Letter of credit

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 payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase. Definition A letter of Credit is the Buyers Bankers promise to the Bank of the Seller / Exporter that the bank will honor the Invoice presented by the Exporter on due date and make payment, when the buyer is unable to make payment on purchase.

Letter of credit
It is a way of reducing the payment risks associated with the movement of goods. Letters of credit are often used in international transactions to ensure that payment will be received.

o Why use a letter of credit - the use of letters of credit has become a very important aspect of international trade.
Due to the nature of international dealings including factors such as o distance differing laws in each country & difficulty in knowing each party personally

Letter of credit
Types of LOC there are five commonly used
type of letter of credit. Each has different features & some are more secure than others. The most common types are: 1- Irrevocable 2- Revocable 3- Unconfirmed 4- Confirmed & 5- Transferable

Types of LOC
Irrevocable

Revocable

TYPES OF LOC

confirmed

transferable

unconfirmed

Types of LOC contd..

1-Irrevocable- it cannot be changed without the written
consent of all parties including the beneficiary/exporter. 2- Revocable it can be change or withdrawn without notifying the beneficiary (exporter). 3- Confirmed - in which another bank apart from the issuing bank has added its guarantee. -Although it is costly but more beneficial for beneficiary as it doubles the guarantee. 4- Unconfirmed which has not been guaranteed or confirmed by any bank apart from the issuing bank.

Types of LOC contd..

5- Transferable LOC- can be passed from one 'beneficiary' (person receiving payment) to others.

Other types of LOC

Revolving letters of credit A single revolving letter of credit can cover several transactions between the same buyer and seller.

Issuance of letter of credit/steps

Buyer/importer

1
Purchase & sales agreement

Seller/exporter

2
Request for letter of credit

4
Advise of letter of credit

3
Request to advise & possibly confirm the letter of credit

Issuing bank

Advising/confirming bank

Payment under a LOC

Advantage of LOC for Importer/buyer

Importer is assured that the Exporter will be paid only if all terms and conditions of the Letter of Credit have been met. Importer is able to negotiate more favorable trade terms with the Exporter when payment by Letter of Credit is offered. Disadvantage - A Letter of Credit does not offer protection to the Importer against the Exporter shipping inferior quality goods and/or a lesser quantity of goods

advantage of LOC for exporter/seller

No risk from buyer side Timely payment

Disadvantage - Some Importers may not be able

to open Letters of Credit due to the lack of credit facilities with their bank which consequently inhibits export growth Documents must be prepared and presented in strict compliance(follow) with the requirements stipulated(rules) in the Letter of Credit.