Presentation on Lc

8/8/2019 Presentation on Lc

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What is a Letter of Credit?

A Letter of Credit is a payment term generally used for international salestransactions. It is basically a mechanism, which allows importers/buyers tooffer secure terms of payment to exporters/sellers in which a bank (or more

than one bank) gets involved. The technical term for Letter of credit is'Documentary Credit'. At the very outset one must understand is that Letters of

credit deal in documents, not goods. The idea in an international tradetransaction is to shift the risk. Thus a LC (as it is commonly referred to) is a

payment undertaking given by a bank to the seller and is issued on behalf of the applicant i.e. the buyer.

If I ship goods,will you pay?

Great!

If I pay,will youship thegoods

Ok, Ill askmy bank toopen a L/C CONTRACT OF SALE |

Importer Exporter


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Importer and Ex porter Importer and Ex porter en ter en ter in to a sal e sin to a sal e s ag reeme n tag reeme n t

AgreementExporter Importer


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IMPORTER APPLIES FOR LC

Id like to openan L/C.

You know that Banksdo not deal in the

merchandise that theLC covers. Banks

only deal indocuments

Yeah Yeah

Payment will only bemade if all terms and

conditions are metand there are NOdiscrepancies!


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The Buyer is the Applicant and the Seller is the Beneficiary.The Bank that issues the LC is referred to as the Issuing Bank

which is generally in the country of the Buyer. The Bank that Advises the LC to the Seller is called the Advising Bank whichis generally in the country of the Seller.

The specified bank makes the payment upon the successfulpresentation of the required documents by the seller within thespecified time frame. Note that the Bank scrutinizes the'documents' and not the 'goods' for making payment. Theprocess works in favor of both the buyer and the seller.

Th e proce ss


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7. D ocume n ts

3 . Letter of Cre di t

App lican t Importer/Buyer

Ex porter s Bank / Advising Bank

Importer s Bank / Iss u ing Bank

Buyer & S e ller Ag ree

6 . D ocume n ts 8 .

D ocume n ts

2 .App lica tion

1 . 1 .

5. P ro d uct is Shi ppe d

2 .

9.

10 .

Ex port Letter of Cre di t Cyc le

4 .Letter of

Cre di t

Be n ef ic ia ryEx porter/ S e ller


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W h y us e a L etter of Cre di t?The need for a letter of credit is a consideration in the course of negotiationsbetween the buyer and seller when the important matter of method of payment

is being discussed.Payment can be made in several different ways: by the buyer remitting cashwith his order; by open account whereby the buyer remits payment at anagreed time after receiving the goods; or by documentary collection through abank in which case the buyer pays the collecting bank for account of the seller in exchange for shipping documents which would include, in most cases, the

document of title to the goods.In the aforementioned methods of payment, the seller relies entirely on thewillingness and ability of the buyer to effect payment. When the seller hasdoubts about the credit-worthiness of the buyer and wishes to ensure promptpayment,the seller can insist that the sales contract provides for payment byirrevocable letter of credit. Furthermore, if the bank issuing the letter of credit

(issuing bank) is unknown to the seller or if the seller is shipping to aforeigncountry and is uncertain of the issuing banks ability to honour its obligation,the seller can, with theapproval of the issuing bank, request its own bank or a bank of international repute such as Scotiabank to assume the risk of theissuing bank by confirming the letter of credit


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Basi c Type s of Letter s of Cre di tThere are three basic features of letters of credit, each of which has twooptions. These are described below.

Each letter of credit has a combination of each of the three features.

S IGHT OR TERM /USANCELetters of credit can permit the beneficiary to be paid immediately upon

presentation of specified documents (sight letter of credit), or at a futuredate as established in the sales contract (term/usance letter of credit).

REVOCA BLE OR IRREVOCA BLE

Letters of credit can be revocable. This means that they can be cancelled

or amended at any time by the issuing bank without notice to thebeneficiary. However, documents negotiated before notice of cancellationor amendment must be honoured by the issuing bank.


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Irre voc abl e An irrevocable letter of credit can neither be amended nor cancelled withoutthe agreement of all parties to the credit. Under UCP500 all letters of credit aredeemed to be irrevocable unless otherwise stated. Here, the importer's bankgives a binding undertaking to the supplier provided all the terms andconditions of the credit are fulfilled.

REVOCA BLE OR IRREVOCA BLE ,,,,,, co n t


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UNCONF IRME D OR CONF IRME D

An unconfirmed letter of credit carries the obligation of the issuing bank

to honour all documents, provided that the terms and conditions of theletter of credit have been complied with.

Un co n f irme d Sigh t Letter Of Cre di tWith an unconfirmed sight letter of credit, payment of funds flows fromthe applicant (buyer) to the beneficiary (seller).

Applicant BENEFICIARY

ISSUINGBANK

NEGOTIATINGBANK


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UNCONF IRME D OR CONF IRME D

A confirmed letter of credit also carries the obligation of another bank

which is normally located in the beneficiarys country, thereby giving thebeneficiary the comfort of dealing with a bank known to him.Con f irme d Sigh t Letter Of Cre di tWith a confirmed sight letter of credit, the payment of funds also flowsfrom the applicant (buyer) to the beneficiary (seller). However, thepayment made by the negotiating/confirming bank is made without

recourse to the beneficiary.

Applicant BENEFICIARY

ISSUINGBANK

NEGOTIATINGBANK/CONFIRMING

BANK


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Con f irme d

A confirmed letter of credit is one in which the advising bank, on theinstructions of the issuing bank, has added a confirmation that payment willbe made as long as compliant documents are presented.

This commitment holds even if the issuing bank or the buyer fails to makepayment. A bank will make an additional charge for confirming a letter of credit. In many cases, the confirming bank is located in Beneficiarys

country.

Confirmation costs will vary according to the country involved, but for manycountries considered a high risk will be between 2%-8%. There also may becountries issuing letters of credit, which banks do not wish to confirm - theymay already have enough exposure in that market or not wish to exposethemselves to that particular risk at all.


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So far a description has been provided of the basic types of letters of credit used to cover the shipment of goods. In addition to these basictypes, there are various specialized formats which meet particular sets of circumstances.Red Cla u s e Letter of Cre di t

A red clause letter of credit incorporates a clause, traditionally written inred, which authorizes the bank acting as the negotiating or paying bank to

pay the beneficiary in advance of shipment. This enables the purchaseand accumulation of goods from a number of different suppliers, and thearrangement of shipment in accordance with the letter of credit terms.Such advances will be deducted from the amount due to be paid when thedocuments called for are presented under the letter of credit. If thebeneficiary fails to ship the goods or cannot do so before the expiry of the

letter of credit, the issuing bank is bound to reimburse the negotiating or paying bank, recovering its payment from the applicant.

Beneficiaries of red clause letters of credit are invariably brokers/agents of buyers in a particular field.

S P EC IAL TY P ES OF LETTERS OF CRE D IT


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Tr ans fer abl e Letter of Cre di t A transferable letter of credit allows the beneficiary to act as a middleman andtransfer his rights under a letter of credit to another party or parties who may be

suppliers of the goods. Depending on whether the letter of credit permits partialshipments, fractional amounts may be transferred to more than one beneficiary.The letter of credit however, can be transferred only once: the secondarybeneficiaries cannot transfer their rights to a third party. Transfer of a letter of credit can be made on specific application by the original beneficiary to theauthorized transferring bank.

Revo lving L etter of Cre di t The revolving credit is used for regular shipments of the same commodity tothe same importer. It can revolve in relation to time or value. If the credit is timerevolving once utilised it is re-instated for further regular shipments until thecredit is fully drawn. If the credit revolves in relation to value once utilised and

paid the value can be reinstated for further drawings. The credit must state thatit is a revolving letter of credit and it may revolve either automatically or subjectto certain provisions. Revolving letters of credit are useful to avoid the need for repetitious arrangements for opening or amending letters of credit.


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Ba ck- to -Ba ck L etter of Cre di t

Although not recorded on a letter of credit, back-to-back is a termused in transactions involving two irrevocable letters of credit.Such transactions originate when a seller receives a letter of creditcovering goods which must be obtained from a third party who in turnrequires a letter of credit. The second issuing bank looks to the first

issuing bank for reimbursement after paying under the second letter of credit.

The difference between back-to-back letters of credit and transferableletters of credit, is such that in a transferable letter of credit, the rightsunder the existing letter of credit are transferred. In a back-to-back

transaction, different letters of credit are actually issued. Becausetechnical problems can arise in back-to-back transactions, banks tendto discourage their use.


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D eferre d P a yme n t Letter of Cre di t(Us uan ce)Under a deferred payment letter of credit, the applicant does not pay until afuture date determined in accordance with the terms of the letter of credit.

No drafts are called for, which avoids stamp duties charged by somecountries on bills of exchange (drafts). One reason an exporter might extendcredit terms to an importer could be the competitiveness of the market andthe need for the exporter to finance the importer if the exporter is to makethe sale.

OT HER TY P ES OF LETTERS OF CRE D IT

The letters of credit described thus far cover the movement of goods from onedestination to another. There are other types of letters of credit which are notspecifically related to the movement of goods.The principal one is as follows:


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S tandb y Letter s of Cre di t

Standby letters of credit may apply in general to transactions which arebased on the concept of default by the applicant in performance of acontract or obligation. In the event of default, the beneficiary ispermitted to draw under the letter of credit.Standby letters of credit may be used as a substitute for performanceguarantees, or issued to guarantee loans granted by one firm toanother, thereby securing payment to the creditor in the event the other party fails to repay its obligation on the due date.Even if the applicant claims to have performed, the bank issuing theletter of credit is obliged to make payment provided the beneficiaryproduces complying documents, usually a sight draft, and a writtendemand for payment.


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P ART IES INVOLVE D IN ALETTER OF CRE D IT TRANSACT ION

In order to help the reader understand the steps taken in a letter of credittransaction, the following is a brief description of the parties most commonlyinvolved in letters of credit.Accept ing Bank The bank named in a letter of credit on whom term drafts aredrawn and who indicates acceptance of the draft by dating and signing across

its face, thereby incurring a legal obligation to pay the amount of the draft atmaturity.

Advising Bank A branch or correspondent bank at or near the domicile of thebeneficiary,to which the issuing bank either sends the letter of credit, or a notification

that a letter of credit has been issued, with instructions to notify thebeneficiary. The advising bank advises the beneficiary of the letter of creditwithout engagement.


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App lican t The buyer or the party who requests the letter of credit to be issued.Be n ef ic ia ry The seller or the party to whom the letter of credit is addressed.

Con f irm ing Bank A bank usually in the country of the beneficiary which, at therequest of the issuing bank, joins that bank in undertaking to honour drawingsmade by the beneficiary, provided the terms and conditions of the letter of credithave been complied with.

Dis cou n ting Bank A bank which discounts a draft for the beneficiary after it hasbeen accepted by an accepting bank.

D r aw ee Bank The bank named in the letter of credit on whom drafts are to bedrawn.

D r aw er The beneficiary of the letter of credit who will draw the draft inaccordance with the terms of the letter of credit.

Iss u ing Bank The bank which opens a letter of credit on behalf of the applicantand forwards it to the advising bank for delivery to the beneficiary.


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Neg ot ia ting Bank Usually the beneficiarys bank which, after satisfying itself that the documents conform with the letter of credit, agrees to purchase the

draft (pay the beneficiary).

P a ying Bank The bank named in the letter of credit where drafts are to bepaid. It is not necessarily the issuing bank, but often a branch of the issuingbank or its correspondent. Once drafts have been paid or accepted by thepaying/drawee bank, there is no recourse to the drawers.

Re imb ur sing Bank The bank authorized by the issuing bank to reimburse thedrawee bank or other banks submitting claims under the letter of credit.


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D OC UMENTS US UALLY REQ UIRE D UND ER A LETTER OF CRE D IT

There is no limit to the number and variety of documents which letters of

credit may stipulate. The following is a list of documents most commonlyseen in a letter of credit transaction. Each document is described in brief with a check-list for preparing the document.

The beneficiary should, on first being advised of the letter of credit, examineit carefully and be satisfied that all the documentary requirements can be

complied with. Unless the documentary requirements can be strictlycomplied with, the beneficiary may not receive payment from the issuingbank.If there are any requirements that cannot be complied with, the beneficiaryshould immediately request the applicant to arrange for an appropriateamendment to the letter of credit.D r a ft

A draft is a bill of exchange and a legally enforceable instrument which maybe regarded as the formal evidence of debt under a letter of credit. Draftsdrawn at sight are payable by the drawee on presentation.

Term (usance) drafts, after acceptance by the drawee, are payable on their indicated due date.


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Sigh t 20

P a y to th e or d er of $

D o lla r s

To

At January 5 00

ABC Exporter 8,020.00

Eight Thousand Twenty Dollars and 00/100

Standard Chartered Bank

New York, NY

ABC Exporter

D RAFT

Drawn under Documentary Credit No. M0491110NS00616, of theStandard Chartered Bank, Seoul, Korea, dated September 17, 1999

Endorse theback!


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There are two different types of bill of lading: A STRAIGHT BILL OF LADING is one that names a specific consignee to

whom goods are to be delivered. It is a non-negotiable document.

An ORDER BILL OF LADING is one that is written to order or to order of anamed party making the instrument negotiable by endorsement. Letters of credit usually call for an order bill of lading blank endorsed, meaning the holder of the bill of lading has title to the goods.

Given that each bill of lading must be either straight or order, the followingis a list of more common types of bill of lading:An OCEAN BILL OF LADING isone issued by an ocean carrier in sets, usually three signed originalscomprising a complete set, any one of which gives title to the goods. Oceanbills of lading may be issuedin straight or order form.

A SHORT FORM BILL OF LADING is one issued by a carrier which does notindicate all the conditions of the contract of carriage. This is acceptable unlessotherwise specified in the letter of credit.


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A CHARTER PARTY BILL OF LADING, is one which shippers may, when large or

bulk cargoes are concerned, lease the carrying vessel for a stated time or specificvoyage under a charter party contract with the owner. Goods carried are thencovered under a form of bill of lading issued by the charterer andindicate as being shipped, subject to the term and conditions of the charter party.Charter party bills of lading are not acceptable unless specifically authorized by theletter of credit.

A MULTIMODAL TRANSPORT DOCUMENT is one covering shipments by atleast two different modes of transport.

Air W a ybill An air waybill is a receipt issued by an air carrier indicating receipt of goods to betransported by air andshowing goods consigned to a named party. Being a non-negotiable receipt it is nota document of title.


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Ins ur an ce P o licy or Cert if ica teUnder the terms of a CIF contract, the beneficiary is obliged to arrange insuranceand furnish the buyer with the appropriate insurance policy or certificate. Theextent of coverage and risks should be agreed upon between the buyer andseller in their initial negotiations and be set out in the sales contract.Since the topic of marine insurance is extremely specialized and with conditionsvarying from country to country, the services of a competent marine insurance

broker are useful and well-advised.

Cert if ica te of Or igin As the name suggests, a certificate of origin certifies as to the country of origin of the goods described andshould comply with any stipulations in the letter of credit as to originating country

and by whom the certificateis to be issued. The certificate should be consistent with and identified with theother shipping documents byshipping marks and numbers, and must be signed.


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Ins pect ion C ert if ica te

When a letter of credit calls for an inspection certificate it will usuallyspecify by whom the certificate is to be issued; otherwise, the samegeneral comments as in the case of the certificate of origin apply.

As a preventative measure against fraud or as a means of protecting thebuyer against the possibility of receiving substandard or unwanted goods,

survey or inspection certificates issued by a reputable third partymay be deemed prudent. Such certificates indicate that the goods havebeen examined and found to be as ordered.

P a cking Lis t A packing list is usually requested by the buyer to assist in identifying the

contents of each package or container. It must show the shipping marksand number of each package. It is not usually required to besigned.


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