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Letters of Credit
Facilitates trade domestic & international Helps in reducing working capital requirement for buyer Helps seller to get immediate payment though credit is extended by him Bank intermediates and lend its creditworthiness for which it charges the applicant Transactions are guided by UCPDC
Letter of Credit
An arrangement by means of which a bank (issuing bank) acting at the request of a customer (applicant) undertakes to pay to a third party (beneficiary) a predetermined amount by a given date according to agreed stipulations and against presentation of stipulated documents
Parties to a Letter of Credit Applicant (Buyer) Issuing Bank (opening bank) Beneficiary (Seller) Advising Bank Confirming Bank Negotiating Bank (Paying Bank) Reimbursing Bank
Negotiating Bank
CONTRACT
IMPORTER
EXPORTER
D O C S P A Y
OPENING BANK
ADVISING BANK
NEGOTIATING BANK
Negotiating bank pays beneficiary first and reimbursement from the opening / confirming bank.
claims
EXPORTER
DOCUMENTS PAYMENT
NEGOTIATING
DOCUMENTS PAYMENT
BANK
Types of LCs
Security wise
Revocable Irrevocable Confirmed
Payment wise
Payment / deferred payment / instalment Acceptance Negotiation
Types of LCs
With advance payment
Red Clause Green Clause
Involving Middlemen
Transferable Back to Back
Others
Revolving
Standby
Opening of LC
Trade Control requirements Exchange Control requirements Credit norms of Central Bank UCPDC Provisions Banks Internal Credit Policies / procedures
Appraisal / Assessment
Means & standing of applicant Application details authorised person Purpose, sources of payment, relationship with turnover Assessment details & maximum expected outstandings Nature of goods marketablility, Seasonality, susceptibility to price changes Import Duty Currency risk Crystallisation
Exercise on Assessment
Annual Cost of Raw materials purchased under LCs Rs. 1903.85 crore Imported - Rs.504.73 crore Indigenous Rs.1399.12 crore
Average usance period for Imports 30 days from shipment Lead time 3 months Local Purchases Lead time 1mth Usance for local purchase 1 month Local purchase without LCs Rs.650 crore
Exercise on Assessment
Monthly purchase of imported RM = 42.06 (D) Avg usance period for imports = 1 month (E) Lead time = 3 months (F)
Total of E & F = 4 months (G) Required LC limit for imported RM = DxG= Rs.168.24 crore (L)
Exercise on Assessment
Monthly purchase of indigenous RM = Rs.116.59 crore (H) Avg usance period for local purchases = 1 month (I)
Local Purchases Lead time 1mth (J) Total of (I) + (J) = 2 months (K) LC limit required for indigenous RM = (H) x (K) = Rs. 233.19 crore (M)
Exercise on Assessment
Total LC limit required = L+M = Rs. 401.43 crore say Rs.400 crore.
Devolvement of LC (Precautions)
The limits for demand LCs and usance LCs should be assessed separately with ample justifications. The usance period should not, generally, exceed the production cycle. In case of bulk imports, establishment of LCs for longer usance period may be considered selectively. When liability under LC is met by creating an irregularity in the Cash Credit account, the relative LC limit should not be released for opening further LCs till the account is adjusted. In other words, the liability should not be marked off in LC liability register merely because of retirement of documents. The relative liability should be marked off only after the account is regularised. In case of devolvement, if the irregularity in the account is not adjusted within 15 days, or if the LC devolved earlier is not adjusted, no further LCs should be opened without adequate margin.
Scrutiny
Level of sundry creditors in the accepted projections in case of Usance LCs Compare with operating cycle Margins & security depending on track record Cash budget monitoring to track availability of funds Irregularity to be rectified before fresh LCs are opened Continuous devolvement is a warning signal
ANY QUESTIONS???
Bank Guarantee
Guarantee is
A contract to perform the promise or discharge the liability of a third person in case of his default The contract of guarantee is distinctly different from the contract of indemnity. Indemnity is A contract by which one party promises to save the other from loss suffered by him by the conduct of the promissor himself or by the conduct of any other person
Bank Guarantee
Parties to the Contract of Guarantee Applicant : The principal debtor person at whose request the guarantee is executed Beneficiary : Person to whom the guarantee is given and who can enforce it in case of default. Guarantor : The person who undertakes to discharge the obligations of the applicant in case of his default.
Thus, the guarantee is a collateral contract, consequential to a main contract between the applicant and the beneficiary.
Bank Guarantee
Parties to the Contract of Indemnity
Indemnifier : person who promises to make good the loss Indemnified : Whose loss is to be made good
Format for BG
Normally, BG should be issued on standardised format only. If some other format is required to be used for issue of BG, it should be ensured that the BG is : a] for a definite period, b) for a definite objective enforceable on the happening of a definite event, c) for a specific amount, d) in respect of bonafide trade/commercial transactions, e) not stipulating any onerous clause, and f) not containing any clause for automatic renewal of the BG on its expiry.
Limitation Clause
Nothwithstanding anything contained herein:
a) our liability under this Bank Guarantee shall not exceed Rs.___________ (Rupees __________________only); b) this Bank Guarantee shall be valid upto __________________; and c) we are liable to pay the guaranteed amount or any part thereof under this Bank Guarantee only and only if you serve upon us a written claim or demand on or before ___________________________ (date of expiry of Guarantee).
Invocation of BG
Important points The Banks liability under BG is absolute and independent and exclusive of any other contract entered into by the applicant and beneficiary. It is, therefore, obligatory on the part of the Bank to pay to the beneficiary without delay and demur the amount of BG on its invocation in accordance with the terms and conditions of the guarantee deeds. It is not necessary for the beneficiary to satisfy the Bank, about the default or the amount of actual loss suffered by him.
Precautions
Should not be open ended Should stipulate maximum liability crystallised Should not contain onerous clauses Ensure customers ability to reimburse Other bank customer - ask why? Performance guarantee assess capacity of customer, means to carry out contract, experience Guarantee liability to have reasonable relation to equity of borrower Counter guarantee by authorised person
Indemnity only one contract between the indemnifier and the indemnified or beneficiary.
Under BG liability of the surety is secondary and arises only when the principal debtor defaults in fulfilling his obligation or promise.
In case of contract of indemnity the liability of the indemnifier is primary and unconditional
Guarantor posses certain rights which are not available to the indemnifier ie right of subrogation or reimbursement