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Letter of Credit and

International Business

LC-What does it mean?


A letter of credit (LC) is a document issued by a bank,
used primarily in trade finance which usually provides
an unalterable payment undertaking.
It is an obligatory document that a buyer can request from
his
bank in order to guarantee that the payment for goods will
be transferred to the seller.

LC what it supposed for:


The letter of credit is a source of
payment for a transaction
redeeming the letter of credit will
pay an exporter.

LC what it supposed for:


Letters of credit are mostly used in
international trade transactions for
deals between a supplier in one
country and a customer in another.
the International Chamber of
Commerce Uniform Customs and
Practice for Documentary Credits
(UCPDC) applies in such cases.

Parties involved in LC
transaction
Applicant - is the party that arranges for
the
letter of credit to be issued.
Beneficiary - is the party named in the
letter
of credit in whose favor the letter of credit
is
issued.

Parties involved in LC
transaction
Issuing or Opening Bank - opens a letter of
credit (L/C) in favor of the beneficiary, at the
request and on the instructions of the applicant.
The issuing bank usually is located in the
applicant's country

Parties involved in LC transaction


Advising Bank - advises the beneficiary that a
letter of credit (L/C) opened by the issuing bank
is
available to him/her and informs the beneficiary
about
the terms and conditions of the L/C. The advising
bank
is not necessarily responsible for the payment of
the
credit which it advises.

Parties involved in LC transaction


Correspondent bank - correspondent bank
used in
international trade refers to another bank in
another
country with which the first bank maintains a
banking
service agreement.
Negotiating bank - negotiates the draft(s) and/or
documents presented by the beneficiary or bona
fide
holder is known as negotiating bank.

Parties involved in LC transaction


The Confirming Bank - the advising bank
which
adds its confirmation to the credit, that is,
adds
its own promise to pay, upon authorization
or
request of the issuing bank is known as
the
confirming bank.

Parties involved in LC transaction


Paying Bank - is the bank nominated in
the letter of credit that makes payment to
the
beneficiary, after determining that
documents
conform, and upon receipt of funds from
the
issuing.

Importance
It is often used in international trade to
eliminate risk of unfamiliarity with the
foreign country, customs, or political
instability.
Basically, a Letter of Credit gives the
seller reassurance that he will receive
the payment for the goods.

Importance
The seller has to present the bank with
the
necessary shipping documents that the
shipment of goods completed within a
given
time frame.

Most common criteria for LC


Almost all letters of credit are irrevocable,
that cannot be amended or canceled
without
prior agreement of the beneficiary, the
issuing
bank and the confirming bank.

Documents provide by the


beneficiary
The documents a beneficiary has to
present
in order to receive payment Includes:
a commercial invoice,
bill of lading, and
other related documents proving the
shipment was insured against loss or
damage in transit.

Documents Called for under a Letter


of Credit
Bill of Exchange: A non-interest-bearing
written
order used primarily in international trade
that
binds one party to pay a fixed sum of
money to
another party at a predetermined future
date.
Commercial Documents: Invoice,
Packing list

Documents Called for under a Letter


of Credit
Shipping Documents
Insurance Certificate, Commercial, Official or
Legal
Documents

Official Documents:
License, Embassy legalization, Origin Certificate,
Inspection Certificate, phytosanitary (free from
pests
and pathogens) Certificate

Documents Called for under a Letter


of Credit
Transport Documents
Bill of Lading: Airway bill, Lorry/truck
receipt, railway receipt, Forwarder Cargo
Receipt, Delivery Challan...etc
Insurance documents
Insurance policy, or Certificate but not a
cover note.

L/C is a non-negotiable instrument but may be


transferable with the consent of the applicant.
the two most basic L/Cs are:
(1)Revocable - letter of credit, and
(2)Irrevocable - letter of credit
(a) Confirmed irrevocable letter of credit , and
(b) Not-confirmed irrevocable letter of credit.

INCOTERMS
International
Commercial Terms

CIF Cost, Insurance and Freight

GROUPTERMStands for

CPT Carriage Paid To

E
EXW Ex Works
F
FCA Free Carrier

CIP Carriage and Insurance Paid To


D
DAF Delivered At Frontier
DES Delivered Ex Ship

FAS Free Alongside Ship


DEQ Delivered Ex Quay

FOB Free On Board


C
CFR Cost and Freight

DDU Delivered Duty Unpaid


DDP Delivered Duty Paid

Types of LC

Revocable Letter of Credit


Irrevocable Letter of Credit
Confirmed Letter of Credit
Unconfirmed Letter of Credit
Standby Letter of Credit
Revolving Letter of Credit
Transferable Letter of Credit
Back-to-Back Letter of Credit

Revocable Letter of Credit

A revocable letter of credit may be


revoked or modified for any reason, at any
time by the issuing bank without
notification. It is rarely used in
international trade and not considered
satisfactory for the exporters.

An irrevocable letter of credit


An irrevocable letter of credit can
neither
be amended nor cancelled without the
agreement of all parties to the credit.
Under
UCPDC 600 all letters of credit are
deemed to
be irrevocable unless otherwise stated.

Unconfirmed

The advising bank forwards an


unconfirmed
letter of credit directly to the exporter
without
adding its own undertaking to make
payment or
accept responsibility for payment at a
future
date, but confirming its authenticity

Confirmed

A confirmed letter of credit is one in which


the advising bank, on the instructions of
the
issuing bank, has added a confirmation
that
payment will be made as long as
compliant
documents are presented. This
commitment
holds even if the issuing bank or the
buyer
fails to make payment.

Sight and Deferred Letter of Credit

Sight L/C states that the payments would be


made by the
issuing bank at sight, on demand or on
presentation.
In case of Deferred/Usance letter of credit, draft are
drawn
on the issuing bank or the correspondent bank at
specified
usance Period.
The credit will indicate whether the usance draft
are to be
drawn on the issuing bank or in the case of

Revolving Letter of Credit


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 (a fixed
amount is available which is refilled when exhausted) or in time
(an amount is available in fixed installments over a period). L/Cs
revolving in time are of two types: in the cumulative, the sum
unutilized in a period is carried over to be utilized in the next
period; whereas in the non-cumulative type, it is not carried over.

Revolving Letter of Credit


The revolving credit is used for regular shipments of the same commodity
to the same importer. It can revolve in relation to time or value.
If the credit is time revolving once utilized it is re-instated for further
regular shipments until the credit is fully drawn.
If the credit revolves in relation to value once utilized and paid the
value can be reinstated for further drawings.
The credit must state that it is a revolving letter of credit and it may
revolve either automatically or subject to certain provisions.
Revolving letters of credit are useful to avoid the need for repetitious
arrangements for opening or amending letters of credit.

Standby Letters of Credit

A guarantee of payment issued by a bank on behalf of a


client that is used as "payment of last resort" should the
client fail to fulfill a contractual commitment with a
third party. Standby letters of credit are created as a sign
of good faith in business transactions, and are proof of a
buyer's credit quality and repayment abilities.

Transferable Letter of Credit

A transferable letter of credit is one in


which the exporter has the right to request
the paying, or negotiating bank to make
either part, or all, of the credit value
available to one or more third parties.
This type of credit is useful for those acting as
middlemen especially where there is a need to
finance purchases from third party suppliers.

Back-to-Back Letter of Credit


Arrangement in which one irrevocable one letter of credit serves as
the collateral for another; the advising bank of the first letter of
credit becomes the issuing bank of the second letter of credit.
Two letters of credit (LCs) used together to help a seller finance the
purchase of equipment or services from a subcontractor. With the
original LC from the buyer's bank in place, the seller goes to his
own bank and has a second LC issued, with the subcontractor as
beneficiary. The subcontractor is thus ensured of payment upon
fulfilling the terms of the contract.

Back-to-Back Letter of Credit


Two letters of credit, one in favor of the buyer's agent and one financing
the seller. A back-to-back credit is created when an exporter holding an
irrevocable Letter of Credit persuades the buyer's bank (the advising
bank) to open a second credit in favor of the merchandise supplier. The
two credits are identical in all respects, except that the supplier becomes
the Beneficiary of the back-to-back credit, and the amount of the second
credit is less than the original export credit. The difference is the import
agent's commission.
A back-to-back letter of credit can be used as an alternative to
the
transferable letter of credit. Rather than transferring the original
letter of
credit to the supplier, once the letter of credit is received by the
exporter
from the opening bank, that letter of credit is used as security to
establish a
second letter of credit drawn on the exporter in favor of his
importer.

Back to Back Letter of Credit


The parties to a Back to Back Letter of Credit are:
1. The buyer and his bank as the issuer of the
original Letter of Credit.
2. The seller/manufacturer and his bank,
3. The manufacturer's subcontractor and his bank.

Advantages of Letter of Credit


The beneficiary is assured of payment
as long as it complies with the terms
and conditions of the letter of credit.
The letter of credit identifies which
documents must be presented and the
data content of those documents.
The credit risk is transferred from the
applicant to the issuing bank.

Advantages of Letter of Credit


The beneficiary can enjoy the advantage of
mitigating the issuing banks country risk by
requiring that a bank in its own country
confirm the letter of credit.
The beneficiary minimizes collection time as
the letter of credit accelerates payment of the
receivables.
The beneficiarys foreign exchange risk is
eliminated with a letter of credit issued in the
currency of the beneficiarys country.

Risks involved in Letter of


Credit
Since all the parties involved in Letter of
Credit deal with the documents and not
with the goods, the risk of Beneficiary
not shipping goods as mentioned in the
LC is still persists.
The Letter of Credit as a payment
method is costlier than other methods of
payment such as Open Account or
Collection

Risks involved in Letter of


Credit
The Beneficiarys documents must
comply with the terms and conditions of
the Letter of Credit for Issuing Bank to
make the payment.
The Beneficiary is exposed to the
Commercial risk on Issuing Bank,
Political risk on the Issuing Banks
country and Foreign Exchange Risk in
case of Usance Letter of Credits.

The process of opening LCs

After a contract is
concluded between
buyer and seller,
buyer's bank supplies a
letter of credit to seller.

The process of opening LCs


Seller consigns the
goods to a carrier
in exchange for a
bill of lading

The process of opening LCs


Seller place bill of
lading for payment
from buyer's bank.
Buyer's bank
exchanges bill of
lading for payment
from the buyer.
Buyer provides bill of
lading to carrier and
takes delivery of
goods.

Methods of Trade Payment


Advance payment - This method of payment is
the most secure for seller. The buyer parts with
money first and waits for the seller to forward
the goods.
Documentary Credit - This method of payment
is more secure for seller as well as buyer. The
bank gives an undertaking on behalf of buyer
and at the request of applicant to pay the
shipper the value of the goods shipped.

Trade Payment methods


Documentary collection - This method of
payment is more secure for buyer and to a
certain extent to seller. where shipment
happens first, then the title documents are
sent to the buyer's bank by seller's bank, for
delivering documents against collection of
payment/acceptance.
Direct payment - This method of payment is
the most secure for buyer. The supplier ships
the goods and waits for the buyer to remit
the bill proceeds, on open account terms.

Process of settlement of LCs

Settlements Under a Letter of


Credit
All commercial letters of credit must clearly indicate
whether they are payable by sight payment, by
deferred
payment, by acceptance, or by negotiation. These are
noted as formal demands under the terms of the
commercial letter of credit.
In a sight payment, the commercial letter of credit is
payable
when the beneficiary presents the complying
documents and if
the presentation takes place on or before the expiration
of the
commercial letter of credit.

Settlements Under a Letter of


Credit
In a deferred payment, the
commercial
letter of credit is payable on a specified
future
date. The beneficiary may present the
complying documents at an earlier
date, but
the commercial letter of credit is
payable only
on the specified future date.

Settlement
An acceptance is a time draft drawn on,
and accepted by, a banking institution,
which promises to honor the draft at a
specified future date. The act of
acceptance is without recourse as it is a
commitment to pay the face amount of
the accepted draft.

Settlement
Under negotiation, the negotiating bank, a
third party negotiator, expedites payment to
the beneficiary upon the beneficiarys
presentation of the complying documents to the
negotiating bank.
The bank pays the beneficiary, normally at a
discount of the face amount of the value of the
documents, and then presents the complying
documents, including a sight or time draft, to
the issuing bank to receive full payment at
sight or at a specified future date.

Opening of LCs and payments for imports


Bangladesh aspect

payments for imports into Bangladesh


should be made through an AD
(Authorized Dealer) in the area where the
holder of the LCAF is resident
In case the importer is a new customer,
the AD should obtain certificate from the
AD through which the applicant imported
earlier to the effect that no bill of entry is
due/overdue for submission by the
importer.

Opening of LCs Bangladesh


aspect
ADs are authorized to issue 'Letter of
Credit Authorization Forms' (LCAFs) in
conformity with the Import Policy Order
(IPO) allowing imports into Bangladesh.

Opening of LCs Bangladesh


aspect
Import permits or clearance permits are
not required for imports by the Ministries
and government Departments against
specific allocation given to them by the
government.
But all Ministries and Government
Departments except the Ministry of
Defense shall duly submit LCAF to their
nominated banks before opening LC for
the purpose of import.

Opening of LCs Bangladesh


aspect
LCAFs remain valid for remittances for one
year
subsequent to the month of issuance. In
terms of
the Importers, Exporters and Indentors
(Registration) Order, 1981 no person can
import
goods into Bangladesh unless he is
registered
with the CCI&E or exempted from the
provisions
of the said Order.

Opening of LCs Bangladesh


aspect
Before Letter of Credit Authorization Form
(LCAF) is issued or Letter of credit (LC) is
opened or remittance is made the AD
should
verify that the importer is registered with
the
CCI&E or otherwise exempted from such
registration.

Opening of LCs Bangladesh


aspect
The AD should ensure that the registration
number of the importer is invariably
furnished
on the IMP form.
Where the importer is exempted from such
registration, a suitable mention of this fact
should be made on the IMP form.

Opening of LCs
Appropriate Inco terms should be
incorporated in the letter of
credit/purchase contract in compliance
with the IPO in force.
Unless otherwise exempted by the Preshipment Inspection Act, 1999, all goods
to be imported shall be inspected by an
NBR designated Pre-shipment Inspection
(PSI) company for quantity, quality,
description, classification and price.

When LCs are opened, full particulars thereof must


be
endorsed on the back of the exchange monitoring
copy of the LCAF under the seal and signature of the
AD.
The Taka equivalent of the LC opened must be
endorsed on the LCAF at the ruling BC selling rate
(spot), but if a forward exchange cover is provided
the
conversion should be made at the actual forward
rate.
Details of amounts remitted, whether under LC or
otherwise, should be endorsed on the back of the
exchange monitoring copy of the LCAF together with

A L/C guarantees payment of a specified


sum in a specified currency
provided the seller meets precisely-defined
conditions and submits the prescribed
documents within a fixed timeframe.
Documents include a clean bill of lading, or
airway bill, commercial invoice, and
certificate of origin.

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