Letter of Credit is one of the most popular and more secured of method of payment in recent times as compared to other methods of payment. A L/C Letter of Credit ) refers to the documents representing the goods and not the goods themselves. Banks are not in the business of examining the goods on behalf of the customers. Typical documents, which are required includes commercial invoice, transport document such as Bill of lading or Airway bill, an insurance documents etc. L/C deals in documents and not goods.
A Letter of Credit can be defined as “an undertaking by importer’s bank stating that payment will be made to the exporter if the required documents are presented to the bank within the validity of the L/C”.
PARTIES INVOLVED IN LETTER OF CREDIT:
- Applicant: The buyer or importer of goods
- Issuing bank: Importer’s bank, who issues the L/C
- Beneficiary: The party to whom the L/C is addressed. The Seller or supplier of goods.
- Advising bank: Issuing bank’s branch or correspondent bank in the exporter’s country to whom the L/C is send for onward transmission to the beneficiary.
- Confirming bank: The bank in beneficiary’s country, which guarantees the credit on the request of the issuing bank.
- Negotiating bank: The bank to whom the beneficiary presents his documents for payment under L/C
A Letter of Credit contains these elements:
- A payment undertaking given by the bank (issuing bank) on behalf of the buyer (applicant)
- To pay a seller (beneficiary) a given amount of money on presentation of specified documents representing the supply of goods within specific time limits
- These documents conforming to terms and conditions set out in the letter of credit
- Documents to be presented at a specified place.
In simple words, the Issuing Bank’s role is twofold:
- To guarantee to the seller that if complete documents are presented, the bank will pay the seller the amount due. This offers security to the seller – the bank says in effect “We will pay you if you present documents (XYZ)”
- To examine the documents and only pay if these comply with the terms and conditions set out in the letter of credit. This protects the buyer’s interests – the bank says “We will only pay your supplier on your behalf if they present documents (XYZ) that you have asked for”
ADVANTAGES OF LETTER OF CREDIT
Advantages to the Exporter:
- No blocking of funds.
- Clearance of import regulations.
- Free from liability.
- Pre- shipment finance.
- Non-refusal by importer.
- Reduction in bad-debts.
Advantages to the Importer:
- Better terms of trade.
- Assurance of shipment of goods.
- Overdraft facility.
- No blocking of funds.
- Delivery on time.
- Better relations.
DISADVANTAGES OF LETTER OF CREDIT:
- Lacks flexibility.
- Complex method
- Expensive for importer
- Problem of revocable L/C
Sample Document: Letter of Credit (Documentary Credit)
|THE MOON BANK|
5 MOONLIGHT BLVD.,
EXPORT-CITY AND POSTAL CODE
|OUR ADVICE NO.|
|ISSUING BANK REF. NO. & DATE|
SBRE-777 January 26, 2005
|We have been requested by The Sun Bank, Sunlight City, Import-Country to advise that they have opened with us their irrevocable documentary credit number SB-87654|
For account of DEF Imports, 7 Sunshine Street, Sunlight City, Import-Country in your favor for the amount of not exceeding Twenty Five Thousand U.S. Dollars (US$25,000.00) available by your draft(s) drawn on us at sight for full invoice value
|Accompanied by the following documents:|
Covering: 100 Sets ‘ABC’ Brand Pneumatic Tools, 1/2″ drive,
|Shipment from:||Moonbeam Port, Export-Country to Sunny Port, Import-Country|
|Documents must be presented for payment within 15 days after the date of shipment.|
|Draft(s) drawn under this credit must be marked|
Drawn under documentary credit No. SB-87654 of The Sun Bank,
|We confirm this credit and hereby undertake that all drafts drawn under and in conformity with the terms of this credit will be duly honored upon delivery of documents as specified, if presented at this office on or before March 26, 2005|
Very truly yours,
Unless otherwise expressly stated, this Credit is subject to the Uniform Customs and Practice for Documentary Credits, 1993 Revision, International Chamber of Commerce Publication No. 500.