assignment on writing a letter of credit

8/2/2019 Assignment on writing a Letter of Credit

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Assignment

On

LETTER OF CREDIT


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Table of content

Serial no: Topic: Page no:

1. Introduction 1

2. Parties to a letter of credit 4

3.Types of Letter of Credit 5

4.

Advantages of Letter of Credit6

5. Commercial Letter of Credit Flow 7

6.Statement under a letter of credit

8

7.

Sample of letter of credit

9

8.Risks involved in Letter of Credit 10

9.

Other things related to letter of credit10

10. Conclusion 11

11. References 12

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Introduction:

The international chamber of commerce defines letter of credit as: Any arrangement however

named or descried where by a bank acting at the request and it accordance with the instruction of

a customer is to make payment to or to the order of a third party or is to pay, accept or negotiate

bills of exchange drawn by the beneficiary or authorize such payment to be made or such drafts

to be paid , accepted or negotiated , by another bank , against stipule documents and compliance

with stipulated terms and condition.

Thus, when a stipulated contract is incorporated in the sale contract t6hat the good shall be paid

by a bankers letter of credit, the seller need not worry heather the goods will be cleared by the

buyer on arrived at the destination, and the buyer need not lockup his fund by making payment in

advance. As a matter of fact, a commercial letter of credit substitutes the credit worthiness of the

of the importer by the credit worthiness of the banker issuing the letter of credit , since it is a

promise by the bank to pay or accept the bills, provided the exporter fulfills the terms and

conditions set out in the credit.

Definition

Letter of credit A letter from a bank guaranteeing that a buyer's payment to a seller will be

received on time and for the correct amount. In the event that the buyer is unable to make payment

on the purchase, the bank will be required to cover the full or remaining amount of the purchase.LC is a document issued mostly by a financial institution, used primarily in trade finance, which

usually provides an irrevocable payment undertaking.

The letter of credit can also be source of payment for a transaction, meaning that redeeming the

letter of credit will pay an exporter. Letters of credit are used primarily in international tradetransactions of significant value, for deals between a supplier in one country and a customer in

another.

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Parties to a letter of credit

The parties are described below:

1) The buyer :

Applies to the bank for opening a letter of credits. The bank may or may not require the

buyer secure the letter of credit by providing sufficient deposits .It depends on the

confidence that the bank has over the buyer applying for the letter of credit.

2) The seller :

Who is the exporter ,is the beneficiary off the letter of credit .The bank issuing the letter of

credit assures the seller that the condition of the credit wil be met, provided the relevant

.document are produced and the terms and condition set out in the credit are strictlycomplied .

3) The bank :

Which issues the letter of credit at the request of buyer is the issuing bank . The issung

bank must be well known and acceptable to the seller the buyer gives instruction regarding

the terms and conditions of the credit.

4) The notifying bank: Is the correspondent bank situated in the same place as the

seller, and advices the credit to the seller ,and advice the credit to the seller .but the

notifying bank does not commit self to any liability under the credit ,generally, the service

of a notifying bank are ulitilized when the credit is advises to the seller through a viable

message.

5) The negotiating bank : Is He bank which negotiates Is the bills or drafts under

the letter or credit .Generally the same bank will act as the notifying bank .The negotiating

bank has to see that the documents negotiated conform strictly with the terms and

conditions of credit.

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6) The paying bank : Is the bank of which the bill or drafts is drams .It can be the

issuing bank, the notifying bank or the confirming bank.

Types of Letter of Credit

Irrevocable

An irrevocable letter of credit can neither be amended nor cancelled without the agreement of all

parties to the credit. Under UCP500 all letters of credit are deemed to be irrevocable unlessotherwise stated. Here, the importer's bank gives a binding undertaking to the supplier provided all

the terms and conditions of the credit are fulfilled.

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 issuingbank, 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.

The added security to the exporter of confirmation needs to be considered in the context of the

standing of the issuing bank and the current political and economic state of the importer's country.A bank will make an additional charge for confirming a letter of credit. In many cases, the

confirming bank is located in Beneficiarys country.

Confirmation costs will vary according to the country involved, but for many countries considereda high risk will be between 2%-8%. There also may be countries issuing letters of credit, which

banks do not wish to confirm - they may already have enough exposure in that market or not wish

to expose themselves to that particular risk at all.

Standby Letters of Credit

A standby letter of credit is used as support where an alternative, less secure, method of payment

has been agreed. They are also used in the United States of America in place of bank guarantees.Should the exporter fail to receive payment from the importer he may claim under the standby

letter of credit. Certain documents are likely to be required to obtain payment including: the

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standby letter of credit itself; a sight draft for the amount due; a copy of the unpaid invoice; proof

of dispatch and a signed declaration from the beneficiary stating that payment has not been

received by the due date and therefore reimbursement is claimed by letter of credit. TheInternational Chamber of Commerce publishes rules for operating standby letters of credit - ISP98

International Standby Practices.

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 utilised it is re-instated

for further regular shipments until the credit is fully drawn. If the credit revolves in relation tovalue 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 foropening or amending letters of credit.

Transferable Letter of Credit

A transferable letter of credit is one in which the exporter has the right to request the paying, ornegotiating 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

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 favour of his importer. Many banks are reluctantto issue back-to-back letters of credit due to the level of risk to which they are exposed, whereas a

transferable credit will not expose them to higher risk than under the original credit.

Advantages of Letter of Credit

1. 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 theissuing bank.

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2. 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. That bank then takes on

the country and commercial risk of the issuing bank and protects the beneficiary.3. The beneficiary minimizes collection time as the letter of credit accelerates payment of the

receivables.

4. The beneficiarys foreign exchange risk is eliminated with a letter of credit issued in thecurrency of the beneficiarys country.

Commercial Letter of Credit Flow

Applicant approaches Issuing/ Opening Bank with LC application form duly filled and requests

Issuing Bank to issue a Letter of Credit in favor of Beneficiary.

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1. Issuing Bank issues a Letter of Credit as per the application submitted by an Applicant and

send it to the Advising Bank, which is located in Beneficiarys country, to formally advise

the LC to the beneficiary.2. Advising Bank advises the LC to the Beneficiary.

3. Once Beneficiary receives the LC and if it suits his/ her requirements, he/ she prepares the

goods and hands over them to the carrier for dispatching to the Applicant.4. He/ She then hands over the documents along with the Transport Document as per LC to

the Negotiating Bank to be forwarded to the Issuing Bank.

5. Issuing Bank reimburses the Negotiating Bank with the amount of the LC post NegotiatingBanks confirmation that they have negotiated the documents in strict conformity of the LC

terms. Negotiating Bank makes the payment to the Beneficiary.

6. Simultaneously, the Negotiating Bank forwards the documents to the Issuing Bank to be

released to the Applicant to claim the goods from the carrier.7. Applicant reimburses the Issuing Bank for the amount, which it had paid to the Negotiating

Bank.

8. Issuing Bank releases all documents along with the titled Transport Documents to the

Applicant

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 underthe 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 thecommercial 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.

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.

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.

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Sample of Letter of Credit

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Risks involved in Letter of Credit

1. 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.2. The Letter of Credit as a payment method is costlier than other methods of payment such as

Open Account or Collection3. The Beneficiarys documents must comply with the terms and conditions of the Letter of

Credit for Issuing Bank to make the payment.4. 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.

Other things related to letter of credit

Negotiable:

The abilityto besold or transferred to anotherparty as a form ofpayment. Something which is

negotiable is transferable by endorsement and delivery. A negotiable instrument could be a check

made out to you, because you could endorse it for payment to you ortransferit to someone else as

payment to them.For example, when a price is said to be negotiable, it means that the selleris

open to the possibility of reducing the price bank.

Bank draftA check drawn by onebankagainst funds deposited into its account at another bank, authorizingthe second bank to makepayment to the individual named in the draft.

Cheque

A bill of exchange drawn on a bank by the holder of a current account; payable into a

bank account, if crossed, or on demand, if uncrossed

Bill of lading

A bill of lading is a document issued by a carrier to a shipper, acknowledging that

specified goods have been received on board as cargo for conveyance to a named

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http://www.businessdictionary.com/definition/ability.htmlhttp://www.businessdictionary.com/definition/ability.htmlhttp://www.investorwords.com/7717/sold.htmlhttp://www.investorwords.com/7717/sold.htmlhttp://www.investorwords.com/3610/party.htmlhttp://www.businessdictionary.com/definition/form.htmlhttp://www.investorwords.com/3634/payment.htmlhttp://www.investorwords.com/3634/payment.htmlhttp://www.investorwords.com/1706/endorsement.htmlhttp://www.investorwords.com/1386/delivery.htmlhttp://www.investorwords.com/3226/negotiable_instrument.htmlhttp://www.businessdictionary.com/definition/endorse.htmlhttp://www.investorwords.com/5048/transfer.htmlhttp://www.investorwords.com/5048/transfer.htmlhttp://www.businessdictionary.com/definition/mean.htmlhttp://www.businessdictionary.com/definition/seller.htmlhttp://www.businessdictionary.com/definition/seller.htmlhttp://www.investorwords.com/3432/open.htmlhttp://www.investorwords.com/401/bank.htmlhttp://www.investorwords.com/2130/funds.htmlhttp://www.investorwords.com/42/account.htmlhttp://www.investorwords.com/3634/payment.htmlhttp://www.businessdictionary.com/definition/individual.htmlhttp://en.wikipedia.org/wiki/Common_carrierhttp://en.wikipedia.org/wiki/Good_(accounting)http://en.wikipedia.org/wiki/Conveyancehttp://www.businessdictionary.com/definition/ability.htmlhttp://www.investorwords.com/7717/sold.htmlhttp://www.investorwords.com/3610/party.htmlhttp://www.businessdictionary.com/definition/form.htmlhttp://www.investorwords.com/3634/payment.htmlhttp://www.investorwords.com/1706/endorsement.htmlhttp://www.investorwords.com/1386/delivery.htmlhttp://www.investorwords.com/3226/negotiable_instrument.htmlhttp://www.businessdictionary.com/definition/endorse.htmlhttp://www.investorwords.com/5048/transfer.htmlhttp://www.businessdictionary.com/definition/mean.htmlhttp://www.businessdictionary.com/definition/seller.htmlhttp://www.investorwords.com/3432/open.htmlhttp://www.investorwords.com/401/bank.htmlhttp://www.investorwords.com/2130/funds.htmlhttp://www.investorwords.com/42/account.htmlhttp://www.investorwords.com/3634/payment.htmlhttp://www.businessdictionary.com/definition/individual.htmlhttp://en.wikipedia.org/wiki/Common_carrierhttp://en.wikipedia.org/wiki/Good_(accounting)http://en.wikipedia.org/wiki/Conveyance


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place for delivery to the consignee who is usually identified. A thorough bill of lading

involves the use of at least two different modes of transport from road, rail, air, and

sea. The term derives from the verb "to lade" which means to load a cargo onto a

ship or other form of transportation.

Invoice

An invoice or bill is a commercial document issued by a seller to the buyer, indicating

the products, quantities, and agreed prices for products or services the seller has

provided the buyer. An invoice indicates the buyer must pay the seller, according to

the payment terms. The buyer has a maximum amount of days to pay these goods

and are sometimes offered a discount if paid before.

Conclusion

The letter of credit can also be source of payment for a transaction, meaning that redeeming the letter ofcredit will pay an exporter. Letters of credit are used primarily in international trade transactions ofsignificant value, for deals between a supplier in one country and a customer in another. In such cases the

International Chamber of Commerce Uniform Customs and Practice for Documentary Credits applies.[2]

They are also used in the land development process to ensure that approved public facilities (streets,

sidewalks, storm water ponds, etc.) will be built. The parties to a letter of credit are usually a beneficiary

who is to receive the money, the issuing bank of whom the applicant is a client, and the advising bank of

whom the beneficiary is a client. Almost all letters of credit are irrevocable, i.e., cannot be amended or

canceled without prior agreement of the beneficiary, the issuing bank and the confirming bank, if any. In

executing a transaction, letters of credit incorporate functions common to giros and Traveler's cheques.

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 were insured against loss or damage in

transit. However, the list and form of documents is open to imagination and negotiation and might containrequirements to present documents issued by a neutral third party evidencing the quality of the goods

shipped, or their place of origin.

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References

LoanUniverse.com.

J. H. Rayner & Co., Ltd., and the Oilseeds Trading Company, Ltd. v.Hambros

Bank Limited [1942]

Finkelstein, H. Legal Aspects of Commercial Letters of Credit, pp. 275-295

Dominique Doise,The 2007 Revision of the Uniform Customs and Practice for

Documentary Credits

Wikipedia.com

Businessdictionary.com

Banking; Theory and Practice, Shekhar & Shekhar(edition:19th)

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