Letter of Credit-Types, Procedure & Modalities
Facilitating international trade is the most important activity of international banking.
Exporter (seller) and Importer (buyer) important players in international activity.
are two trading
Requirements of Exporter and Importer What the seller (exporter) wants
3) Contract fulfillment (payment) 4) Convenience (of Receiving payment in a bank in his own country) 5) Prompt Payment 6) Expert Advice.
What the buyer buyer (Importer) wants
3) Contract fulfillment (Goods) 4) Convenience of using an intervening third party in whom both have confidence, such as a bank. 5) Credit -possibility of obtainin finance. 6) Expert advice and assistance.
Letter
of credit provides the mechanism to fulfill the above requirements of exporters and importers. Function of Letter of Credit: Letter of credit is one of the methods of financing international trade. Other methods-Open account method. Documentary collection and Payment in advance. Letter of Credit---Defined: A letter of credit can be defined as an instrument instr ument issued by th e bank furnishes its credit which by a bank in which the is both good and well known, k nown, in place of the buyer’s credit, which may be good but is not n ot so well known. ‘ ‘
A bank issues a letter of credit on behalf of one of its customers authorizing an individual or firm to draw draft (bill of exchange) on the bank or one of its correspondents for the bank’s account under certain conditions stipulated in the credit.
Article 2 of the ICC, Uniform Customs and Practices, brochure 500 defines a letter of credit as: ‘Any arrangement however named or described, whereby a bank issues a letter of credit on behalf of a customer the “Applicant “or on its own behalf,
Is to make payment to or to the order of a third party (the beneficiary) or is to accept and pay bills of exchange (draft) drawn by the beneficiary or
Authorizes another bank to effect such payment or to accept and pay such bills of exchange (draft) or
Authorizes another bank to negotiate against stipulated documents, provided the terms and conditions of the credit are complied with.
Bill of Exchange-(Draft)Defined
A bill of exchange is an instrument in writing containing an unconditional order, signed by the maker, directing a certain person, to pay on demand or at a fixed or determinable future time a certain sum of money only to or to the order of a certain certain person person or or to the bearer of the instrument.” “ “
A bill of exchange drawn payable to bearer can not n ot be not
made payable on demand.
Parties to a Documentary Credit: 1) Applicant (opener of L.C) 2) Issuing bank (opening bank) 3) Advising bank 4) 5)
Beneficiary (exporter or seller) Confirming bank.
6) Negotiating bank 7) Reimbursing bank
Modes of Payment of Letter of Credit i.
Available by negotiation or
iii. Available by acceptance or v. Available by sight payment or vii. Available by deferred payments
Types of Documentary Credits: i. Revocable Letter of Credit ii. Irrevocable Letter of Credit iii. Irrevocable Confirmed Letter of Credit iv. Revolving Credit v. Transferable Letter of Credit vi. Back to Back Letter of Credit vii. Red Clause or Packing Credit viii.Green Clause Letter of Credit ix. Stand by Credit
Issuing a Letter of Credit-Procedure i. ii. iii. iv.
L.C Application Form Indent Proforma invoice/Purchase Order Insurance cover note /Marine insurance policy Fixation of margin (depending on credit worthiness of applicant & SBP instructions regarding margin requirements) v. Credit report of exporter vi. Forward exchange booking (at request of importer) vii. Selection of foreign correspondent/Advising bank. viii. Transmission of letter of credit.
Inland Letter of Credit i.
L.C application form
ii. Performa Invoice, Indent/Order form iii. Insurance Cover note iv. Demand Promissory note Procedure for inland letter of credit is same as for international letter of credit. L.C is opened in Pak rupees and advised through local branch of issuing bank.
Commonsense Rules For Importer (buyer) & Exporter (seller) 1) The instructions to the issuing bank must be clear, correct and precise. 3) The terms and conditions and documents called for should be in agreement with sales contract.
1) He should study the credit in depth and request the changes at the earliest, if deemed necessary. 2) He should satisfy himself that terms and conditions and documents called for are in agreement with sales contract.
Commonsense Rules For Importer (buyer) & Exporter (seller)
1) Any examination/inspection of goods prior to shipment or at the evidenced by a document. the issuer of such inspection document must be stated in the credit.
7) The credit should not call for the documents which the seller can not provide, nor set out conditions that he can not meet.
1) When it is the time to present the documents: ii. He should present documents conforming to the terms and conditions as stipulated in the credit. iii. Present the documents within the validity of the credit and within the period as specified in the credit. 4) He must remember that noncompliance with terms stipulated in the credit or irregularities in the
Documentary Credits:Advantages & Problems: Advantages Advantages: Payment Secured (banks’ Advantages: undertaking), Low risk, General acceptability, Time saving instrument. Problems: Country risk, opening bank’s low rating, customers’ low rating, high charges etc.
How the exporter can minimize the problems —By insisting for confirmed L.C. Course of action when an exporter has Presented documents which do not Conform to the credit: c) Exporter may ask advising bank to send the documents to issuing bank on collection basis. d) Exporter can ask the negotiating bank to negotiate the discrepant documents against indemnity or guarantee of the exporter. e) The advising bank can approach the issuing bank for waiver of discrepancies.
Flow chart - Letter of Credit Process Importer (account party)
Exporter (beneficiary)
Importer’s Bank (issuing bank)
Exporter’s bank (Adv,/ Confirming bank)
