Letter of Credit:
A letter of credit is widely used to make payments for domestic and international trading. A letter of credit is also known as a documentary credit. A letter of credit is basically unfunded credit given by the issuing bank on behalf of the buyer (the importer).
A letter of credit commitment by the issuing bank to place a certain amount of money with the goods seller (exporter or beneficiary) under previously agreed-upon terms. With the documentary credit, the seller no longer depends on the buyer’s willingness to pay; moreover, he can get funds if the goods are shipped properly, as depicted in the clause (terms) on the letter of credit.
A key principle underlying a letter of credit (L/C) is that banks deal only with the documents, not the goods. The decision to pay under a letter of credit will be based on whether the documents presented to the bank are in accordance with the terms and conditions of the letter of credit.
Types of Letter of credit:
01) Revocable Letter of Credit:
A revocable letter of credit can be canceled or amended for any reason, at any time by the issuing bank without any prior notification to the seller. In very rare cases, this sort of LC is used in international trade and is not considered satisfactory for the exporters but has great benefits for the importers. It must be indicated in LC that the credit is revocable. If there is no such indication on the L/C, it should be considered irrevocable.
02) Irrevocable Letter of Credit:
A revocable letter of credit is most common and cannot be canceled or amended without agreement among the issuing bank, the confirming bank, and the beneficiary. This credit is a firm undertaking by the issuing bank to pay the beneficiary against the stipulated documents presented to the negotiating bank or the issuing bank, and UCPDC complies with the terms and conditions of the credit. In terms of confirmation an Irrevocable Letter of Credit can be of two types as below;
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Confirmed Letter of Credit:
By adding confirmation to the Letter of Credit the corresponding bank undertakes to honor the documents that conform to the terms & conditions of the credit & presented before the LC expiry date.
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Un-Confirmed Letter of Credit:
In such cases advising bank simply advising bank advise the beneficiary that the credit has opened. It does not itself provide any firm undertaking to pay & obligation to honor documents presented by the beneficiary
03) Sight Letter of Credit (At sight LC):
Sight credit states that the payments will be made within the shortest possible time by the issuing bank upon presentation of corrected documents. Even though receiving payment is fairly quick, that doesn’t mean that it is instant. The exporter’s or seller’s bank will first review all of the submitted documents to confirm that they meet all of the requirements of the letter of credit. This may take a few business days.
Sight letters of credit are widely used in Bangladesh to export garments from Bangladesh.
04) Usance LC ( Deferred LC):
This type of letter is called a “usual example letter of credit,” and it states that payment is to be made within the allowable period of time. LC payment is made with a usance long after the required documents are presented. This could be 30, 60, 90, or 180 days after the documents are presented. This type of credit really helps the buyer to get the goods in hand, sell the goods to the end consumer, and make money to pay the exporter. Most of the time, LC is preferred where a buyer and a seller have a close and long-term business relationship. Both parties(buyer & seller) must agree on the interest rate for usance period
05) Back-to-Back Letter of Credit:
Back-to-back credit is a new credit opened in favor of another supplier by the beneficiary bank by submitting the original LC (Master LC). The original LC offers his bank the security of opening a second line of credit under the back-to-back concept, which is referred to as a “back-to-back letter of credit.”
06) Transferable Letter of Credit:
A transferable documentary credit is a type of credit under which the first party/beneficiary usually acts as a middleman and requests his bank to transfer credit in whole or in part to the second party/beneficiary. On LC clause should mention LC is transferable to forward this to the 2nd party, otherwise not possible to follow this transfer process through the beneficiary bank.
During forward LC by the beneficiary bank should endorse 1st party commission percentage of the first beneficiary. The first beneficiary or middleman has the right to change the following terms and conditions (as reduced unit price, amount, shipment date) of the letter of credit during forwarding LC
07) Red Clause LC.
The seller can request an advance for an agreed amount of the LC before the shipment of goods and submittal of required documents. This red clause is so termed because it is usually printed in red on the document to draw attention to the “advance payment” term of the credit.
Parties involved in Letter of Credit:
- Applicant: Applicant normally stands for the buyer or Importer of the goods, who will make payment to the seller. L/C is issued by the bank (issuing bank) at the buyer’s request as follows his instructions.
- Beneficiary: Beneficiary is normally stood for the seller (exporter) of the goods, who has to receive payment from the applicant(importer). A credit is issued in his favor to enable him to obtain payment on surrender of the stipulated document which is complied with the conditions of the L/c.
- Issuing Bank: The issuing bank is the one that opens a letter of credit and takes the responsibility to make the payments on receipt of the goods shipment documents from the beneficiary bank. The payment has to be made to the exporter within seven working days from the date of receipt of the documents at their hand.
- Advising Bank: An Advising Bank provides advice to the beneficiary and takes responsibility for sending the documents to the LC issuing bank. Advising Bank normally located in the country of the beneficiary(Exporter)
- Confirming Bank: Confirming bank adds confirmation or guarantee to the credit opened by the LC issuing bank. Add confirming bank undertaking the responsibility of delivered goods payment to the exporter. The confirming bank normally assigns in favor of the exporter when the exporter is not fully satisfied with the undertaking of the issuing bank. Confirming Bank is normally located in the country of the importer of the goods
- Negotiating Bank: Negotiating Bank is negotiating the documents submitted to them by the exporter to release goods payment under the credit. Negotiating bank is the bank that verifies the shipped documents and confirms the terms and conditions under LC on behalf of the beneficiary to resolve any further discrepancies. In their negotiation process, they will claim reimbursement and makes the payment to the beneficiary if all is in accordance with the terms and conditions of the letters of credit.
- Reimbursing Bank: Reimbursing Bank is the bank authorized to honor the reimbursement claim settlement by the negotiating bank. reimbursement bank is often but not always, the issuing bank or issuing the bank has an account for further settlement of LC payment
- Second Beneficiary: Second Beneficiary is the party who represents the original Beneficiary of credit. In this case, the credit belongs to the original beneficiary this must be transferable as mentioned on LC. Normally secondary beneficiary could be the goods manufacturer/shipper & original beneficiary is the buyer agent.
Importers Documents list to import under L/C;
- Valid IRC or Equivalent certificate
- Valid trade license
- Indent/proforma invoice/Sales Contact
- Membership certificate from the Chamber of Commerce or Trade Association
- TIN certificate (tax identification certificate)
- Income Tax paid certificate declaration of submission of income tax return
- Last 03 years audited/provisional balance sheet of company (For limited company)
- VAT license (value-added tax)
- Application & agreement for the letter of credit with the stamp of T.K 150 duly filled up & signed by Importer
- Indent/proforma invoice/Sales contract duly signed with Chopped by both parties (Importer& exporter)
- Insurance cover note with money receipt covering all risk for 110% of the LC value
- LCA form duly filled up & signed by Importer
- IMP form duly signed by the importer
- In the case of importing drugs & medicines, required valid drug license
- In the case of importing pharmaceuticals raw & packing materials, required the approval of the list of items with the corresponding amount from the Director, of the Drug Administration
- In the case of the public sector, required attested copy of Government permission
- Any other document as required as per Import Policy ( public notice/ Chamber of Commerce instruction)
Uniform practices of documentary credit:
The Uniform Customs and Practice for Documentary Credits (UCP) is the set rule for Documentary credits. It was developed by the international chamber of Commerce (ICC) to avoid the doubts caused by individual countries incorporating their own national rules on documentary credit practice. UPC 600 established uniformity to practice, obtain a global understanding, and follow the best application of documentary credit.
Author with two decades of expertise in Clothing merchandise & Digital marketing in the world’s most renowned Apparel companies.
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