A letter of credit, also known as a documentary credit or bankers commercial credit, or letter of undertaking, is a payment mechanism used in international trade to provide an economic guarantee from a creditworthy bank to an exporter of goods. Wikipedia

1. DEFINITION
It is also called documentary credit.
It is a payment assurance from the issuing bank to beneficiary
It guarantees the payments to the beneficiary when he fulfills all the conditions
Among all the international documents letter of credit considered as the most
essential one.
Conditions should be mentioned in the contract in right order and at the right time.
It is also very important document for custom clearance of export and import
consignment.
It is most important segment of non fund based business for banks.

2. Parties in LC
Transaction
Applicant
The buyer who
finalizes the terms
and conditions of
purchase
transaction
and submits a
request to his bank
for issuing a LC in
favor of the seller.
Beneficiary
The beneficiary of
the letter of credit is
generally the seller
of the goods and
services or the
person in whose
favor the credit has
been issued.

3. Parties in LC Transaction
ISSUING BANK / OPENING BANK
An issuing bank is the one which on receipt of request from its customer, the applicant’s (purchaser’s) bank
examines the proposal and open a LC in favor of the beneficiary with the stipulated terms and condition.
ADVISING BANK/ CORRESPONDENT BANK
In case seller (beneficiary) resides in a different lace or in a foreign country, the issuing bank may contact
some other bank in the beneficiary’s country may agree to advise the credit to the beneficiary and thus play
the role of an advising bank.
CONFIRMING BANK :
The Confirming bank adds its guarantee to the credit opened by another bank, thereby undertaking the
responsibility of payment/negotiation acceptance under the credit, in additional to that of the issuing bank.
Confirming bank play an important role where the exporter is not satisfied with the undertaking of only the
issuing bank.

4. Parties in LC Transaction
REIMBURSING BANK
Reimbursing Bank is the bank authorized to honor the reimbursement claim in settlement of
negotiation/acceptance/payment lodged with it by the negotiating bank. It is normally the bank with which
issuing bank has an account from which payment has to be made.
NOMINATED/ NEGOTIATING BANK :
The Negotiating Bank is the bank who negotiates the documents submitted to them by the beneficiary
under the credit either advised through them or restricted to them for negotiation. On negotiation of the
documents they will claim the reimbursement under the credit and makes the payment to the beneficiary
provided the documents submitted are in accordance with the terms and conditions of the letters of credit.
SECOND BENEFICIARY:
Second Beneficiary is the person who represent the first or original Beneficiary of credit in his absence. In
this case, the credits belonging to the original beneficiary is transferable. The rights of the transfer are
subject to terms of transfer.

5. Contents of Letter of Credit
Correct and complete name
and address of the beneficiary
(exporter)
Correct and complete name
and address of the applicant
(importer)
Type of the L/C
Amount of L/C
How the credit shall be available,
i.e. by sight payment, deferred
payments, acceptance or
negotiation
Name of the nominated bank,
which shall make the payment to
the beneficiary.
The name of the drawee on the
draft and the tenor of the draft.
Term of delivery: FOB, CFR, CIF etc.
Description of goods, quantity and
unit price.
Port of discharge and place of final
destination.

6. TYPES OF LC
REVOCABLE LC
Allows for amendments,
modifications and cancellation
of the terms outlined in the letter
of credit at any time and without
the consent of the exporter or
beneficiary. Generally, not
accepted.
IRREVOCABLE LC
Requires the consent of the
issuing bank, the beneficiary and
applicant before any
amendment, modification or
cancellation to the original terms
can be made.
DEFERRED
PAYMENT LC
Deferred payment LCs allows the
issuing bank to make the
payment to the beneficiary in
installments. The timing and the
amounts of these installments
are predetermined.
REVOLVING LC
Single L/C that covers multiple-
shipments over a long period.
Instead of arranging a new L/C
for each separate shipment, the
buyer establishes a L/C that
revolves either in value or in time
TRANSFERABLE LC
To be transferable, the L/C must
be so marked by the issuing bank
on the instructions of the buyer
or importer (the account-party).
On the instructions of the first
beneficiary the advising bank
can transfer it to the second
beneficiary but not any further.
ANTICIPATORY LC
It is a letter of credit under which
payment is made to the
beneficiary even at the pre-
shipment stage. red clause
credit, advance is given for
purchase of raw material,

7. Mechanism of LC
STEP 1
The seller and the buyer enters
into a sales contract where
buyer agrees to purchase goods
from the seller. This agreement
may be a purchase order, an
accepted pro-forma invoice, a
formal contract, as to how and
when goods are to be shipped
and insured, and how and when
payment is
to be effected. In this case they
agree that letter of credit will be
used as the mechanism of
payment.
The buyer applies to his bank
for a letter of credit in favor
of the seller (beneficiary),
signing the
bank’s letter of credit
application/agreement form
specifying the terms and
condition under which
the Letter of Credit shall be
issued.
STEP 2
After approving the
application, the issuing bank
issues the actual letter of
credit instrument and
sends it to the beneficiary
(the seller), thus
undertaking the definite
obligation of effecting
payment
to the beneficiary upon
presentation of documents,
strictly complying with the
terms and condition
of the credit .
STEP 3

8. Mechanism of LC
STEP 4
As soon as the seller receives
Letter of Credit (issuing
bank’s assurance of
payment), the seller ships
the goods to the buyer
provided the terms of credit
meets the terms of
underlying sales contract.
The seller prepares the
documents called for in the
letter of credit and presents
them to the Issuing
bank. The issuing bank
examines the documents
whether they strictly comply
with the terms of
letter of credit. If the
documents meet the
requirement the issuing bank
pays the beneficiary
(seller) in the manner
stipulated under the credit.
STEP 5 & 6
The issuing bank sends the
documents to the buyer
(applicant) and obtains
payment in accordance
with the terms of the
applicant’s letter of credit
agreement ( usually by debit
to the applicant’s
account)
STEP 7 & 8

9. Mechanism of LC
STEP 9
On receiving the documents
from bank, the applicant
(buyer) is in a position to pick
up the
merchandise from the
carrier, completing the letter
of credit cycle.

10. Advantages and Disadvantages of Using a Letter of Credit
Advantages to the Importer
Importer is assured that the Exporter will be paid only if
all terms and conditions of the Letter of Credit have been
met.
Importer is able to negotiate more favourable trade
terms with the Exporter when payment by Letter of
Credit is offered.
Disadvantages to the Importer
A Letter of Credit does not offer protection to the
Importer against the Exporter shipping inferior quality
goods and/or a lesser quantity of goods.
It is necessary for the Importer to have a line of credit
with a bank before the bank is able to issue a Letter of
Credit.

11. Advantages and Disadvantages of Using a Letter of Credit
Advantages to the Exporter
The risk of payment relies upon the creditworthiness of the
Issuing Bank and the political risk of the Issuing Bank’s
domicile, and not the credit worthiness of the Importer.
Exporter agrees in advance to all requirements for payment
under the Letter of Credit. If the Letter of Credit is not issued
as agreed, the Exporter is not obligated to ship against it.
Disadvantages to the Exporter
Documents must be prepared and presented in strict
compliance with the requirements stipulated in the
Letter of Credit
Some Importers may not be able to open Letters of Credit
due to the lack of credit facilities with their bank which
consequently inhibits export growth.