LETTER OF CREDIT

A letter of credit is a letter from a bank guaranteeing that a buyer's payment to a seller will be
received on time and for the correct amount. In the event that the buyer is unable to make a
payment on the purchase, the bank will be required to cover the full or remaining amount of
the purchase. It is also known as documentary credit or bank commercial credit

PARTIES INVOLVED IN LETTER OF CREDIT

 Buyer / Importer (herein after called “The Applicant”)

The Applicant means the importer (buyer) who requests a bank to issue a Letter of Credit.
 Seller / Exporter(herein after called “The Beneficiary”)
The Beneficiary means the exporter (seller) who finally ships the goods and receives the
payment on fulfillment of terms and conditions laid down in the Letter of Credit.
 The Issuing Bank:
The issuing bank( Importer’s Bank) issues the L/C and makes the payment on behalf of importer
as per the terms and conditions prescribed in L/C. The exporter may negotiate with the buyer
to select a particular bank (if possible) for issuance of the L/C and may ask the Advising Bank if it
has a corresponding bank in the buyer’s country and suggest that bank to the buyer as the
issuing bank. It is not necessary that the issuing bank shall be the same bank where the buyer
or the seller has a commercial account. It can be any other bank, mutually agreed upon by the
importer and exporter.
 The Advising Bank:
Advising bank is usually in the country of the seller. The Advising Bank advises the exporter /
seller / beneficiary that an L/C is received from the issuing bank and provides information on
terms and conditions of the L/C. The advising bank is not responsible for any payment under
L/C.
TYPES OF LETTER OF CREDIT
 Irrevocable LC. This LC cannot be cancelled or modified without consent of the
beneficiary (Seller). This LC reflects absolute liability of the Bank (issuer) to the other
party.
 Revocable LC. This LC type can be cancelled or modified by the Bank (issuer) at the
customer's instructions without prior agreement of the beneficiary (Seller). The Bank will
not have any liabilities to the beneficiary after revocation of the LC.
 Stand-by LC. This LC is closer to the bank guarantee and gives more flexible collaboration
opportunity to Seller and Buyer. The Bank will honor the LC when the Buyer fails to fulfill
payment liabilities to Seller.
 Confirmed LC. In addition to the Bank guarantee of the LC issuer, this LC type is confirmed
by the Seller's bank or any other bank. Irrespective to the payment by the Bank issuing
the LC (issuer), the Bank confirming the LC is liable for performance of obligations.
 Unconfirmed LC. Only the Bank issuing the LC will be liable for payment of this LC.
 Transferable LC. This LC enables the Seller to assign part of the letter of credit to other
partIES). This LC is especially beneficial in those cases when the Seller is not a sole
 manufacturer of the goods and purchases some parts from other parties, as it eliminates
the necessity of opening several LC's for other parties.
 Back-to-Back LC. This LC type considers issuing the second LC on the basis of the first
letter of credit. LC is opened in favor of intermediary as per the Buyer's instructions and
on the basis of this LC and instructions of the intermediary a new LC is opened in favor of
Seller of the goods.
 Payment at Sight LC. According to this LC, payment is made to the seller immediately
(maximum within 7 days) after the required documents have been submitted.
 Deferred Payment LC. According to this LC the payment to the seller is not made when
the documents are submitted, but instead at a later period defined in the letter of credit.
In most cases the payment in favor of Seller under this LC is made upon receipt of goods
by the Buyer.
 Red Clause LC. The seller can request an advance for an agreed amount of the LC before
shipment of goods and submittal of required documents. This red clause is so termed
because it is usually printed in red on the document to draw attention to "advance
payment" term of the credit.
ADVANTAGES/DISADVANTAGES OF LETTER OF CREDIT
LC is a complex product for new importers & exporters. It’s ideal to check the advantages and
disadvantages of a letter of credit (LC) before opting for it. A letter of credit is highly
customizable and enables new trade relationships by reducing credit risk, but it can add to the
cost of doing business in the form of bank fees and formalities. Let’s see its benefits and
drawbacks in details:
Advantages
 Safely expand business internationally
 Highly customizable
 Seller receive money on fulfilling terms
 Works as a credit certificate for buyer
 Seller if free of credit risk
 Quick to execute credit worthy parties
Disadvantages
 Additional cost-bank fee
 Time consuming formalities
 Possibility of misuse
 Current risk
 Time bound
 Risk of default by issuing bank
STEPS TO OPEN LETTER OF CREDIT
STEP 1
Importers select the product which can be import legally and select the supplier
Step 2
Agreement between purchaser (applicant)and supplier (beneficiary)on stamp paper
Step 3
The applicant and beneficiary negotiate terms and conditions of LC as per the agreement they
have made
Step 4
The applicant applies to the issuing bank to issue LC on an application form
Step 5
.the issuing banks require the following document from the applicant
 Formal contract between importer and exporter
 Pro form a invoice
 Buyers purchase order
After inspecting all these documents bank issues the LC and forward it to advisory bank
Step 6
The advisory bank checks the apparent authenticity of the LC and advises the LC to the
beneficiary
Step 7
The beneficiary checks if the LC complies with the formal contract and if all the terms and
conditions specified in LC can be satisfied and ships the goods to the importer
Step8
The beneficiary assemble the documents specified in LC , checks the documents for
discrepancies with the LC ,draws the draft and present the draft and documents to the advisory
bank
Step 9
The advisory banks inspects the draft and the documents against terms and conditions of LC
and forward them to issuing bank
Step 10
The issuing bank checks if the documents comply with the LC and makes a payment
immediately (if LC is available by sight) or on certain date (if LC is available by deferred
payment