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A Report On: How To Open Letter Of Credit

Prepared For: Sir Mumtaz Hassan

Prepared By: Muhammad Waseem

Roll No: 1204136

DATED: 8th, April, 2015

TABLE OF CONTENTS

S.No

Topic

01

Executive summary

02

Introduction

03

Letter of credit

04

Types of L/C

05

How to open L/C

06

Availability

07

Documents call for under L/C

08

Standard form of documentation

09

Intr. Trade payment methods

10

Risk in L/C transaction

11

Conclusion

13

Appendix (A)

14

Appendix (B)

15

Bibliography

16

Index

Page
No

EXECUTIVE SUMMARY
Whatever sector you might be located, you may have to open a
letter of credit throughout your professional career one day.
A letter of credit is a method of securing payment to a vendor.
When a seller asks a buyer to obtain a letter of credit, it means
the seller would like to ensure payment for a product he sells to
that customer. Typically letters of credit are issued by a bank.
The most common forms are standby letters of credit for
domestic transactions and documentary letters of credit for
international transactions.
Letter of credit is a payment method in international trade
which is used by almost all sectors from textile to machinery,
food manufacturing to construction, oil trading to customer
goods. You may assume that there are big differences exist on
letter of credit application process for all these different
sectors. But this is not correct. You have to follow similar
procedures when opening a letter of credit regardless of the
sector you may be located.
Two types of L/C is wideley used around the globe which is
Revocable L/C and Irrevocable L/C and the following parties are
involved in letter of credit; Applicant of L/C, L/C issuing bank,
beneficiary party, advising bank, confiming bank, negotiating
bank and second beneficiary. Typically, the documents a
beneficiary has to present in order to receive payment include
a commercial invoice, bill of lading, and documents proving the
shipment was insured against loss or damage in transit.
However, the list and form of documents is open to imagination

and negotiation and might contain requirements to present


documents issued by a neutral third party evidencing the
quality of the goods shipped, or their place of origin.

INTRODUCTION
when you hear the phrase letter of credit, it might be natural to
think it would refer to a document verifying that you are
creditworthy, but that isn't the case. a letter of credit is a
document issued by a third party that guarantees payment for
goods or services when the seller provides acceptable
documentation. letters of credit are usually issued by banks or
other financial institutions, but some creditworthy financial
services companies, like insurance companies or mutual funds,
might issue letters of credit under certain circumstances.
The purpose of this report is to get deeper knowledge of the
procedure to open letter of credit. In this regard we were
advised to visit any bank and collect the relevant information
regarding Letter of Credit. We have visited the Habib Metro
Bank ( Bahudarabad Branch).The branch manager was really
co-operative and he gave us not only his precious time but also
his valuable and practical insights on Letter of credit as he has
years of experience in this feild.
This report helped us a lot and a great addition in our
knowledge.Now we are fimiliar with procedure of opening letter
of credit .

LETTER OF CREDIT
DEFINITION:
L/C. A binding document that a buyer can request from his
bank in order to guarantee that the payment for goods will be
transferred to the seller. Basically, a letter of credit gives the
seller reassurance that he will receive the payment for the
goods. In order for the payment to occur, the seller has to
present the bank with the necessary shipping documents
confirming the shipment of goods within a given time frame. It
is often used in international trade to eliminate risks such as
unfamiliarity with the foreign country, customs, or political
instability.

TYPES OF LETTER OF CREDIT


There most common types of letter of credit are:

REVOCABLE L/C:
The Revocable L.C can be amended and cancel without the
exporter permission on knowledge.

IRREVOCABLE L.C
An Irrevocable L.C cannot amended and cancel without the
permission or knowledge of the exporter.

HOW TO OPEN LETTER OF


CREDIT
A business called the InCosmetika from time to time imports
goods from a business called ACME, which banks with the ABC
Bank. InCosmetika holds an account at the Commonwealth
Bank. InCosmetika wants to buy $500,000 worth of
merchandise from ACME, who agrees to sell the goods and give
InCosmetika 60 days to pay for them, on the condition that
they are provided with a 90-day letter of credit for the full
amount. The steps to get the letter of credit would be as
follows:
InCosmetika goes to The Commonwealth Bank and requests
a $500,000 letter of credit, with ACME as the beneficiary.
The Commonwealth Bank can issue an LC either on approval
of a standard loan underwriting process or by InCosmetika
funding it directly with a deposit of $500,000 plus fees which
are typically between 1% and 8% of the face value of the LC.
The Commonwealth Bank sends a copy of the LC to the ABC
Bank, which notifies ACME that payment is available and
they can ship the merchandise InCosmetika has ordered with
the full assurance of payment to them.
On presentation of the stipulated documents in the letter of
credit and compliance with the terms and conditions of the
letter of credit, the Commonwealth Bank transfers the
$500,000 to the ABC Bank, which then credits the account of
ACME for that amount.
Note that banks deal only with documents required in the
letter of credit and not the underlying transaction.
Many exporters have mistakenly assumed that the payment
is guaranteed after receiving the LC. The issuing bank is

obligated to pay under the letter of credit only when the


stipulated documents are presented and the terms and
conditions of the letter of credit have been met.

AVAILABILITY
LC being an irrevocable undertaking of the issuing bank makes
available the Proceeds, to the Beneficiary of the Credit
provided, stipulated documents strictly complying with the
provisions of the LC, UCP 600 and other international standard
banking practices, are presented to the issuing bank, then:
I.

if the Credit provides for sight payment by payment at


sight against compliant presentation

II.

if the Credit provides for deferred payment by payment


on the maturity date(s) determinable in accordance with the
stipulations of the Credit; and of course undertaking to pay
on due date and confirming maturity date at the time of
compliant presentation

III.

(A) if the Credit provides for acceptance by the Issuing


Bank by acceptance of Draft(s) drawn by the Beneficiary
on the Issuing Bank and payment at maturity of such tenor
draft, or
(B). if the Credit provides for acceptance by another
drawee bank by acceptance and payment at maturity
Draft(s)drawn by the Beneficiary on the Issuing Bank in
the event the drawee bank stipulated in the Credit does
not accept Draft(s) drawn on it,

IV.

or by payment of Draft(s) accepted but not paid by such


drawee bank at maturity;

V.

if the Credit provides for negotiation by another bank by


payment without recourse to drawers and/or bona fide
holders, Draft(s) drawn by the Beneficiary and/or
document(s) presented under the Credit, (and so negotiated
by the nominated bank )

VI.

Negotiation means the giving of value for Draft(s) and/or


document(s) by the bank authorized to negotiate, viz the

nominated bank. Mere examination of the documents and


forwarding the same to LC issuing bank for reimbursement,
without giving of value / agreed to give, does not constitute a
negotiation.

SOME OF THE DOCUMENTS CALLED


FOR UNDER LC

Financial Documents
Bill of Exchange, Co-accepted Draft

Commercial Documents
Invoice, Packing list

Shipping Documents
Transport Document, Insurance Certificate, Commercial,
Official or Legal Documents

Official Documents
License,
Embassy
legalization,
Origin
Inspection Cert , Phyto-sanitary Certificate

Certificate,

Transport Documents
Bill of Lading (ocean or multi-modal or Charter party),
Airway bill, Lorry/truck receipt, railway receipt, CMC Other
than Mate Receipt, Forwarder Cargo Receipt, Deliver
Challan...etc

Insurance documents
Insurance policy, or Certificate but not a cover note. Pre
shipment packing list.

STANDARD
FORMS
DOCUMENTATION

OF

When making payment for product on behalf of its customer,


the issuing bank must verify that all documents and drafts
conform precisely to the terms and conditions of the letter of
credit. Although the credit can require an array of documents,
the most common documents that must accompany the draft
include:

Commercial Invoice
The billing for the goods and services. It includes a description
of merchandise, price, FOB origin, and name and address of
buyer and seller. The buyer and seller information must
correspond exactly to the description in the letter of credit.
Unless the letter of credit specifically states otherwise, a
generic description of the merchandise is usually acceptable in
the other accompanying documents.

Bill of Lading
A document evidencing the receipt of goods for shipment and
issued by a freight carrier engaged in the business of
forwarding or transporting goods. The documents evidence
control of goods. They also serve as a receipt for the
merchandise shipped and as evidence of the carrier's obligation
to transport the goods to their proper destination .

Warranty of Title
A warranty given by a seller to a buyer of goods that states that
the title being conveyed is good and that the transfer is
rightful. This is a method of certifying clear title to product
transfer. It is generally issued to the purchaser and issuing bank
expressing an agreement to indemnify and hold both parties
harmless.

Letter of Indemnity
Specifically indemnifies the purchaser against a certain stated
circumstance. Indemnification is generally used to guaranty
that shipping documents will be provided in good order when
available.

INTERNATIONAL TRADE PAYMENT


METHODS
Advance payment (most secure for seller)
Where the buyer parts with money first and waits for the seller
to forward the goods

Documentary Credit (more secure for seller as well as


buyer)

subject to ICC's UCP 600, where the bank gives an undertaking


(on behalf of buyer and at the request of applicant ) to pay the
shipper ( beneficiary ) the value of the goods shipped if certain
documents are submitted and if the stipulated terms and
conditions are strictly complied.
Here the buyer can be confident that the goods he is expecting
only will be received since it will be evidenced in the form of
certain documents called for meeting the specified terms and
conditions while the supplier can be confident that if he meets
the stipulations his payment for the shipment is guaranteed by
bank, who is independent of the parties to the contract.

Documentary collection (more secure for buyer and


to a certain extent to seller)
subject to ICC's URC 525, sight and usance, for delivery of
shipping documents against payment or acceptances of draft,

where shipment happens first, then the title documents are


sent to the [collecting bank] buyer's bank by seller's bank
[remitting bank], for delivering documents against collection of
payment/acceptance

Direct payment (most secure for buyer)


Where the supplier ships the goods and waits for the buyer to
remit the bill proceeds, on open account terms

RISKS IN LC TRANSACTION
Fraud Risks
The payment will be obtained for nonexistent or worthless
merchandise against presentation by the beneficiary of
forged or falsified documents.
Credit itself may be forged.

Sovereign and Regulatory Risks


Performance of the Documentary Credit may be prevented
by government action outside the control of the parties.

Legal Risks
Possibility that performance of a Documentary Credit may be
disturbed by legal action relating directly to the parties and
their rights and obligations under the Documentary Credit

Force Majeure and Frustration of Contract


Performance of a contract including an obligation under a
Documentary Credit relationship is prevented by external
factors such as natural disasters or armed conflicts

Risks to the Applicant


Non-delivery of Goods
Short Shipment
Inferior Quality
Early /Late Shipment
Damaged in transit
Foreign exchange
Failure of Bank viz Issuing bank / Collecting Bank

Risks to the Issuing Bank


Insolvency of the Applicant
Fraud Risk, Sovereign and Regulatory Risk and Legal Risks

Risks to the Reimbursing Bank

No obligation to reimburse the Claiming Bank unless it has


issued a reimbursement undertaking.

Risks to the Beneficiary


Failure to Comply with Credit Conditions
Failure of, or Delays in Payment from, the Issuing Bank
Credit Issued by Party other than Bank

Risks to the Advising Bank


The Advising Banks only obligation if it accepts the Issuing
Banks instructions is to check the apparent authenticity of
the Credit and advising it to the Beneficiary

Risks to the Nominated Bank


Nominated Bank has made a payment to the Beneficiary
against documents that comply with the terms and
conditions of the Credit and is unable to obtain
reimbursement from the Issuing Bank

Risks to the Confirming Bank


If Confirming Banks main risk is that, once having paid the
Beneficiary, it may not be able to obtain reimbursement from
the Issuing Bank because of insolvency of the Issuing Bank
or refusal of the Issuing Bank to reimburse because of a

dispute as to whether or not payment should have been


made under the Credit.

CONCLUSION
Whatever sector you might be located, you may have to open a
letter of credit throughout your professional career one day.
A letter of credit is a method of securing payment to a vendor.
When a seller asks a buyer to obtain a letter of credit, it means
the seller would like to ensure payment for a product he sells to
that customer. Typically letters of credit are issued by a bank.
The most common forms are standby letters of credit for
domestic transactions and documentary letters of credit for
international transactions.

APPENDIX (A)
Bill of Lading: A detailed list of a ship's cargo in the form of a
receipt given by
cancelled unless everyone involved agrees. Irrevocable letters
of credit provide more security than revocable ones.

Commercial Invoice : A commercial invoice is a document


used in foreign trade. It is used as a customs declaration
provided by the person or corporation that is exporting an item
across international borders.

Deferred Payment: temporary postponement of the


payment of an outstanding bill or debt, usually involving
repayment by instalments.

Documentary collection:

A process, in which the seller

instructs his bank to

Documentary Credit: The documentary credit is one of the


most secure payment methods in international trade, offering
the exporter a conditional payment guarantee from the
importer's bank.
forward documents related to the export of goods to the
buyer's bank with a

Irrevocable L/C: An irrevocable letter of credit cannot be


changed or

Issuing Bank: The importer's bank which issued the letter of


credit called the issuing bank.

Letter of credit: A letter of credit is a document from a bank


guaranteeing that a seller will receive payment in full as long as
certain delivery conditions have been met. In the event that the
buyer is unable to make payment on the purchase, the bank
will cover the outstanding amount.

Letter of Indemnity: It is the document by which two parties


to a misrepresentation against third parties settle their
differences in advance should a third party in the future make a
valid claim as a result of the misrepresentation.
request to present these documents to the buyer for payment,
indicating

Revocable L/C: A revocable letter of credit can be changed or


cancelled by the bank that issued it at any time and for any
reason.

Sight Payment: A payment due on demand. An at sight


payment will require the party receiving the good or service to
pay a certain sum immediately upon being presented with the
bill of exchange.
the master of the ship to the person consigning the goods.
when and on what conditions these documents can be released
to the buyer.

APPENDIX (B)

BIBLIOGRAPHY
www.businessdictionary.com

www.investopedia.com
www.smedia.org
www.wikipedia.org

INDEX
Bill of Lading
Commercial Invoice
Deferred Payment
Documentary collection
Documentary Credit:
Irrevocable L/C
Issuing Bank
Letter of credit:
Letter of Indemnity
Revocable L/C:
Sight Payment