credit complied documents are received. Hold the
documents at the disposal of negotiating bank in case of rejection.
Advising bank: Verify the authenticity of the LC received from issuing bank.
Advise LC without delay. Inform issuing bank immediately if authenticity
could not be established
Negotiating bank (nominated bank ) : negotiating the bills under LC and
paying the amount before getting reimbursement on date specified
Negotiation : 
 
Negotiation means the purchase by the nominated bank of drafts
(drawn on a bank other than the nominated bank) and/or documents
under a complying presentation, by advancing or agreeing to advance
funds to the beneficiary on or before the banking day on which
reimbursement is due to the nominated bank.  
Buyers Credit
• Buyer's credit is a short term credit available to an importer (buyer)
from overseas lenders , generally arranged by the importer from a
bank outside India.
• A is an importer and Y is the exporter. A wants credit terms, Y cannot
give credit. A will arrange for a bank in Ys country who will pay Y.
Generally that Bank agrees to pay only because A’s bank guarantees
the payment
• The overseas banks usually lend the importer (buyer) i.e pay the
supplier, based on the letter of comfort (a bank guarantee) issued by
the importer's bank.
Suppliers Credit
• Suppliers credit is a trade credit funded to the importer on basis of
Letter Of Credit (LC). Under the LC method of payment, the overseas
suppliers or financial institutions preferably from the seller's country
finances the importers at cheaper rates than the local source of
funding, which are close to Libor rates.
Financing of Exports
Post shipment and Preshipment Finance
Introduction
• The export transactions are required to be compulsorily routed
through an authorised dealer.
• Each export transaction has two parts viz. physical export of
commodities and service from India AND repatriation of proceeds into
India.
• While physical export of commodities is regulated by the Directorate
General for Foreign Trade (DGFT) through the ‘Exim Policy’,
repatriation of export proceeds is monitored by Reserve Bank of India
(RBI) through authorised dealers under Exchange Control Regulations.
Preshipment finance
Rupee
• Packing credit (clean)
• Shipping loan (Hypothecation)
• Shipping loan (Pledge)
Foreign Currency
• Preshipment
(Preshipment in rupees and post shipment by rediscounting of export bills abroad or
preshipment in foreign currency and post shipment under EBR – repayment by
purchasing currency is not allowed)
Post shipment Finance

• Export bills purchased/ discounted/negotiated

• Advances against export bills for collection
Release of preshipment Credit
Export orders / LCs
( verify the name of buyers, commodity, quantity, value, date of
shipment, terms of payment, destination of export, on whom the LC
stands ( applicant)

Running Account or against orders from 14th March , 1992 onwards

Requirements
( convince the bank of his capacity to execute orders)
• Past performance and future projections
• New exporters – domestic market
Import – Export Code (Import Export (IE) Code is a registration required for
persons importing or exporting goods and services from India. IE Code is issued by the Directorate
General of Foreign Trade (DGFT), Ministry of Commerce and Industries, Government of India). This is
done through the bank
• Caution / defaulters list of RBI and SAL of ECGCI Ltd
• Restricted cover country of ECGCI
Assessment
Credit Risk

• Properly introduced
• Good track record
• Export finance outstanding with other banks
• Overdue bills including collection bills
• Procurement of export orders
• Credit reports of the overseas buyers
Assessment
Commodity Risk
• Ready market
• Not banned or restricted

Country Risk
Against Order
• Current orders
• Release against particular order
• After keeping margin
• If LC is available then negotiation date and shipping date mentioned
in LC should be in currency
Running Account
• Good track record
• No orders at time of release
• Orders collected within reasonable time ( generally 30 days)
• No bills can be sent on collection ( no limit purchase but restrict pre
shipment finance)
• Realisation of bill on FIFO method basis.
Quantum of finance
• The quantum of finance will be fixed on the FOB value of the
contract/ LC or domestic value of the goods whichever is less after
deducting profit margin.
• Advance for freight and insurance charges will be released when
goods are ready for export
• FOB vs CIF vs CNF
• FOB – Free on Board (or Freight on Board). This basically means that
the cost of delivering the goods to the nearest port is included but the
buyer is responsible for the shipping from there and all other fees
associated with getting the goods to your country/address.
• CIF – Cost, Insurance and Freight. In this case, the price also includes
sea freight charges and insurance to deliver the goods to the buyer’s
port. But only to port – from that point onwards, the buyer takes the
shipment into his hands.
• CNF – Cost & Freight (or Cost, no Insurance, Freight). Similar to CIF
only this time insurance is not included.
Period of finance
Production cycle
• Upto the date of shipment mentioned in order/LC
• Shipment within 360 days from date of finance failing which the
finance will cease to qualify for any concession
(Banks have interest brackets for concessional interest within the 360 days)
End Use of funds
• Disbursements in stages
• Submission of stock statements
Liquidation of pre-shipment advance
• With export proceeds of the relevant shipment
• Pre to post
If export does not take place, then what?
Substitution of export contracts. Liquidation against export documents
of another order / different commodity. But relative bill should not
have pre shipment outstanding in any bank. Substitution of export
orders permitted from December 1994
Operational procedure
• There should be an order
• The credit should be liquidated from export proceeds
• Extended in stages/ ways depending on the nature of production-
initial stage-clean, then hypothecation. Seasonal purchase – pledge
• Produced in bulk - again hypothecation- pledge ( not raw materials
but finished goods ) to avoid blocking of funds for execution of further
orders
Difference between purchase/ discounted and negotiated

• DP bills ( demand) - purchased

• DA bills ( usance ) - discounted
• LC bills ( Demand or usance) - negotiated
Crystallisation of bills
• Why important ( to minimize the currency risk to the bank and transfer to
the exporter)
• Banks book forward contracts while they purchase foreign currency bills.
They have a commitment to deliver foreign currency funds on due date
whether export bill proceeds are realized or not.
• When bills (foreign exchange) is not surrendered on the due date, banks
have to purchase currency in the market to meet forward contracts. If
banks incur charges/ or gain they must pass it on to the borrower.
• Export bills remaining unpaid for a period of 30 days/60 days are to be
crystallised. The value converted to rupee.