Letter of Credit – The Overview
We can assist with any company’s international trade finance needs by providing documentary letters of credit to assist with corporate cash flow requirements.
We will play a role of the ‘Lead Credit Appraisal Manager’ and can open letters of credit through our ‘USA / UK Lending Resources & Principal’ to fulfill inventory financing needs for large and small purchase orders through our purchase order financing scheme, and to provide an enhancement to current banking arrangements.
Our ‘USA / UK Lending Resources & Principal’s’ expert staff can work with clients to arrange their transfer letters of credit, performance guarantee requirements, cash against document requests and other such trade instruments by using our extensive global banking facilities.
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Letter of Credit: The Basics
Definition
A documentary credit is a (conditional) bank undertaking of payment. It is a written undertaking by a bank (issuing bank) given to the seller (beneficiary) at the request, and on the instructions of the buyer (applicant) to pay at sight or at a determinable future date up to a stated sum of money, within a prescribed time limit and against stipulated documents or other conditions. The issuing bank is putting out its credit and good name for the sake of the buyer.
Buyer
Because the documentary credit is a conditional undertaking, payment is made on behalf of the buyer against documents, which may represent the goods and give the buyer rights to them.
Seller
Because the documentary credit is a bank undertaking, the seller can look to the bank for payment, instead of relying upon the ability or willingness of the buyer to pay.
Summary
Documentary credits therefore:
- Are arrangements by banks for settling international commercial transactions
- Provide a form of security for the parties involved
- Ensure payment, provided that the terms and conditions of the documentary letter of credit have been fulfilled
- Mean that payment by such means is based on documents only, and not on merchandise or services involved
Letter of Credit – The Types
Documentary, Merchandise, Commercial, Trade
The majority of DLC’s issued are in payment for goods in shipment or current services performed. Payment is normally made against documents for goods shipped. (Article 2 UCP 600)
Standby
Normally, this type of LC functions like a guarantee. This type of credit can be drawn against only upon performance of service or financial obligation default. It is a definite undertaking of the issuing bank. The standby letters of credit from CIB and GEBS both state that they are governed by UCP 600. If that is the case, should we mention ISP98.
Revocable
Under UCP 600 a letter of credit is revocable even if there is no indication to that effect (article 3).
Unconfirmed
Bears only the obligation of the issuing bank. The beneficiary should look to the credit worthiness of only the issuing bank, and not to any intermediary (Article 7 UCP 600)
Confirmed
Is a credit in which a second obligation is added to the letter of credit by another bank (Article 8 UCP 600)
Sight
Payment is at sight, which means that the drafts and documents are honored, if in order, by making payment without delay.
Time, Usance
The draft honored by accepting it for payment at a future date. Payment is delayed until the maturity of the draft.
Transferable credit
Can be transferred by the original beneficiary to one or more other parties. It is normally used when the first beneficiary does not supply the merchandise himself, but is a middleman and wants to transfer all or part of his rights to the actual supplier (Article 38 UCP 600)
| Method | Goods Available | Time of Payment | Risk to Exporter | Risk to Importer |
|---|---|---|---|---|
| Cash in Advance | After Payment | Before Shipment | Very Low | Maximum – Relies on exporter to ship goods as ordered |
| Letter of credit *Confirmed *Unconfirmed (Advised) | After Payment | When documents are available at shipment | Very Low | Assured of quantity and quality of shipment if inspection report is required |
| Documentary Collection Sight Draft Documents against Payment | After Payment | On presentation or draft to importer | If draft unpaid, goods must be returned or disposed of, usually at loss | Assured of quantity, also quality, if goods are inspected before shipment |
| Documentary Collection Time Draft Documents against Acceptance | Before Payment | On maturity of draft | Relies on importer to pay draft | Minimal – Can check shipment for quantity and quality before payment |
| Consignment | Before payment, exporter retains title until goods are sold or used | After use; inventory and warehousing cost to exporter | Substantial risk unless through foreign branch of subsidiary | Very Low |
| Open Account | Before payment | As agreed | Relies on importer to pay account as agreed — complete risk | Very Low |
Process Flow Chart for Documentary Letter of Credit
- Application form to be filled out including all KYC (Know your Client) information along with attached documents.
- Purchase Order from Client and Pro-forma Invoice from Supplier showing all Terms of supply and full bank details.
- Draft of instrument is prepared and submitted for final approval. If any changes are required Lender will amend the document at this stage.
- Once draft is approved by BOTH buyer and seller they both sign and stamp ‘OK TO ISSUE’.
- Indemnities and undertakings bonds are signed and witnessed by the Buyer / Borrower / Supplier / Exporter.
- Fees are paid by the Buyer / Borrower immediately once the instrument is agreed & signed off, then the further process will take 3-5 working days for issuance. This is after the fees have been received by the Lender.
- LC Number and hard copy supplied to Buyer / Borrower by the Lender.
- Please Note further that the Lender’s Fees are paid prior to the instrument being issued BUT only after approval and documents are signed.
- The Lender uses its own Lines of Credit for issuance of Documentary Letter of Credit.
- The Supplier may or may not discount the Documentary Letter of Credit further, But Lender or Principal will not involve directly or indirectly.
- There is No Collateral Security required for issuance of Documentary Letter of Credit except the Buyer/Borrower and Supplier/Exporter needs to sign the indemnities & undertakings Bonds.
Buyer and seller agree terms, including means of transport, period of credit offered (if any), latest date of shipment, Incoterm to be used. Buyer applies to bank for issue of letter of credit. Bank will evaluate buyer’s credit standing, and may require cash cover and/or reduction of other lending limits. Issuing bank issues L/C, sending it to the Advising bank by airmail or (more commonly) electronic means such as telex or SWIFT. Advising bank establishes authenticity of the letter of credit using signature books or test codes, then informs seller (beneficiary). Advising bank MAY confirm L/C, i.e. add its own payment undertaking. Seller should now check that L/C matches commercial agreement, and that all its terms and conditions can be satisfied, (e.g. all documents can be obtained in good time.) If there is anything that may cause a problem, an AMENDMENT must be requested. Seller ships the goods, then assembles the documents called for in the L/C (invoice, transport document etc.) Before presenting the documents to the bank, the seller should check them for discrepancies with the L/C, and correct the documents where necessary. The documents are presented to a bank, often the Advising bank. The Advising bank checks the documents against the L/C. If the documents are compliant, the bank pays the seller and forwards the documents to the Issuing bank. The Issuing bank now checks the documents itself. If they are in order (and it is a sight L/C), it reimburses the seller’s bank immediately. The Issuing bank debits the buyer and releases the documents (including transport document), so that the buyer can claim the goods from the carrier.
For Trouble-Free Documentary Letter of Credit transactions:
- Communicate with your customers in detail before they apply for documentary letters of credit. The documentary letter of credit is part of the sales process, not the shipping process!
- Consider whether a confirmed letter of credit is needed (for discounting further by the Seller/Supplier) – if in doubt, seek advice!
- Ask for a Copy of the Draft Documentary Letter of Credit to be faxed to you, so you can check for terms or conditions that may cause you problems in compliance!
- Upon first advice of the documentary letter of credit, check that all its terms and conditions can be complied with within the prescribed time limits!
- Many presentations of documents run into problems with time-limits. You must be aware of up to three time constraints – the expiry date of the credit, the latest shipping date and the presentation period – maximum time allowed between dispatch and presentation of documents
- If the documentary letter of credit calls for documents supplied by third parties, make reasonable allowance for the time this may take to organize!
- After dispatch of the goods , check all the documents both against the terms of the credit and against each other for internal consistency!
- Please feel free to contact us for further expert guidance!
To enquire about Documentary Letter of Credit – Confirmed/Unconfirmed, please complete the form on the contact us page and one of our specialists will contact you in confidence within 24 hours.