Define Pledge, Hypothecation and Mortgage.

(1) Pledge is used when the lender (pledgee) takes actual possession of
assets (i.e. certificates, goods ). Such securities or goods are movable
securities. In this case the pledgee retains the possession of the goods
until the pledgor (i.e. borrower) repays the entire debt amount.

In case

there is default by the borrower, the pledgee has a right to sell the goods
in his possession and adjust its proceeds towards the amount due (i.e.
principal and interest amount). Some examples of pledge are Gold
/Jewellery Loans, Advance against goods,/stock, Advances against
National Saving Certificates etc.

(2) Hypothecation is used for creating charge against the security of

movable assets, but here the possession of the security remains with the
borrower itself.

Thus, in case of default by the borrower, the lender (i.e.

to whom the goods / security has been hypothecated) will have to first
take possession of the security and then sell the same.
of this type of arrangement are Car Loans.

The best example

In this case Car / Vehicle

remains with the borrower but the same is hypothecated to the bank /
financer.

In case the borrower, defaults, banks take possession of the

vehicle after giving notice and then sell the same and credit the proceeds
to the loan account. Other examples of these hypothecation are loans
against stock and debtors. [Sometimes, borrowers cheat the banker by
partly selling goods hypothecated to bank and not keeping the desired
amount of stock of goods.

In such cases, if bank feels that borrower is

trying to cheat, then it can convert hypothecation to pledge i.e. it takes

over possession of the goods and keeps the same under lock and key of
the bank].

(3) Mortgage : is used for creating charge against immovable property

which includes land, buildings or anything that is attached to the earth or
permanently fastened to anything attached to the earth (However, it does
not include growing crops or grass as they can be easily detached from
the earth). The best example when mortage is created is when someone
takes a Housing Loan / Home Loan. In this case house is mortgaged in
favour of the bank / financer but remains in possession of the borrower,
which he uses for himself or even may give on rent.

Difference Between Pledge, Hypothecation and Mortgage at a Glance:

Pledge
Type
of
Movable
Security

Hypothecatio Mortgag
n
e
Movable

Possession
Remains
withRemains
of
the
lender (pledgee) Borrower
security

Immovab
le
Usually
withRemains
with
Borrower

Gold
Loan,
Examples Advance againstCar / Vehilce
of
LoanNSCs,
AdvLoans,
AdvHousing
where
against
goodsagainst stockLoans
used
(also given underand debtors
hypothecation)

Pledge, Hypothecation and Mortgage Under Indian Law

Pledge : Section 172 of the Indian Contract Act defines pledge as "The
bailment of goods as a security for the payment of a debt or performance

of a promise"

The bailor in this case is called a Pawnor and the bailee is

called Pawnee

To create a valid pledge in the eyes of Law, the three important points
needs to be noted : (a) Delivery of Possession : As in bailment, in pledge
too delivery of possession is required. For exmaple, in Revenue Authority
vs Sundarsanam Pictures, AIR 1968, it was held NOT to be pledge because
the film producer borrowed a sum of money from a financier and agreed to
deliver the final prints of the film when ready. Thus, there was no delivery
of the goods at the time of agreement; (b) Delivery is in return of a loan
or promise to perform something.

Therefore, if your friend gives you his

Motor-cycle to go to college, it is not pledge but can be called simple

bailment; (c) It should be in pursuance of a contract : The delivery must
be done under a contract (oral or written).

However, it is not necessary

that delivery and loan take place at the same time. Delivery can be made
even after the loan is received.

Hypothecation:

was not defined under Indian Law for long time and was

used more on the basis of practice.

However, now under the

Secruitisation and Reconstruction of Financial Assets and Enforcement of

Security Interest Act, hypothecation is defined as "a charge in or upon any
movable property, existing or future, created by a borrower in favour of a
secured creditor without delivery of possession of the movable property to
such creditor, as a security for financial assistance, and includes floating
charge and crystallization into fixed charge on movable property". .

Mortgage : is defined in Section 58 of the "Transfer of Property Act

1882". It is the transfer of an interest in specific immovable property for
the purpose of securing payment of money advanced by way of loan.

What is an Assignment ?

There is another term (i.e. Assignment) which is sometimes confused with

above terms. An assignment constitutes an action taken with a contract.
Assignment occurs when the owner of a contract, known as the assignor,
gives a contract to another party, known as the assignee.

The assignee

assumes all responsibilities and benefits of the contract. When it comes

to loans, assignment can relate to life insurance policies and mortgage
contract from one party to another.

Mortgages and other contracts

sometimes contain provisions limiting or stipulating conditions for

assignment.

What is a Dormant Account or What is an Inoperative Account ?

In layman's language dormant means inactive and inoperative means

which is not being operated i.e. no transactions have been undertaken
recently.

In terms of RBI guidelines "A savings as well as current account

should be treated as inoperative / dormant if there are no transactions in

the account for over a period of two years".

Further clarifying the issue

RBI says "for the purpose of classifying an account as inoperative both

the type of transactions i.e., debit as well as credit transactions induced
at the instance of customers as well as third party should be considered.
However, the service charges levied by the bank or interest credited by

the bank should not be considered". However, when the interest on Fixed
Deposit account is credited to the Savings Bank accounts as per the
mandate of the customer, it is treated as a customer induced transaction.
However, it may be mentioned that some banks had certain internal
guidelines / periods before an account can be termed as dormant and / or
inoperative.

Bankers needs to check their internal circulars for this

purpose, but the above period of two years is applicable as per RBI
guidelines. Therefore, as per RBI guidelines, there is no difference
between dormant accounts and inoperative accounts.

What is the Background for creation of different class of accounts under

the head of dormant or inoperative ?

Section 26 of the Banking Regulation Act, 1949 provides, inter alia, that
every banking company shall, within 30 days after close of each calendar
year submit a return in the prescribed form and manner to the Reserve
Bank of India as at the end of each calendar year (i.e., 31st December) of
all accounts in India which have not been operated upon for 10 years.
Such deposits are considered as unclaimed deposits.
complying with these guidelines.

Thus, banks were

Slowly, the amount of unclaimed

deposits has increased to a level which came to severe criticism in the

media and some other reports.

To check this trend, RBI has initiated a move and wanted banks to play a
pro-active role so that unclaimed deposits can be nipped in the bud

itself.

Thus, it has issued certain guidelines to banks as to how to

monitor such dormant and inopertive accounts.

What are the Rules for banks for monitoring of Dormant / Inoperative
Accounts ? Is Bank Required to inform customer about his account
becoming dormant / inoperative?

In terms of RBI guidelines, banks are required to make an annual review of

accounts in which there are no operations (i.e., no credit or debit other
than crediting of periodic interest or debiting of service charges) for more
than one year.

In case there have no "transactions", the bank is required

to inform the account holder to activate the account by putting through

any single debit or credit transaction which can also be put through a
third party. If the account is still not activated and no reply is received,
the bank will classify the account as dormant at the end of two years from
the date of last transaction.

RBI has also specified the procedure to be

followed in case the letter sent is returned back.

However, where the account holder replies and gives the reasons for not
operating the account, bank will continue classifying the same as an
opertive account for one more year within which period the account holder
can operate the account. However, if the account holder still does not
operate the same during the extended period, the account will be
classified as inoperative at the end of the extended period.

Interest on savings bank accounts should be credited on regular basis

whether the account is operative or not.

Banks are also advised to ensure that the amounts lying in inoperative
accounts ledger are properly audited by the internal auditors / statutory
auditors of the bank.

What is the purpose behind classifying the account as dormant or

inoperative ?

The purpose for segregation of inoperative accounts is to reduce the risk

of frauds etc. The classification is done merely to bring the attention of
dealing staff about the increased account in such an account.

Thus,

transactions in such accounts may be monitored at a higher level both

from the point of view of preventing fraud and making a Suspicious
Transactions Report. However, the entire process remains un-noticable by
the customer.
Can a customer issue a cheque on a dormant account ?
Yes. However, the bank is expected to exercise due diligence as to the
genuineness of the transaction, verification of the signature, identify etc.,
and use its discretion while making payment of such cheques.
Can Bank charge for account remaining as dormant?

Yes, bank can charge as per the schedule of charges declared by the
bank.
Can bank charge for reactivating the same i.e. making the account again
an active account?
However, banks can not charge any fee /charges for converting a
dormant / inoperative account as operative.
What are the guidelines for unclaimed accounts ?
We have already explained about unclaimed deposits.

Banks are now

supposed to play a more pro-active role in finding the whereabouts of the

accountholders of unclaimed deposits/ inoperative accounts.
advised

banks

that

they

should

display

the

list

of

RBI has
unclaimed

deposits/inoperative accounts which are inactive / inoperative for ten

years or more on their respective websites. The list so displayed on the
websites must contain only the names of the account holder (s) and
his/her address in respect of unclaimed deposits/inoperative accounts. In
case such accounts are not in the name of individuals, the names of
individuals authorized to operate the accounts should also be indicated.
However, the account number, its type and the name of the branch shall
not be disclosed on the banks website. The list so published by the banks
should also provide aFind option to enable the public to search the list
of accounts by name of the account holder.
Banks should also give on the same website, the information on the
process of claiming the unclaimed deposit/activating the inoperative
account and the necessary forms and documents for claiming the same.
Banks are required to have adequate operational safeguards to ensure
that the claimants are genuine.

Many business organization needs funding for fulfilling their monetary requirement.
The funding can either be short term or long term. Nowadays people choose a short
term loan like cash credit and overdraft. Cash Credit is a type of facility provided
by the bank or financial institution in which, a company can withdraw an amount
more than what he holds in his credit against the security of stock. Overdraft is
another facility, in which the bank permits the customer to debit his current account
below zero but only up to a specified limit. After a complete research, a compilation
of difference between cash credit and overdraft is made considering various
criterion.

Content: Cash Credit and Overdraft

1. Comparison Chart
2. Definition
3. Key Differences
4. Similarities
5. Conclusion
Comparison Chart
BASIS OF
COMPARISO

CASH CREDIT

OVERDRAFT

Meaning

Cash credit is a type of short

Overdraft is a facility given by the

term loan provided to

bank to companies, to withdraw

companies to fulfill their

money "more" than the balance

BASIS OF
COMPARISO

CASH CREDIT

OVERDRAFT

working capital requirement.

available in their respective

accounts.

Security

Account

Pledge or hypothecation of

Assets like financial instrument

inventory.

and property.

Cash Credit Account

Current Account

Definition of Cash Credit

Cash Credit is a type of short term loan facility in which the withdrawal of money by
the company is not restricted to the amount the borrower holds in his cash credit
account but up to a predefined limit. The cash credit account is functions like a
current account with cheque book facility. The facility is provided against pledge or
hypothecation of stock i.e. raw materials, work in progress, finished goods, etc. or
on the guarantee of book debts (debtors) or other collateral security as per banking
company norms. The purpose of taking cash credit is to fulfill working capital
requirement of the firm. The cash credit limit is supposed to be equal to the
working capital requirement of the company less the margin funded by the
company itself.
The drawing limit is specified by the bank or financial institution as well as it can
vary from bank to bank and borrower to borrower. Interest is charged by the bank
on the amount utilized not on the limit sanctioned. The bank has the right to
demand money lent at any time.

Definition of Overdraft
Overdraft means the act of overdrawing money from the bank account. Bank
Overdraft is a facility provided by the bank to its customers withdraw money more
than the amount he holds in his account. The overdraft limit sanctioned is
predefined by the bank depending upon the securities pledged or repayment
capacity of the Account holder. The drawing limit is specified by the bank or
financial institution may vary from bank to bank and borrower to borrower. Interest
is charged on the amount utilized not on the limit sanctioned. Amount withdrawn
above the specified limit will be subject to additional charges.
The overdraft are repayable on demand i.e. the bank has the right to call the money
lent to the customer at short notice. Cheque book is provided to the account holder
to operate these account.
When the overdraft facility is provided without any security in order to meet urgent
financial needs, it is known as Clean Overdraft. However, when it is provided
against the security of assets like land & building, shares, debentures, etc. it is
known as Secured Overdraft.

Key Differences Between Cash Credit and Overdraft

1. The withdrawing facility provided by the bank in which the person can
withdraw amount more than what he holds in his credit, against the
hypothecation of stock or any other collateral security is known as cash
credit. Overdraft is another type of withdrawing facility in which the bank
allows the customer to withdraw amount more than more than what he holds
in his credit, but only upto a certain extent is known as Overdraft.
2. The Cash Credit is divided into two categories, i.e. Key Cash Credit and Open
Cash Credit. The Overdraft is divided into two categories, i.e. secured
overdraft and clean overdraft.

3. For availing cash credit facility the borrower must have a cash credit account
with the bank or financial institution. Conversely, Overdraft facility can be
availed by the borrower, if he has a current account with the bank.
4. Cash credit facility is given against the pledge or hypothecation of inventory
or other current assets or collateral security. Overdraft facility is given against
the security of fixed assets (if securitised).
Similarities

Payable on demand

Money can be withdrawn more, than the amount actually available in the
account.

Security

Limit

Line of credit

Conclusion
For fulfilling the working capital requirement of the company at the time of need,
the banks provides many facilities. These facilities include cash credit, overdraft, bill
discounting and working capital loan, etc. Cash credit and Overdraft are the popular
ones, they are very similar in many aspects. The difference between cash credit and
overdraft is quite subtle. But, overdraft is one of the oldest concept as compared to
the cash credit.
Difference between Overdraft and Cash Credit
Overdraft and cash credit are widely used external sources of finance for
availing short term borrowing at some cost. Both cash credit and overdraft are used
by businesses to manage short term working capital requirements. However, they
differ on various aspects which include nature of account, charges and fees,
amount, purpose, type of security, use of funds, interest rate etc.

Both these facilities are repayable on demand and therefore classified as sources of
finance payable on demand or loans payable on demand. However, these facilities
are rarely re-called in real-life scenario except in very rare circumstance like
customers business and financial position is going from bad to worse phase as time
passes by or in case when the value of the security is found extremely low during
period re-valuation of the security or during renewal of the facility.
Although both these facilities are very similar in nature, one needs to understand
cash credit vs. overdraft difference in order to understand them better.
Cash Credit Facility

Account requirement

Security Requirement

Limits Sanctioning Rationale

End Use

Length of Credit Period

Limits Availability

Overdraft Facility

Overdraft can be availed on the

existing current account. It is like
One needs to usually open a
a facility of excess withdrawal
separate cash credit account with given in current account and at
a bank to avail cash credit facility. times even in savings account.
Overdraft facility does not
necessarily require current assets
as security. An overdraft facility
may be extended by taking
shares, other investments like
Company inventory and
FDs, insurance policies as
receivables are usually taken as security. At times even based on
security for allowing cash credit the credibility of the person,
facility.
overdraft limit may be approved.
Limit is usually allotted taking into
consideration the assets
collateralised and also on the
Limit is usually a percentage of
basis of financial statements of
the stocks or receivables.
the company.
This is generally given specifically Overdraft Facility can be used for
for the purpose of the business
any purpose and not necessarily
operation (as working capital). for business.
Cash Credit is usually for a short
period. That means, the limit is
Overdraft facility is allowed for a
allowed for a period of 1 year and very short duration at times (Say
is renewed every year. In some
a month or even for a week in
cases, renewals or review may be some cases), but can be allowed
stipulated half yearly as well.
for a period of up to 1 year.
The cash credit withdrawal limit The amount or the overdraft limit
keeps changing with the change that the customer gets remains
in the amount of current assets
constant since limits sanctioned is
kept as security. Withdrawal limit not based on current assets.
from the CC facility is
However, if OD is against shares
called drawing power.
or insurance policy surrender
value, the limit changes based on
the underlying security value at

Rate of Interest

periodic intervals.
The rate of interest charged under The rate of interest charged
cash credit facility is lesser than under over draft facility is higher
what is usually charged under the than what is usually charged
overdraft facility.
under the cash credit facility.

What is the difference between overdraft and cash credit?

By Investopedia
Both "overdraft" and "cash credit" can refer to a type of secured line of credit with a
lender. These terms can also refer to financial institutions that allow you to withdraw
more funds than you actually have in your demand deposit accounts, although the
specific functionalities of these allowances can vary. These provisions are
sometimes referred to as overdraft protection, while others might be called cash
credits. Be aware of the policies at your own bank or credit union, and know what
costs are associated with overdrawing on your account.
Both overdraft and cash credit are really forms of borrowing. The institution allows
you to withdraw funds that you do not have a demand claim to, usually in small
amounts. The primary differences between these two forms of borrowing is how
they are secured and whether the money is lent out of a separate account.
Cash credits are more commonly offered for businesses than individuals. They
require that a security be offered up as collateral on the account in exchange for
cash. This security can be a tangible asset, such as stock in hand, raw materials or
some other commodity. The credit limit extended on the cash credit account is
normally a percentage of the value of the security offered.
Sometimes a financial institution offers a cash reserve account but calls it a cash
credit instead. Cash reserves (sometimes called cash reserve credits) are unsecured
lines of credit that act like overdraft protection. They typically offer higher overdraft
limits and have smaller real interest costs on borrowed funds than overdrafts, since
penalty fees are not assessed for using the cash reserve account.
There are several different types of overdrafts, but the two most common are
standard overdrafts on individual demand deposit accounts and secured overdraft
accounts that loan cash against various financial instruments.
A standard overdraft is the act of withdrawing more funds from an account than
your balance would normally permit. If you have $30 in a checking account, but you
withdraw $35 to pay for an item, a bank that permits overdrafts spots you the $5
and typically charges you a fee for the service. You are generally charged a
separate fee for every purchase in excess of your demand deposit balance.
Overdraft accounts, however, act more like a traditional loan. Money is lent by a
financial institution as with a cash credit account, but a wider range of collateral can
be used to secure the credit. For example, you might be allowed to use mutual fund
shares, LIC policies or even debentures. There are even clean overdraft accounts, in

which no specific collateral is offered; instead, clean overdrafts are granted against
the worth of the individual. This is usually only possible when the borrower has a lot
of funds parked at the financial institution and enjoys a long-standing relationship
with the bank.
Advantages and Disadvantages of Bank Overdraft
A bank overdraft is a temporary facility extended by a bank to corporates and other
clients to withdraw funds from their account in excess of the balance. This facility is
provided by the bank for a fee and interest is charged on the excess amount that is
withdrawn for the length of the time. It is important to know the advantages and
disadvantages of the bank overdraft facility in order to use it effectively.
An overdraft facility allows the facility holder to withdraw money from the account
despite having no balance. There is usually a limit on the amount that can be
overdrawn from the account. The overdraft limit is usually set by the banks basis
the amount of working capital and credit worthiness of the facility taker.
Advantages of Bank Overdraft:
Handles Timing Mismatch of Flow of Funds: A bank overdraft is
usually helpful for a business where it has cash flows moving in an out many
times during a month. In other words, if sales proceeds and purchases result in
flow of money in and out many times during a week / month; an overdraft
facility allows managing cash flow gaps that might arise due to timing
mismatch.
o Helps in Keeping Good Track Record: It helps to maintain a good
payment history as any payment made via cheque does not bounce due to
insufficient funds, which may have been made against some receivable,
which may come a couple of days later.
o Timely Payments: It also aids in ensuring that timely payments are made
and no late payments penalties are faced, as payments would be made
even if there is no balance in the account.
o Less Paperwork: Overdraft facility is usually easy to avail compared
to long term loans which may require more paperwork.
Flexibility: Overdraft facility is flexible in the nature that one may take it
whenever required for whatever amount (up to the limit allotted) and for even
as less as one or two days.
Benefit in Interest Cost: Since the interest is calculated only on the
amount of funds utilized, there are great savings in the interest cost when
compared to a normal loan taken on fixed interest rate. In other loans, you have
to pay interest even if you are not using the money. The meter of interest starts
with the payments you make but it stops instantly when there are receipts.

Disadvantages of Bank Overdraft:

o

Higher Interest Rates: Overdraft facility comes with a cost. The cost is
usually higher than the other sources of borrowing. Also if one goes above or
exceeds the overdraft limit, the charges thereby are much higher.

Risk of Reduction in Limit: Overdraft facility is a temporary loan and

undergoes regular revisit by the bank. Hence, it runs a risk of decrease in the
limit or withdrawal of the limit. The withdrawal of limit may happen usually
when company financials may represent poor performance; hence the facility
may be withdrawn largely when the company may require it the most.
Risk of Seizing: Bank overdraft facility may at times be secured against
inventory or other collateral like shares, life insurance policies etc. Company
may run risk of those assets being seized, if it fails to meet payments.
Debtors Collection becomes Lethargic: At times, availability of
overdraft facility may make the company less strict on the collection of debtors
payment. In other words, a company may not be too much on their feet to
collect payments from debtors, as immediate payment outflows can be
managed by overdraft facility.

Conclusion:
Overdraft is a temporary facility obtained by the companies to meet their ultra-short
term cash shortage / requirement. One needs to bear in mind that such facility
comes with high cost and should be used as a stop gap management of funds or as
an emergency activity rather than a routine funding activity. Higher dependence on
overdraft for working capital management indicates poor working capital
management and a liquidity constraint faced by the company. Only temporary
working capital should be financed by bank overdraft. The permanent working
capital should be financed by long term loans having lower interest rates.
Current Account Vs Saving Account
Whenever we go for opening an account in a bank, one thing comes to our mind
which type of account is best suited for us a saving account, current account,
recurring deposit account or a fixed deposit account. People normally go for either
saving bank account or current account, but they are still confused between the
two. Here, a full fledged research on it is conducted, which will help you to
understand the difference between them.

1. Comparison Chart
2. Definition
3. Key Differences
4. Similarities

5. Conclusion
Comparison Chart
BASIS OF

SAVING ACCOUNT

DIFFERENCE

Meaning

CURRENT ACCOUNT

A bank deposit account

A bank deposit account that supports

that encourages savings of

regular money transactions related

a person.

to a business.

Suitable for

Individual

Businessman or company

Interest

Yes

No

Withdrawals

Limited

Unlimited

Issue of

Yes

No

Passbook

Definition of Saving Account

Savings Account is the most common type of deposit account. An account held with
a commercial bank, for encouraging savings and investments is known as a Saving
Bank Account. Savings account provides an array of facilities like ATM cum Debit
Card facility with different variants, calculation of interest on a daily basis, internet
banking, mobile banking, online money transfer etc.
The account can be opened by any Individual, Agencies or institutions (if they are
registered under the Societies Registration Act, 1860). A Pvt. Ltd and a Ltd.
company is not allowed to open a savings account.

Definition of Current Account

A deposit account maintained with any commercial bank, for supporting frequent
money transactions is known as Current Account. A plethora of facilities are
provided to you, when you opt for a current account like payment on standing
instructions, transfers, overdraft facility, direct debits, no limit on the number of
withdrawals/deposits, Internet Banking, etc.
This type of account fulfills the very need of an organization that requires frequent
money transfers in its day-to-day activity.
This type of account could be opened by an Individual, Hindu Undivided Family
(HUF), Firm, Company, etc. Account maintenance charges are applicable as per the
bank rules. The current account is also known as checking account or
atransactional account.
Key Differences Between Savings Account and Current Account
1. An account that stimulates savings and investments is known as Saving
account. An account that advocates highly liquid transactions is known as a
current account.
2. Saving Account is ideal for salaried people because of regular monthly
savings. Conversely, Current Account is ideal for businessmen because of day
to day money transactions.
3. There is a restriction on the number of monthly transactions, in case of a
savings account. There is no such cap for a Current Account.
4. The major difference between them is current account is non-interest bearing
whereas savings account offers interest on daily basis.
Similarities

Type of Demand Deposit

Internet Banking Facility

Multi city Cheque Facility

Nomination facility

Conclusion
We have discussed in detail about both the entities and it is quite clear that the two
are important in place. If we talk about the major difference between them, it is the
number of transactions withdrawal or deposit .
Letters of credit
What is a letter of credit?
A letter of credit - sometime known as 'documentary credit' - is basically a
guarantee from a bank that a particular seller will receive a payment due from a
particular buyer. The bank guarantees that the seller will receive a specified amount
of money within a specified time. In return for guaranteeing the payment, the bank
will require that strict terms are met. It will want to receive certain documents - for
example shipping confirmation - as proof.
Why use a letter of credit?
Letters of credit are most commonly used when a buyer in one country purchases
goods from a seller in another country. The seller may ask the buyer to provide a
letter of credit to guarantee payment for the goods.
The main advantage of using a letter of credit is that it can give security to both the
seller and the buyer.
Advantages for sellers
By asking for an appropriate letter of credit a seller is reassured that they will
receive their money in full and on time. A letter of credit is one of the most secure
methods of payment for exporters as long as they meet all the terms and
conditions. The risk of non-payment is transferred from the seller to the bank (or
banks).
Advantages for buyers

When a buyer uses a letter of credit they get a guarantee that the seller will honour
their side of the deal and provide documentary proof of this.
Other things to consider
It's important to be aware of the additional costs involved in using a letter of credit.
Banks make charges for providing them, so it's sensible to weigh up the costs
against the security benefits.
If you're an exporter you should be aware that you'll only receive payment if you
keep to the strict terms of the letter of credit. You'll need to give documentary proof
that you have supplied exactly what you contracted to supply. Using a letter of
credit can sometimes cause delays and other administrative problems.
A Letter of Credit is a payment term mostly used for long-distance and international
commercial transactions.
Letters of credit are indispensable for international transactions since they ensure
that payment will be received. Using documentary letters of credit allows the seller
to significantly reduce the risk of non-payment for delivered goods, by replacing the
risk of the buyer with that of the banks. Letters of credit have become a crucial
aspect of international trade , due to differing laws in each country and the difficulty
of knowing each party personally.
After trade between countries made it impossible to do business by traditional
payment methods, Letters of credit make it possible to do business worldwide.
Originally, Letter of Credit was literally a letter written by the buyer's bank to the
seller's bank promising that they guarantee to pay the seller in case of the buyer's
default.
In modern business world, a letter of credit is basically an undertaking by a bank to
make a payment to a named Beneficiary within a specified time, against the
presentation of documents which is strictly in compliance with the terms of the
letter of credit.That is to say, banks issue letters of credit as a way to ensure sellers
that they will get paid as long as they do what they've agreed to do. Hence, in
essence, letter of credit is a promise to pay.This mechanism has its own jargon:The
Buyer is the Applicant or the Account Party and the Seller or the Ultimate Recipient
of Funds is the Beneficiary.
The Bank that issues the LC is referred to as the Issuing Bank which is generally in
the country of the Buyer.The Bank that Advises the LC to the Seller is called the
Advising Bank which is generally in the country of the Seller
Abbreviations for 'letter of credit' include L/C, LC, and LOC .In the very beginning,
one must note that Letters of credit deal in documents, not goods, thus the Bank
scrutinizes the 'documents' and not the 'goods' for making payment which explains
why the technical term for Letter of credit is 'Documentary Credit'.

In this context, the process works both in favour of both the buyer and the seller.
The instrument is designed to reduce the risk taken by each party. The Seller gets
assured that if documents are presented on time and in the way that they have
been requested on the LC the payment will be made and Buyer on the other hand is
assured that the bank will thoroughly examine these presented documents and
make sure that they meet the terms and conditions stipulated in the LC.
Letter of credit advantages for the seller

The seller has the obligation of buyer's bank's to pay for the shipped goods;

Reducing the production risk, if the buyer cancels or changes his order

The opportunity to get financing in the period between the shipment of the
goods and receipt of payment (especially, in case of deferred payment).

The seller is able to calculate the payment date for the goods.

The buyer will not be able to refuse to pay due to a complaint about the
goods

Letter of credit advantages for the buyer

The bank will pay the seller for the goods, on condition that the latter
presents to the bank the determined documents in line with the terms of the
letter of credit;

The buyer can control the time period for shipping of the goods;

By a letter of credit, the buyer demonstrates his solvency;

In the case of issuing a letter of credit providing for delayed payment, the
seller grants a credit to the buyer.

Providing a letter of credit allows the buyer to avoid or reduce pre-payment.