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Letter Of Credit and its types

Letter of Credit is a letter from a bank guaranteeing that a buyers payment to a seller will bereceived on time and for the correct amount. In the event that the buyer is unable to makepayment on the purchase, the bank will be required to cover the full or remaining amount of thepurchase.

Letters of credit are often used in international transactions to ensure that payment will bereceived. Due to the nature of international dealings including factors such as distance, differinglaws in each country and difficulty in knowing each party personally, the use of letters of credithas become a very important aspect of international trade. The bank also acts on behalf of thebuyer (holder of letter of credit) by ensuring that the supplier will not be paid until the bankreceives a confirmation that the goods have been shipped.

Definitions of related terms:

1. Advising Bank: The Bank which advises a Letter of Credit to the Beneficiary at the requestof the issuing Bank is known as the Advising Bank

2. Applicant: Applicant is the party on whose request the issuing bank issues a credit.

3. Beneficiary: Beneficiary is the party who is to receive the benefit (payment) of the LC. Theconsignee of an LC and the beneficiary may not be the same. The credit is issued in hisfavor.

4. Confirming bank: The Bank which adds confirmation to an LC is termed as ConfirmingBank. It does so at the request of the issuing bank and taking authorization from the issuingbank.

5. Honour: Honour means act according to commitment of the LC.

6. Issuing bank: The bank which issues a credit is known as issuing bank.

7. Nominated Bank: The bank with which credit is available is termed as Nominated Bank of that credit. If no bank is mentioned in the credit as nominated bank, all banks are nominatedbank.

8. Presentation : Presentation is either delivery of documents against an LC or the documentitself.

9. Complying presentation : A presentation is said to be complying presentation when it is inaccordance with:

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the terms and conditions of the creditthe applicable provisions of International Chamber of Commerce andinternational standard banking practice

10. Negotiation: A bank (Nominated Bank) is said to negotiate a document if it purchases adraft and/or documents under a complying presentation either by making advance or

agreeing to advance funds to the beneficiary on or before the date on which reimbursementis due to the nominated bank . A draft drawn on a nominated bank can not be purchased byitself.

Types of Letter of Credit:

1. Confirmed Letter Of Credit:

A confirmed letter of credit is typically used when the issuing bank of the letter of credit may have

questionable creditworthiness and the seller seeks to get a second guarantee to assure payment.

2. Transferable Letter Of Credit:

A letter of credit that permits the beneficiary of the letter to make some or all of the credit availableto another party, thereby creating a secondary beneficiary. The bank issuing the letter of creditmust approve the transfer. The letter of credit must state expressly that the credit is transferable.

3. Irrevocable LC:

In this type of LC, Any changes (amendment) or cancellation of the LC (except it is expired) isdone by the Applicant through the issuing Bank. It must be authenticated by the Beneficiary of theLC. Whether to accept or reject the changes depends on the beneficiary.

4. Deferred / Usance LC:

It is kind of credit that won't be paid and assigned immediately after checking the validdocuments but paying and assigning it requires an indicated duration which is accepted by bothof the buyer and seller. In reality, seller will give an opportunity to the buyer to pay the requiredmoney after taking the related goods and selling them. Usance time can be between 30 and 180days after the bill of lading date.

5. Sight Letter Of Credit:

A letter of credit that is payable once it is presented along with the necessary documents. Anorganization offering a sight letter of credit commits itself to paying the agreed amount of fundsprovided the provisions of the letter of credit are met. A sight letter of credit is thus more ondemand than some other types of letters of credit.

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