ch11 | Letter Of Credit | Credit (Finance)


‡ Topics to be Discussed in Chapter
± Letter of Credit
‡ Uniform Customary and Practices for Documentary Credits

± Standby Letters of Credit ± Alternative Methods of Guaranteeing Performance ± Alternative Methods of Financing
‡ Seller ‡ Buyer ‡ Government Programs

. ± Purposes ‡ Guarantees payment by the buyer (letter of credit) or to guarantee performance by seller (standby letter of credit.LETTERS OF CREDIT ‡ Letters of Credit a commercial bank guarantee of either payment by the buyer or performance by the seller. ‡ Once letter of credit is issued. the seller can use instrument to finance production of goods.

LETTERS OF CREDIT ‡ Functions of Letters of Credit ± Payment Instrument ‡ In absence of letter of credit. sight or time drafts used. ± Payment by bank would not be released until goods and document conforms to specifications on letter of credit. ± Letters of Credit Involves Bank in Transaction. ± Finance Instrument ‡ Seller can use letter of credit as collateral to finance production and exportation of good. . No Guarantee of Payment. ± Performance Guarantee ‡ In Documentary Transaction no guarantee of performance.

must get written agreement. ‡ Most Popular in International Commercial Transaction ± Revocable Letter of Credit-bank can revoke letter of credit.LETTERS OF CREDIT ‡ Types of Letters of Credit ± Irrevocable Letter of Credit-bank cannot revoke letter of credit. To change letter of credit. . ‡ Very Seldom Used.

Freight Forwarder prepares documents. ‡ US bank prepares a letter of confirmation to exporter along with irrevocable letter of credit ‡ Exporter arranges for freight forwarded to deliver goods. Bank bound by ³rule of strict compliance´ ‡ Bank reviews documents and authorizes payment . ‡ Buyer¶s bank sends irrevocable letter of credit to a US bank for confirmation. buyer arranges for bank to open letter of credit.LETTERS OF CREDIT ‡ Letter of Credit Transaction ‡ After formation of contract. ‡ Buyer¶s bank prepares irrevocable letter of credit. ‡ Exporter presents document to Bank indicating full compliance.

The applicant must specify that the letter be confirmed The currency of the letter of credit should be designated using ISO currency code.UNIFORM CUSTOMS AND PRACTICES FOR DOCUMENTARY CREDITS ‡ Uniform Customs and Practices for Documentary Credits are rules and procedure published by International Chamber of Commerce ± Provisions ‡ ‡ ‡ ‡ Care should be taken in specifying expiration dates The applicant must specify if the letter of credit is transferable. ‡ The applicant should designate the nominating bank .

banks are authorized to reject documents if there are any discrepancies. ‡ Facial Compliance Rule-bank only required to review documents. ± The letter of credit should provide transport details ± Under ³rule of strict compliance´. ± Applicant must specify clearly whether the letter of credit will be available for partial shipment. ‡ Banks are not required to investigate trade customs or usage .UNIFORM CUSTOMS AND PRACTICES FOR DOCUMENTARY CREDITS ‡ Uniform Customs and Practices for Documentary Credits-provisions continued.

± Time periods for presentation of documents must be specified. should list the contents of each document.UNIFORM CUSTOMS AND PRACTICES FOR DOCUMENTARY CREDITS ‡ Uniform Customs and Practices for Documentary Credits-provisions continued ± Description of the Goods should be clear and brief as possible. ± Insurance Documents must be clear. ± Transportation Documents must be clear. ± In the listing of documents. ± Title of Letter of Credit should specify irrevocable. .

STANBY LETTER OF CREDIT ‡ Standby Letter of Credit is a letter of credit that represents an obligation to the beneficiary on the part of the issuer ± International Standby Practices ± Standby Letters of Credit secures contractual obligations in construction contracts. warranties. counter-trade trade obligations. service contracts. . secures international loans and supplies.

‡ Bid Bond-insure against the risk that a bidder may not honor its bid. ‡ Credit Surety-guarantees the repayment to a bank or lender who finances an export transaction or development project. Exim Bank of World Bank .ALTERNATIVE METHODS OF GUARANTEEING PERFORMANCE ‡ Alternative Methods of Guaranteeing Performance ± Types ‡ Performance Bond-a guarantee from an insurance company to pay insured in case of default.

a percentage is deducted from each payment due to the supplier or contractor and is retained in a fund pending completion of project.ALTERNATIVE METHODS OF GUARANTEEING PERFORMANCE ‡ Types-Continued ± Retention Fund-in large or government projects. ± Demand Guarantee secures performance of a non-monetary obligation. .

‡ Back to Back Letter of Credit-buyer makes arrangements with third bank to make loan. ‡ Forfaithing-selling at a discount.SOURCES OF TRADE FINANCE ‡ Commercial Banks ± Export Financing ‡ Borrowing against trade documents ‡ Factoring-exporter transfers title to its account receivable to a factoring company at a discount. ‡ Transferable Credit-suppliers accept part of the letter of credit that seller receives from buyer in export transaction. of longer term receivables or promissory notes to a foreign buyer. .

SOURCES OF TRADE FINANCE ‡ Government Assistance Programs ± Eximbank in United States± Arranges loans. working capital and insurance ± Foreign Corporation Insurance Agency ± Protects against default on exports sold under open accounts ± Overseas Private Insurance Corporation ± Offers performance bonds ± Small Business Administration ± Revolving line of credit . guarantees.

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