Letter of credit is a mode of payment when business is carried across boundaries of the country where buyer & seller are unaware of the other’s financial positions. In that case it is most suitable to deal through the bankers of the respective countries.
- In this method the seller should have the confidence that the buyer will pay him for the goods as & when it is due either immediately or after the agreed period of credit. In case the seller is not fully satisfied then, he may ask for an assurance from a banker that the terms of the trade will qualify & his interest will be protected. This assurance given by the banker in the international trade through a system is called Letter Of Credit (LC).
The Buyer has the following advantages-
- No payment has to be made in advance to the seller.
- The bills are paid over a period of time thereby giving additional credit to the buyer.
- The buyer can demand for the certification of the quality of goods being supplied along with bills for negotiation.
The seller has the following advantages-
- The seller is assured that he will receive the payment as mentioned in the LC.
- On shipment of the goods, the seller can draw & negotiate the bills thereby getting immediate payment in his country.
- The seller need not bother about the import regulations of the buyer’s country since it is the responsibility of the buyer.
PARTIES TO A LETTER OF CREDIT
- Applicant-Buyer-Importer-Opener- He is the person who applies to the bank to open a LC, since he will be either purchasing the goods or availing services for which the payment has to be made.
- Issuing Bank-The bank which opens the LC on the request of the buyer or importer’s bank.
- Beneficiary-Seller- it is the person who is entitled to receive the payments under the LC.
- Advising Bank- The bank in the beneficiary country. The Advisory bank only forwards the LC to the Beneficiary, thereby enabling the beneficiary to rely on its authenticity & genuineness.
- Negotiating Bank- the bank of the beneficiary’s country which actually negotiates the bills & makes the payment & accepts the documents.
- Reimbursing Bank- It is the bank which is appointed by the issuing bank to make reimbursement to the negotiating, paying or confirming bank.
TYPES OF LETTERS OF CREDIT
- Acceptance Credit- the LC which are payable over a specified period of time, also called Usance bills. The bills drawn on different dates are payable on maturity.
- Irrevocable Credit- It is a credit that can neither be amended nor cancelled without the consent of the beneficiary.
- Confirmed Credit- If a bank advising the credit adds its own confirmation to the credit, and then the credit is called the confirmed. Only irrevocable LC can be confirmed.
- With recourse or without recourse Credit- The liability of the beneficiary is extinguished only when the payment is done. It is called recourse bills. However the beneficiary can exclude his liability by adding to the bills “without recourse” which means the right against the drawer under the bill is not available to endorse of the bill of exchange.
- Transferable Credits- A transferable credit is one under which the beneficiary can transfer his rights to third parties.
- Back-to-back Credits- in this type of LC, the beneficiary in whose favor then LC is issued uses the same to open another credit from his bank in favor of the supplier.
- Anticipatory Letter of Credit-In certain credits the beneficiary will be entitled to get an advance of the price. These credits contain a Red clause which authorizes a bank to make an advance payment to the beneficiary before shipment. Another one is Green clause which not only permits pre-shipment advances but also permits advances to cover storage at the port of the shipment.
DOCUMENTS UNDER A LETTER OF CREDIT
It is necessary for a banker to understand the documents to accompany a letter of credit.
- Bill of Exchange- It is a financial document. In a LC the right to draw the bills is conferred only to the beneficiary. The bill amount should be within the limits fixed in the LC.
- Invoice- This document gives the details of the sale. It should be made in the name of the importer unless required otherwise in the LC. All the details mentioned in the invoice should tally as mentioned in the LC, failing which it , may account to a discrepancy, making the documents liable for rejection.
- Transport Documents- the mode of dispatch of the goods would depend on the terms of the contract between the buyer & the seller and incorporated in the LC.
- Bills of Lading- If the goods are shipped through the sea, the documents evidencing the shipment is called bills of lading.
- Airway Bill- The documents which evidences that the goods have been received by an Airline company or agent. Like a bill of lading, an airway bill does not carry with it the right to the goods, i.e. it is not a document of title to the goods.
- Insurance Documents-the goods shipped if required to be insured under the terms as mentioned in the LC, then the insurance documents is required to be enclosed with the other documents.
UCPDC600– Uniform Customs & Practices For Documentary Credits 600.