Letter Of Credit VariationsPresentation Transcript
CHAPTER NINE LETTER OF CREDIT VARIATIONS
One of the great strength of the letter of credit is its flexibility . The basic letter of credit can be changed according to the needs of buyers and sellers.
Letters of credit can provide financing for the buyer, advance funds to the seller or permit a large international bank to provide financial support to smaller banks or to customers. This flexibility makes letters of credit the principle means of bank financing for international trade.
Export Letters of Credit
Every international letters of credit is both an export credit and an import credit. To the beneficiary and his bank, it is an export credit; to the buyer and to the opening bank it is an import credit. All commercial L/Cs are opened at the request of the buyer (importer) to it’s local bank.
Confirmed Letters of Credit (Teyitli akreditif)
If an unknown small bank in an unstable country, say in North Cyprus at the request of the buyer (importer) opens a letter of credit in favor of a seller, say in the US, the seller (exporter) may ask also that a US bank adds its confirmation in addition to the foreign bank. This is an irrevocable obligation of the US bank and this L/C is called confirmed L/C. The exporter now has a L/C that bears the promise of two banks .
The draft in a confirmed L/C will usually be drawn on the confirming bank (US bank) so that you can pay the exporter immediately.
When a reputable bank adds its confirmation to a L/C issued by a foreign bank, it charges a fee (commission) to the foreign bank that is ultimately passed on the foreign buyer.
Many exporters are willing to accept L/C without an added confirmation of a second bank due to experience, trust and competition. In this case the exporter accepts the B/L as soon as is it advised by his bank at home. This type of L/C is called advised credit or unconfirmed L/C.
L/Cs Available By Time Drafts
2. Sight L/C :
Drafts are drawn on the issuing bank and payment is made by the issuing bank as soon as the documents are received by this bank. The bank releases the documents to the importer after receiving the money. So, with a sight draft the seller surrenders title to the merchandise for a cash payment.
Time L/C :
The seller agrees to wait a period of time, before receiving full payment. The reason can be a highly competitive market or a tradition in the sector etc.
In any event, the seller surrenders title to the merchandise in return for a promise of the issuing bank to pay for it at a future date (eg.90 days after sight). The issuing bank is responsible for payment therefore should find a way of guaranteeing itself from the nonpayment of the importer (collateral, trust etc). The bank stands in place of the buyer in both sight and time letters of credit until the drafts are paid in cash.
The differences between the sight L/C and time L/C are:
The added credit risk assumed by the issuing bank
The technical procedure of creating an acceptance liability
DEFERRED PAYMENT L/C
If the seller wishes to extend credit to the buyer for a year or so he can do it. This deferred payment may be particularly suitable in sales of heavy equipment. To do this, the L/C may specify that sight draft to be presented not at the time of the shipment but, for example, one year later. All other shipping documents will be presented at the time of shipment takes place. A year later the shipper presents the sight draft to the bank; bank pays it and looks to the buyer for reimbursement at that time. The actual financing is made by the seller, who is willing to wait a year before payment.
3. OTHER L/C
The L/C is a flexible document. Clauses may be added to the basic L/C or may be changed to meet the special needs of banks customers.
Red Clause L/C
The buyer of the goods makes cash advances to the seller before shipment. Usually the seller is the agent of the buyer and needs cash to buy a crop from farmers. When the crop is shipped the remaining money is paid to the seller on the presentation of the concerned documents. A Green Clause (Australian use) means an advance payment can be made to the seller providing the merchandise be stored under banks control until it is shipped.
A L/C is used only by the addressed party (the seller of the merchandise). In some cases, The L/C can be transferred to the third party (transferees). This is called transferable L/C. This transfer can be made partly or wholly. The name of the transferee should be given to the bank from whom documents will be accepted. This type L/C is useful for business representative making a buying trip.
Assignment of Proceeds
A beneficiary of a L/C may seek financing from another supplier or third party in order to prepare the shipment. As a collateral the beneficiary agree to pledge to the supplier the proceeds of the draft drawn under the L/C. This is done by instructing the bank to pay a portion or sell of the L/C payments to the third party. Called an “assignment of proceeds” it is of value only if the beneficiary presents documents in compliance with the L/C.
Back to Back L/C
Back to back L/Cs are two L/Cs with identical documentary requirements except for a differences in the price of the merchandise and perhaps expiration date. This is appropriate when an agents acts between a buyer and a seller.
Ultimate buyer - L/C - Agent - L/C - Seller.
The agent agrees to purchase the goods against a L/C. The agent may prefer to use a back to back L/C instead of a transferable L/C in order to keep the identity of seller secret.
When a series of identical shipments for the same amount with the parties involved are to be made over a period of time, and the total value is greater than the amount the bank or the buyer is willing to have outstanding at any time, a L/C may be issued for a smaller amount with the provision that, after a shipment takes place and an amount is drawn the credit will be automatically received.
Straight and Negotiation Credits
In straight credits , documents are presented to the confirming bank. If some other bank negotiates the documents, there is no legal commitment to the bank.
It is appropriate if the beneficiary is in the same city.
In negotiation credits , documents are presented to banks other than the confirming bank. It is appropriate if the beneficiary is in another area and will need to negotiate the draft through another bank.
If a letter can be cancelled by the buyer or the opening bank without the agreement of the seller is called a revocable L/C.
Authority to Pay (yetki mektuplari)
It is an advice to pay but carries no banks obligation. Not really a L/C.
Authority to Purchase
Asian L/C. It can be either revocable or irrevocable.
In some instances a bank will issue its L/C in favor of a beneficiary where it does not have a correspondent bank. The paying bank is authorized to draw on another bank to reimburse itself for the payment it makes. Usually this third bank (reimburse bank) will be correspondent of both, the other two banks. This is a reimbursement arrangement, which is basically a paying mechanism .
4. DOMESTIC L/C
The L/C is applicable in financing of merchandise within a country. Time can be saved and many troublesome credit problems eliminated by the use of the L/C domestically .
Recently, request to banks to provide credit to support a borrower’s commitment to pay a third party or to perform certain contracting obligations have tremendously increased. This can be done with a stand by L/C. It is available only if another business transaction is not performed. If the account party does not pay or perform, then the issuing bank should pay.
Using the Series of a Correspondent Bank
The beneficiary of a standby L/C looks just to the account party for the payment before seeking payment from the bank. In Contrast, in a commercial L/C the beneficiary obtains payment from the issuing bank without looking to the buyer for payment even in the first place.
Standby L/C has also been used to borrow from private and institutional lenders at lower rates than their own bank. Especially if the issuing bank has a strong credit rating in bond or commercial paper market.
The L/Cs are reflected in a bank’s financial statement as contingent accounts.
The financial standby letters have a credit conversion factor of 100%. They back repayment of financial obligations (such as commercial paper or individual loans). Standby letters of credit that back the performance of non financial commercial contracts such as construction bids are called performance standby L/Cs that have a credit conversion factor of 50%.