Facilitating international trade is the most important activity of international banking.
Exporter (seller) and Importer (buyer) are two
important players in international trading activity. Requirements of Exporter and Importer What the seller (exporter) wants What the buyer (Importer) wants
3) Contract fulfillment (Goods)
3) Contract fulfillment 4) Convenience of using an (payment) intervening third party in 4) Convenience (of whom both have confidence, Receiving payment in a such as a bank. bank in his own country) 5) Credit -possibility of obtaining finance. 5) Prompt Payment 6) Expert advice and assistance. 6) Expert Advice. 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 issued by a bank in which the bank furnishes its credit which is both good and well known, in place of the buyer’s credit, which may be good but is not 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 person or to the bearer of the instrument.”
A bill of exchange drawn payable to bearer can not be
made payable on demand. Parties to a Documentary Credit: 1) Applicant (opener of L.C) 2) Issuing bank (opening bank) 3) Advising bank 4) Beneficiary (exporter or seller) 5) 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. L.C Application Form ii. Indent Proforma invoice/Purchase Order iii. Insurance cover note /Marine insurance policy iv. 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 the1) He should study the issuing bank must be credit in depth and clear, correct and request the changes at precise. the earliest, if deemed necessary. 3) The terms and 2) He should satisfy conditions and himself that terms and documents called for conditions and should be in agreement documents called for with sales contract. are in agreement with sales contract. Commonsense Rules For Importer (buyer) & Exporter (seller) 1) Any examination/inspection of 1) When it is the time to present goods prior to shipment or at the evidenced by a document. the documents: the issuer of such inspection ii. He should present documents document must be stated in the credit. 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 7) The credit should not call for the documents which the seller in the credit. can not provide, nor set out 4) He must remember that non- conditions that he can not meet. compliance with terms stipulated in the credit or irregularities in the documents, oblige the bank to Documentary Credits:- Advantages & Problems: Advantages: Payment Secured (banks’ 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 Exporter (account party) (beneficiary)
Exporter’s bank Importer’s Bank (Adv,/ (issuing bank) Confirming bank)