Letter of credit


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Letter of credit

  1. 1. Letter of Credit Anurag Sharma MBA-IB University Business School
  2. 2. Contents  Introduction  Definition  Principle  Parties to Letter of Credit  Process of settlement  Types of Letter of Credit 2University Business School
  3. 3. Introduction • Letter of Credit L/c also known as Documentary Credit is a widely used term to make payment secure in domestic and international trade. • The document is issued by a financial organization at the buyer‟s(or Importer‟s) request. Buyer also provides the necessary instructions in preparing the document. University Business School 3
  4. 4. Definition The International Chamber of Commerce (ICC) in the Uniform Custom and Practice for Documentary Credit (UCPDC) defines L/C as: “Any arrangement whereby a bank acting at the request and in accordance with the instructions of a customer(the importer) undertakes to make payment to or to the order of third party(the exporter) against stipulated documents and compliance with stipulated terms & conditions” University Business School 4
  5. 5. Principle • A key principle underlying letter of credit (L/C) is that banks deal only in documents and not in goods. • The decision to pay under a letter of credit will be based entirely on whether the documents presented to the bank appear on their face to be in accordance with the terms and conditions of the letter of credit. University Business School 5
  6. 6. L/c(sample) • Bank‟s name • L/c number • Wholesaler‟s acc • Expiry date 6 University Business School
  7. 7. Parties to Letter of Credit University Business School 7
  8. 8. Applicant  Applicant (Opener): Applicant which is also referred to as account party is normally a buyer or customer of the goods, who has to make payment to beneficiary. LC is initiated and issued at his request and on the basis of his instructions. University Business School 8
  9. 9. Issuing Bank  Issuing Bank (Opening Bank) : The issuing bank is the one which create a letter of credit and takes the responsibility to make the payments on receipt of the documents from the beneficiary or through their banker. University Business School 9
  10. 10. Beneficiary  Beneficiary : Beneficiary normally stands for seller of the goods, who has to receive payment from the applicant. A credit is issued in his favour to enable him or his agent to obtain payment on surrender of stipulated documents and comply with the term and conditions of the L/c. University Business School 10
  11. 11. Advising Bank  Advising Bank: The Bank to whom the L/c is sent for authentication and delivery is known as “Advising Bank”. It is expected to take reasonable care while verifying the authenticity of the documentary credit. 11University Business School
  12. 12. 12 University Business School Issuing Bank Documents reuired
  13. 13. Confirming Bank  Confirming Bank: The bank which adds the confirmation, is known as “Confirming Bank”. It gives its commitment to make the payment if conditions stipulated in the credit are complied with even if the advising bank is unable to pay or refuses to make the payment.  Normally, advising bank and confirming bank are one and the same. 13University Business School
  14. 14. Paying Bank  Paying Bank: It is normally the bank with which issuing bank has an account from which payment has to be made. 14University Business School
  15. 15. Negotiating Bank  Negotiating Bank: When paying bank is not located in exporter‟s place, credit permits any bank to make the negotiation of documents and disburse payment to exporter.  After payment, the negotiating bank claims reimbursement from the paying bank 15University Business School
  16. 16. Process of settlement 16
  17. 17. Types of L/C  Documentary L/C  Revocable and Irrevocable L/C  With recourse or without recourse L/C  Confirmed and unconfirmed L/C  Transferrable and Non-Transferrable L/C  Fixed and revolving L/C  Freely negotiable and restricted L/C  Red Clause and Green Clause L/C  Back to Back L/C  Assignable & non-assignable L/C  Deffered period of credit  Stand by credit University Business School 17
  18. 18. Documentary letter of credit • Sight or usance bill of exchange • Commercial invoice/Customs invoice • Consular invoice • Packing list • Bill of lading • Inspection certificate • Marine insurance policy • Certificate of origin • Any other document required by the buyer University Business School 18
  19. 19. Revocable & Irrevocable • Revocable: The opening bank reserves the right to cancel or modify the credit, at any time, without the consent of the beneficiary. • Irrevocable: The opening bank has no right to change the terms of credit, without the consent of the beneficiary. University Business School 19
  20. 20. 20 University Business School We hereby establish our irrevocable letter of credit This L/c is specifically issued at the request of operator
  21. 21. With recourse & without recourse • „With Recourse‟- The negotiating bank can make the exporter liable, in case of default in payment by the opening bank or importer. • „Without Recourse‟-The negotiating bank has no recourse to the exporter. University Business School 21
  22. 22. Confirmed & Unconfirmed • Exporter and importer may remain in different countries. Exporter may insist that the local bank should add confirmation to the credit opened. • Importer would not be willing to add confirmation to credit as it involves additional commission of the confirming bank. • After confirmation, letter of credit becomes confirmed and irrevocable. 22University Business School
  23. 23. Transferrable & non- Transferrable • Under Transferrable L/c, exporter can transfer the credit fully or partially to one or more parties. • Used when seller is the middleman who can transfer a part of the credit to the exporter for shipping the goods. University Business School 23
  24. 24. Fixed & Revolving • A fixed letter of credit is for a fixed period and amount. L/C expires if the credit is exhausted or period is over, whichever is earlier. • Revolving: The L/c would be revived automatically for the same amount and period once it is exhausted. 24University Business School
  25. 25. Freely negotiable & Restricted • When the letter of credit does not put any condition for the negotiation of documents, it is a freely negotiable letter of credit. • In case the credit names a specific bank for negotiation, then the letter of credit is a restricted credit. 25University Business School
  26. 26. Red Clause & Green Clause • A Red Clause L/c is one that authorises the exporter to avail pre- shipment finance on the strength of the credit. • The clause is printed in red ink. • In a green clause L/c, in addition to pre-shipment finance, storage facilities are allowed at the port of shipment to the exporter by opening bank. • The clause is printed in green ink. 26University Business School
  27. 27. Back-to-back L/c  When the beneficiary wants to purchase raw materials from a third party for the purpose of executing export order, or is only a middleman and not the actual supplier of goods, he can ask the bank to open a new letter of credit, on the strength of this credit, in favour of a third party. 27University Business School
  28. 28. Assignable & Non-Assignable  An assignable letter of credit can be assigned to a third party by the beneficiary of the credit. When the buyer is not able to find the real exporter, in the meantime, he opens the credit in favor of his agent or representative.  When the agent is able to find an exporter who is willing to supply the goods on the terms of the buyer, he assigns the letter of credit to the supplier of goods. 28University Business School
  29. 29. Stand by Credit • The credit assures the beneficiary that in the event of non- performance or non-payment of any obligation, the beneficiary may request the issuing bank to make the payment. • The beneficiary has to draw the claim by drawing a bill on the issuing bank, accompanied with documentary evidence in support of non-performance of contract. 29University Business School
  30. 30. Thank You 30University Business School