A Report On: How To Open Letter Of CreditHow To Open Letter Of Credit

Prepared For: Sir Sir Mumtaz HassanMumtaz Hassan

Prepared By: Muhammad WaseemMuhammad Waseem

Roll No: 12041361204136

DATED: 88thth, April, 2015, April, 2015

TABLETABLE OFOF CONTENTSCONTENTS

S.No Topic Page No

01 Executive summary

02 Introduction03 Letter of credit

04 Types of L/C

05 How to open L/C

06 Availability

07 Documents call for under L/C08 Standard form of documentation

09 Intr. Trade payment methods

10 Risk in L/C transaction11 Conclusion

13 Appendix (A)

14 Appendix (B)

15 Bibliography

16 Index

EXECUTIVE SUMMARYEXECUTIVE SUMMARY

Whatever sector you might be located, you may have to open aWhatever sector you might be located, you may have to open a letter of credit throughout your professional career one day.letter of credit throughout your professional career one day.

A letter of credit is a method of securing payment to a vendor.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 meansWhen 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 tothe seller would like to ensure payment for a product he sells to that customer. Typically letters of credit are issued by a bank.that customer. Typically letters of credit are issued by a bank. The most common forms are standby letters of credit forThe most common forms are standby letters of credit for domestic transactions and documentary letters of credit fordomestic transactions and documentary letters of credit for international transactions.international transactions.

Letter of credit is a payment method in international tradeLetter of credit is a payment method in international trade which is used by almost all sectors from textile to machinery,which is used by almost all sectors from textile to machinery, food manufacturing to construction, oil trading to customerfood manufacturing to construction, oil trading to customer goods. You may assume that there are big differences exist ongoods. You may assume that there are big differences exist on letter of credit application process for all these differentletter of credit application process for all these different sectors. But this is not correct. You have to follow similarsectors. But this is not correct. You have to follow similar procedures when opening a letter of credit regardless of theprocedures when opening a letter of credit regardless of the sector you may be located.sector you may be located.

Two types of L/C is wideley used around the globe which isTwo types of L/C is wideley used around the globe which is Revocable L/C and Irrevocable L/C and the following parties areRevocable L/C and Irrevocable L/C and the following parties are involved in letter of credit; Applicant of L/C, L/C issuing bank,involved in letter of credit; Applicant of L/C, L/C issuing bank, beneficiary party, advising bank, confiming bank, negotiatingbeneficiary party, advising bank, confiming bank, negotiating bank and second beneficiary.bank and second beneficiary. Typically, the documents aTypically, the documents a beneficiary has to present in order to receive payment includebeneficiary has to present in order to receive payment include a commercial invoice, bill of lading, and documents proving thea commercial invoice, bill of lading, and documents proving the shipment was insured against loss or damage in transit.shipment was insured against loss or damage in transit. However, the list and form of documents is open to imaginationHowever, the list and form of documents is open to imagination

and negotiation and might contain requirements to presentand negotiation and might contain requirements to present documents issued by a neutral third party evidencing thedocuments issued by a neutral third party evidencing the quality of the goods shipped, or their place of origin.quality of the goods shipped, or their place of origin.

INTRODUCTIONINTRODUCTION

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 CREDITLETTER OF CREDIT

DEFINITION: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 CREDITTYPES OF LETTER OF CREDITThere most common types of letter of credit are:

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

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

HOW TO OPEN LETTER OF CREDITHOW TO OPEN LETTER OF CREDITA 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.

AVAILABILITYAVAILABILITYLC 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 FORSOME OF THE DOCUMENTS CALLED FOR UNDER LCUNDER LC

Financial DocumentsFinancial Documents Bill of Exchange, Co-accepted Draft

Commercial DocumentsCommercial Documents Invoice, Packing list

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

Official DocumentsOfficial Documents

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

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

STANDARD FORMS OF DOCUMENTATIONSTANDARD FORMS OF DOCUMENTATIONWhen 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 InvoiceCommercial InvoiceThe 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 LadingBill of LadingA 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 TitleWarranty of TitleA 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 IndemnityLetter of IndemnitySpecifically 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 METHODSINTERNATIONAL TRADE PAYMENT METHODS

Advance payment (most secure for seller) 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 asDocumentary Credit (more secure for seller as well as buyer)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 Documentary collection (more secure for buyer and to a certain extent to seller) 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) 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 TRANSACTIONRISKS IN LC TRANSACTION

Fraud RisksFraud 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 RisksSovereign and Regulatory Risks Performance of the Documentary Credit may be prevented

by government action outside the control of the parties.

Legal RisksLegal 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 ContractForce 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 ApplicantRisks 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 BankRisks to the Issuing Bank Insolvency of the Applicant Fraud Risk, Sovereign and Regulatory Risk and Legal Risks

Risks to the Reimbursing BankRisks to the Reimbursing Bank No obligation to reimburse the Claiming Bank unless it has

issued a reimbursement undertaking.

Risks to the BeneficiaryRisks 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 BankRisks to the Advising Bank The Advising Bank’s only obligation – if it accepts the Issuing

Bank’s instructions – is to check the apparent authenticity of the Credit and advising it to the Beneficiary

Risks to the Nominated BankRisks 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 BankRisks to the Confirming Bank If Confirming Bank’s 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.

CONCLUSIONCONCLUSIONWhatever sector you might be located, you may have to open aWhatever sector you might be located, you may have to open a letter of credit throughout your professional career one day.letter of credit throughout your professional career one day.

A letter of credit is a method of securing payment to a vendor.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 meansWhen 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 tothe seller would like to ensure payment for a product he sells to that customer. Typically letters of credit are issued by a bank.that customer. Typically letters of credit are issued by a bank. The most common forms are standby letters of credit forThe most common forms are standby letters of credit for domestic transactions and documentary letters of credit fordomestic transactions and documentary letters of credit for international transactions.international transactions.

APPENDIX (A)APPENDIX (A)

Bill of LadingBill 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 InvoiceCommercial 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: Deferred Payment: temporary postponement of the payment of an outstanding bill or debt, usually involving repayment by instalments.

Documentary collectionDocumentary collection: A process, in which the seller instructs his bank to

Documentary CreditDocumentary 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/CIrrevocable L/C:: An irrevocable letter of credit cannot be changed or

Issuing BankIssuing Bank: : The importer's bank which issued the letter of credit called the issuing bank.

Letter of creditLetter 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: 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/CRevocable 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 PaymentSight 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)APPENDIX (B)

BIBLIOGRAPHYBIBLIOGRAPHY

www.businessdictionary.com

www.investopedia.com

www.smedia.org

www.wikipedia.org

INDEXINDEX

Bill of LadingBill of Lading

Commercial InvoiceCommercial Invoice

Deferred PaymentDeferred Payment

Documentary collectionDocumentary collection

Documentary CreditDocumentary Credit:

Irrevocable L/CIrrevocable L/C

Issuing BankIssuing Bank

Letter of creditLetter of credit:

Letter of IndemnityLetter of Indemnity

Revocable L/CRevocable L/C:

Sight PaymentSight Payment