Assignment On

LETTER OF CREDIT

Table of content

Serial no:
1. 2. 3. 4.

Topic:
Introduction Parties to a letter of credit

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Types of Letter of Credit Advantages of Letter of Credit

5. 6. 7. 8.

Commercial Letter of Credit Flow

Statement under a letter of credit Sample of letter of credit

Risks involved in Letter of Credit

9. Other things related to letter of credit 10. 11. Conclusion References

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Introduction:
The international chamber of commerce defines letter of credit as: Any arrangement however named or descried where by a bank acting at the request and it accordance with the instruction of a customer is to make payment to or to the order of a third party or is to pay, accept or negotiate bills of exchange drawn by the beneficiary or authorize such payment to be made or such drafts to be paid , accepted or negotiated , by another bank , against stipule documents and compliance with stipulated terms and condition. Thus, when a stipulated contract is incorporated in the sale contract t6hat the good shall be paid by a bankers letter of credit, the seller need not worry heather the goods will be cleared by the buyer on arrived at the destination, and the buyer need not lockup his fund by making payment in advance. As a matter of fact, a commercial letter of credit substitutes the credit worthiness of the of the importer by the credit worthiness of the banker issuing the letter of credit , since it is a promise by the bank to pay or accept the bills, provided the exporter fulfills the terms and conditions set out in the credit.

Definition
Letter of credit A letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount. In the event that the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase. LC is a document issued mostly by a financial institution, used primarily in trade finance, which usually provides an irrevocable payment undertaking. The letter of credit can also be source of payment for a transaction, meaning that redeeming the letter of credit will pay an exporter. Letters of credit are used primarily in international trade transactions of significant value, for deals between a supplier in one country and a customer in another.

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Parties to a letter of credit

The parties are described below: 1) The buyer : Applies to the bank for opening a letter of credits. The bank may or may not require the buyer secure the letter of credit by providing sufficient deposits .It depends on the confidence that the bank has over the buyer applying for the letter of credit. 2) The seller : Who is the exporter ,is the beneficiary off the letter of credit .The bank issuing the letter of credit assures the seller that the condition of the credit wil be met, provided the relevant .document are produced and the terms and condition set out in the credit are strictly complied .

3) The bank:

Which issues the letter of credit at the request of buyer is the issuing bank . The issung bank must be well known and acceptable to the seller the buyer gives instruction regarding the terms and conditions of the credit.

4) The notifying bank: Is the correspondent bank situated in the same place as the

seller, and advices the credit to the seller ,and advice the credit to the seller .but the notifying bank does not commit self to any liability under the credit ,generally, the service of a notifying bank are ulitilized when the credit is advises to the seller through a viable message.

5) The negotiating bank : Is He bank which negotiates Is the bills or drafts under

the letter or credit .Generally the same bank will act as the notifying bank .The negotiating bank has to see that the documents negotiated conform strictly with the terms and conditions of credit.

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6) The paying bank: Is the bank of which the bill or drafts is drams .It can be the

issuing bank, the notifying bank or the confirming bank.

Types of Letter of Credit

Irrevocable An irrevocable letter of credit can neither be amended nor cancelled without the agreement of all parties to the credit. Under UCP500 all letters of credit are deemed to be irrevocable unless otherwise stated. Here, the importer's bank gives a binding undertaking to the supplier provided all the terms and conditions of the credit are fulfilled. Unconfirmed The advising bank forwards an unconfirmed letter of credit directly to the exporter without adding its own undertaking to make payment or accept responsibility for payment at a future date, but confirming its authenticity. Confirmed A confirmed letter of credit is one in which the advising bank, on the instructions of the issuing bank, has added a confirmation that payment will be made as long as compliant documents are presented. This commitment holds even if the issuing bank or the buyer fails to make payment. The added security to the exporter of confirmation needs to be considered in the context of the standing of the issuing bank and the current political and economic state of the importer's country. A bank will make an additional charge for confirming a letter of credit. In many cases, the confirming bank is located in Beneficiarys country. Confirmation costs will vary according to the country involved, but for many countries considered a high risk will be between 2%-8%. There also may be countries issuing letters of credit, which banks do not wish to confirm - they may already have enough exposure in that market or not wish to expose themselves to that particular risk at all. Standby Letters of Credit A standby letter of credit is used as support where an alternative, less secure, method of payment has been agreed. They are also used in the United States of America in place of bank guarantees. Should the exporter fail to receive payment from the importer he may claim under the standby letter of credit. Certain documents are likely to be required to obtain payment including: the
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standby letter of credit itself; a sight draft for the amount due; a copy of the unpaid invoice; proof of dispatch and a signed declaration from the beneficiary stating that payment has not been received by the due date and therefore reimbursement is claimed by letter of credit. The International Chamber of Commerce publishes rules for operating standby letters of credit - ISP98 International Standby Practices. Revolving Letter of Credit The revolving credit is used for regular shipments of the same commodity to the same importer. It can revolve in relation to time or value. If the credit is time revolving once utilised it is re-instated for further regular shipments until the credit is fully drawn. If the credit revolves in relation to value once utilized and paid the value can be reinstated for further drawings. The credit must state that it is a revolving letter of credit and it may revolve either automatically or subject to certain provisions. Revolving letters of credit are useful to avoid the need for repetitious arrangements for opening or amending letters of credit. Transferable Letter of Credit A transferable letter of credit is one in which the exporter has the right to request the paying, or negotiating bank to make either part, or all, of the credit value available to one or more third parties. This type of credit is useful for those acting as middlemen especially where there is a need to finance purchases from third party suppliers.

Back-to-Back Letter of Credit A back-to-back letter of credit can be used as an alternative to the transferable letter of credit. Rather than transferring the original letter of credit to the supplier, once the letter of credit is received by the exporter from the opening bank, that letter of credit is used as security to establish a second letter of credit drawn on the exporter in favour of his importer. Many banks are reluctant to issue back-to-back letters of credit due to the level of risk to which they are exposed, whereas a transferable credit will not expose them to higher risk than under the original credit.

Advantages of Letter of Credit

1. The beneficiary is assured of payment as long as it complies with the terms and conditions of the letter of credit. The letter of credit identifies which documents must be presented and the data content of those documents. The credit risk is transferred from the applicant to the issuing bank.
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2. The beneficiary can enjoy the advantage of mitigating the issuing banks country risk by requiring that a bank in its own country confirm the letter of credit. That bank then takes on the country and commercial risk of the issuing bank and protects the beneficiary. 3. The beneficiary minimizes collection time as the letter of credit accelerates payment of the receivables. 4. The beneficiarys foreign exchange risk is eliminated with a letter of credit issued in the currency of the beneficiarys country.

Commercial Letter of Credit Flow

Applicant approaches Issuing/ Opening Bank with LC application form duly filled and requests Issuing Bank to issue a Letter of Credit in favor of Beneficiary.
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1. Issuing Bank issues a Letter of Credit as per the application submitted by an Applicant and send it to the Advising Bank, which is located in Beneficiarys country, to formally advise the LC to the beneficiary. 2. Advising Bank advises the LC to the Beneficiary. 3. Once Beneficiary receives the LC and if it suits his/ her requirements, he/ she prepares the goods and hands over them to the carrier for dispatching to the Applicant. 4. He/ She then hands over the documents along with the Transport Document as per LC to the Negotiating Bank to be forwarded to the Issuing Bank. 5. Issuing Bank reimburses the Negotiating Bank with the amount of the LC post Negotiating Banks confirmation that they have negotiated the documents in strict conformity of the LC terms. Negotiating Bank makes the payment to the Beneficiary. 6. Simultaneously, the Negotiating Bank forwards the documents to the Issuing Bank to be released to the Applicant to claim the goods from the carrier. 7. Applicant reimburses the Issuing Bank for the amount, which it had paid to the Negotiating Bank. 8. Issuing Bank releases all documents along with the titled Transport Documents to the Applicant

Settlements under a Letter of Credit

All commercial letters of credit must clearly indicate whether they are payable by sight payment, by deferred payment, by acceptance, or by negotiation. These are noted as formal demands under the terms of the commercial letter of credit. In a sight payment, the commercial letter of credit is payable when the beneficiary presents the complying documents and if the presentation takes place on or before the expiration of the commercial letter of credit. In a deferred payment, the commercial letter of credit is payable on a specified future date. The beneficiary may present the complying documents at an earlier date, but the commercial letter of credit is payable only on the specified future date. An acceptance is a time draft drawn on, and accepted by, a banking institution, which promises to honor the draft at a specified future date. The act of acceptance is without recourse as it is a commitment to pay the face amount of the accepted draft. Under negotiation, the negotiating bank, a third party negotiator, expedites payment to the beneficiary upon the beneficiarys presentation of the complying documents to the negotiating bank.

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Sample of Letter of Credit

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Risks involved in Letter of Credit

1. Since all the parties involved in Letter of Credit deal with the documents and not with the goods, the risk of Beneficiary not shipping goods as mentioned in the LC is still persists. 2. The Letter of Credit as a payment method is costlier than other methods of payment such as Open Account or Collection 3. The Beneficiarys documents must comply with the terms and conditions of the Letter of Credit for Issuing Bank to make the payment. 4. The Beneficiary is exposed to the Commercial risk on Issuing Bank, Political risk on the Issuing Banks country and Foreign Exchange Risk in case of Usance Letter of Credits.

Other things related to letter of credit

Negotiable: The ability to be sold or transferred to another party as a form of payment. Something which is negotiable is transferable by endorsement and delivery. A negotiable instrument could be a check made out to you, because you could endorse it for payment to you or transfer it to someone else as payment to them. For example, when a price is said to be negotiable, it means that the seller is open to the possibility of reducing the price bank. Bank draft A check drawn by one bank against funds deposited into its account at another bank, authorizing the second bank to make payment to the individual named in the draft. Cheque
A bill of exchange drawn on a bank by the holder of a current account; payable into a bank account, if crossed, or on demand, if uncrossed

Bill of lading
A bill of lading is a document issued by a carrier to a shipper, acknowledging that specified goods have been received on board as cargo for conveyance to a named 11 | P a g e

place for delivery to the consignee who is usually identified. A thorough bill of lading involves the use of at least two different modes of transport from road, rail, air, and sea. The term derives from the verb "to lade" which means to load a cargo onto a ship or other form of transportation.

Invoice
An invoice or bill is a commercial document issued by a seller to the buyer, indicating the products, quantities, and agreed prices for products or services the seller has provided the buyer. An invoice indicates the buyer must pay the seller, according to the payment terms. The buyer has a maximum amount of days to pay these goods and are sometimes offered a discount if paid before.

Conclusion

The letter of credit can also be source of payment for a transaction, meaning that redeeming the letter of credit will pay an exporter. Letters of credit are used primarily in international trade transactions of significant value, for deals between a supplier in one country and a customer in another. In such cases the International Chamber of Commerce Uniform Customs and Practice for Documentary Credits applies.[2] They are also used in the land development process to ensure that approved public facilities (streets, sidewalks, storm water ponds, etc.) will be built. The parties to a letter of credit are usually a beneficiary who is to receive the money, the issuing bank of whom the applicant is a client, and the advising bank of whom the beneficiary is a client. Almost all letters of credit are irrevocable, i.e., cannot be amended or canceled without prior agreement of the beneficiary, the issuing bank and the confirming bank, if any. In executing a transaction, letters of credit incorporate functions common to giros and Traveler's cheques. Typically, the documents a beneficiary has to present in order to receive payment include a commercial invoice, bill of lading, and documents proving the shipment were insured against loss or damage in transit. However, the list and form of documents is open to imagination and negotiation and might contain requirements to present documents issued by a neutral third party evidencing the quality of the goods shipped, or their place of origin.

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References

LoanUniverse.com. J. H. Rayner & Co., Ltd., and the Oilseeds Trading Company, Ltd. v.Hambros Bank Limited [1942] Finkelstein, H. Legal Aspects of Commercial Letters of Credit, pp. 275-295 Dominique Doise,The 2007 Revision of the Uniform Customs and Practice for Documentary Credits Wikipedia.com Businessdictionary.com Banking; Theory and Practice, Shekhar & Shekhar(edition:19th)

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