What is Letters of Credit
The letter of credit adds a bank's promise to pay the exporter to that of the foreign buyer provided that the exporter has complied with all the terms and conditions of the letter of credit. The foreign buyer applies for issuance of a letter of credit from the buyer's bank to the exporter's bank and therefore is called the applicant; the exporter is called the beneficiary. Payment under a documentary letter of credit is based on documents, not on the terms of sale or the physical condition of the goods. The letter of credit specifies the documents that are required to be presented by the exporter, such as an ocean bill of lading (original and several copies), consular invoice, draft, and an insurance policy. The letter of credit also contains an expiration date. Before payment, the bank responsible for making payment, verifies that all document conform to the letter of credit requirements. If not, the discrepancy must be resolved before payment can be made and before the expiration date.
A letter of credit issued by a foreign bank is sometimes confirmed by a U.S. bank. This confirmation means that the U.S. bank (the confirming bank), adds its promise to pay to that of the foreign bank (the issuing bank). If a letters of credit is not confirmed, it is advised through a U.S. bank and thus called an advised letter of credit. U.S. exporters may wish to confirm letters of credit issued by foreign banks if they are unfamiliar with the foreign banks or concerned about the political or economic risk associated with the country in which the bank is located. An Export Assistance Center or international banker can assist exporters in evaluating the risks to determine what might be appropriate for specific export transactions.
A letter of credit may either be irrevocable and thus, unable to be changed unless both parties agree; or revocable where either party may unilaterally make changes. A revocable letter of credit is inadvisable as it carries many risks for the exporter.
A change made to a letter of credit after it has been issued is called an amendment. Banks also charge fees for this service. It should be specified in the amendment if the exporter or the buyer will pay these charges. Every effort should be made to get the letter of credit right the first time since these changes can be time-consuming and expensive.
To expedite the receipt of funds, wire transfers may be used. Exporters should consult with their international bankers about bank charges for such services.
A Typical Letter of Credit Transaction
Here are the typical steps of an irrevocable letter of credit that has been confirmed by a U.S. bank:
1. After the exporter and buyer agree on the terms of a sale, the buyer arranges for its bank to open a letter of credit that specifies the documents needed for payment. The buyer determines which documents will be required.
2. The buyer's bank issues, or opens, its irrevocable letter of credit includes all instructions to the seller relating to the shipment.
3. The buyer's bank sends its irrevocable letter of credit to a U.S. bank and requests confirmation. The exporter may request that a particular U.S. bank be the confirming bank, or the foreign bank may select a U.S. correspondent bank.
4. The U.S. bank prepares a letter of confirmation to forward to the exporter along with the irrevocable letter of credit.
5. The exporter reviews carefully all conditions in the letter of credit. The exporter's freight forwarder is contacted to make sure that the shipping date can be met. If the exporter cannot comply with one or more of the conditions, the customer is alerted at once.
6. The exporter arranges with the freight forwarder to deliver the goods to the appropriate port or airport.
7. When the goods are loaded, the freight forwarder completes the necessary documentation.
8. The exporter (or the freight forwarder) presents the documents, evidencing full compliance with the letter of credit terms, to the U.S. bank.
9. The bank reviews the documents. If they are in order, the documents are sent to the buyer's bank for review and then transmitted to the buyer.
10. The buyer (or the buyer's agent) uses the documents to claim the goods.
11. A draft, which accompanies the letter of credit, is paid by the buyer's bank at the time specified or, if a time draft, may be discounted to the exporter's bank at an earlier date.
Example of a Confirmed Irrevocable Letter of Credit
The example of a confirmed irrevocable letter of credit in illustrates the various parts of a typical letter of credit. In this sample, the letter of credit was forwarded to the exporter, The Walton Building Supply Company (A), by the confirming bank, Mega bank Corporation (B), as a result of c letter of credit being issued by the Third Hong Kong Bank, HongKong (C), for the account of the importer, HHB Hong Kong (D). The date of issue was March 8, 1997 (E), and the exporter must submit the proper documents (e.g., a commercial invoice in one original and three copies) (F) by June 23, 1997 (G) in order for a sight draft (H) to be honored.
Tips on Using a Letter of Credit
When preparing quotations for prospective customers, exporters should keep in mind that banks pay only the amount specified in the letter of credit - even if higher charges for shipping, insurance, or other factors are incurred and documented.
Upon receiving a letter of credit, the exporter should carefully compare the letter's terms with the terms of the exporter's pro forma quotation. This step is extremely important, since the terms must be precisely met or the letter of credit may be invalid and the exporter may not be paid. If meeting the terms of the letter of credit is impossible or if any of the information is incorrect or even misspelled, the exporter should contact the customer immediately and ask for an amendment to the letter of credit.
The exporter must provide documentation showing that the goods were shipped by the date specified in the letter of credit or the exporter may not be paid. Exporters should check with their freight forwarders to make sure that no unusual conditions may arise that would delay shipment.
Documents must be presented by the date specified for the letter of credit to be paid. Exporters should verify with their international bankers that there will be sufficient time to present the letter of credit for payment.
Exporters may request that the letter of credit specify that partial shipments and transshipment will be allowed. Specifying what will be allowed can prevents unforeseen last minute problems.
Letter of Credit
An irrevocable Letter of Credit is also an often used payment method. It is often referred to an L/C. Letters of Credit are formal payment methods that offer a lot of protection to the parties.
Simply put, a letter of credit is a letter written by the importer's bank to the exporter. It verifies that the payment will be guaranteed when the bank is presented with the concrete documents (bill of lading, and freight documents). Most letters of credit are "irrevocable" once the importer has had them sent.
A letter of credit usually includes applicant (you, the importer), beneficiary (our I/E agent), opening bank, negotiating bank, specification and quantity of the goods, amount of money, loading port and destination port, shipment date, the validity date of the L/C, terms and conditions agreed by both the importer and seller, and the documents required by the importers (bill of lading, commercial invoice, packing list, insurance certificate, etc.)
The letter of credit adds a bank's promise to pay the exporter to that of the foreign buyer provided that the exporter has complied with all the terms and conditions of the letter of credit. The foreign buyer applies for issuance of a letter of credit from the buyer's bank to the exporter's bank and therefore is called the applicant; the exporter is called the beneficiary. Payment under a documentary letter of credit is based on documents, not on the terms of sale or the physical condition of the goods. The letter of credit specifies the documents that are required to be presented by the exporter, such as an ocean bill of lading (original and several copies), consular invoice, draft, and an insurance policy. The letter of credit also contains an expiration date. Before payment, the bank responsible for making payment, verifies that all document conform to the letter of credit requirements. If not, the discrepancy must be resolved before payment can be made and before the expiration date.
A letter of credit issued by a foreign bank is sometimes confirmed by a U.S. bank. This confirmation means that the U.S. bank (the confirming bank), adds its promise to pay to that of the foreign bank (the issuing bank). If a letters of credit is not confirmed, it is advised through a U.S. bank and thus called an advised letter of credit. U.S. exporters may wish to confirm letters of credit issued by foreign banks if they are unfamiliar with the foreign banks or concerned about the political or economic risk associated with the country in which the bank is located. An Export Assistance Center or international banker can assist exporters in evaluating the risks to determine what might be appropriate for specific export transactions.
A letter of credit may either be irrevocable and thus, unable to be changed unless both parties agree; or revocable where either party may unilaterally make changes. A revocable letter of credit is inadvisable as it carries many risks for the exporter.
A change made to a letter of credit after it has been issued is called an amendment. Banks also charge fees for this service. It should be specified in the amendment if the exporter or the buyer will pay these charges. Every effort should be made to get the letter of credit right the first time since these changes can be time-consuming and expensive.
To expedite the receipt of funds, wire transfers may be used. Exporters should consult with their international bankers about bank charges for such services.
A Typical Letter of Credit Transaction
Here are the typical steps of an irrevocable letter of credit that has been confirmed by a U.S. bank:
1. After the exporter and buyer agree on the terms of a sale, the buyer arranges for its bank to open a letter of credit that specifies the documents needed for payment. The buyer determines which documents will be required.
2. The buyer's bank issues, or opens, its irrevocable letter of credit includes all instructions to the seller relating to the shipment.
3. The buyer's bank sends its irrevocable letter of credit to a U.S. bank and requests confirmation. The exporter may request that a particular U.S. bank be the confirming bank, or the foreign bank may select a U.S. correspondent bank.
4. The U.S. bank prepares a letter of confirmation to forward to the exporter along with the irrevocable letter of credit.
5. The exporter reviews carefully all conditions in the letter of credit. The exporter's freight forwarder is contacted to make sure that the shipping date can be met. If the exporter cannot comply with one or more of the conditions, the customer is alerted at once.
6. The exporter arranges with the freight forwarder to deliver the goods to the appropriate port or airport.
7. When the goods are loaded, the freight forwarder completes the necessary documentation.
8. The exporter (or the freight forwarder) presents the documents, evidencing full compliance with the letter of credit terms, to the U.S. bank.
9. The bank reviews the documents. If they are in order, the documents are sent to the buyer's bank for review and then transmitted to the buyer.
10. The buyer (or the buyer's agent) uses the documents to claim the goods.
11. A draft, which accompanies the letter of credit, is paid by the buyer's bank at the time specified or, if a time draft, may be discounted to the exporter's bank at an earlier date.
Example of a Confirmed Irrevocable Letter of Credit
The example of a confirmed irrevocable letter of credit in illustrates the various parts of a typical letter of credit. In this sample, the letter of credit was forwarded to the exporter, The Walton Building Supply Company (A), by the confirming bank, Mega bank Corporation (B), as a result of c letter of credit being issued by the Third Hong Kong Bank, HongKong (C), for the account of the importer, HHB Hong Kong (D). The date of issue was March 8, 1997 (E), and the exporter must submit the proper documents (e.g., a commercial invoice in one original and three copies) (F) by June 23, 1997 (G) in order for a sight draft (H) to be honored.
Tips on Using a Letter of Credit
When preparing quotations for prospective customers, exporters should keep in mind that banks pay only the amount specified in the letter of credit - even if higher charges for shipping, insurance, or other factors are incurred and documented.
Upon receiving a letter of credit, the exporter should carefully compare the letter's terms with the terms of the exporter's pro forma quotation. This step is extremely important, since the terms must be precisely met or the letter of credit may be invalid and the exporter may not be paid. If meeting the terms of the letter of credit is impossible or if any of the information is incorrect or even misspelled, the exporter should contact the customer immediately and ask for an amendment to the letter of credit.
The exporter must provide documentation showing that the goods were shipped by the date specified in the letter of credit or the exporter may not be paid. Exporters should check with their freight forwarders to make sure that no unusual conditions may arise that would delay shipment.
Documents must be presented by the date specified for the letter of credit to be paid. Exporters should verify with their international bankers that there will be sufficient time to present the letter of credit for payment.
Exporters may request that the letter of credit specify that partial shipments and transshipment will be allowed. Specifying what will be allowed can prevents unforeseen last minute problems.
Letter of Credit
An irrevocable Letter of Credit is also an often used payment method. It is often referred to an L/C. Letters of Credit are formal payment methods that offer a lot of protection to the parties.
Simply put, a letter of credit is a letter written by the importer's bank to the exporter. It verifies that the payment will be guaranteed when the bank is presented with the concrete documents (bill of lading, and freight documents). Most letters of credit are "irrevocable" once the importer has had them sent.
A letter of credit usually includes applicant (you, the importer), beneficiary (our I/E agent), opening bank, negotiating bank, specification and quantity of the goods, amount of money, loading port and destination port, shipment date, the validity date of the L/C, terms and conditions agreed by both the importer and seller, and the documents required by the importers (bill of lading, commercial invoice, packing list, insurance certificate, etc.)
L/C Forms and Types
Letters of Credit are regulated by International Chamber of Commerce under the Uniform Customs and Practice for Documentary Credits (UCP 600). I strongly recommend you obtain this document from the International Trade Department of your financial institution or from ICC Australia* and read it very carefully. Sometimes it's difficult to understand what it means, as the document is drafted for the banking professionals and its language is very technical. Do not hesitate to call your bank and ask questions. Any mistakes, unclear or incorrectly stipulated terms, even typos in a L/C may cost you dearly.
In "plain English", L/C is a conditional bank guarantee of payment for supplied goods. "Conditional" means that to get paid you have to present the bank-guarantor with documents, which strictly comply with the terms and conditions specified in the L/C.
There are different forms and types of L/C, which you may (or should not) use in your operations, viz
Revocable and Irrevocable L/C "A revocable L/C may be amended or cancelled by the Issuing Bank at any moment and without prior notice to the Beneficiary. This is as simple, as that. Never accept this form of L/C in your export arrangements.
Agree that the L/C is irrevocable before you go any further in your L/C negotiations. Although UCP 500 requires that L/C should indicate whether it is revocable or irrevocable , it also says "in the absence of such indication the Credit shall be deemed to be irrevocable." Confirmed L/CWhen you export to a country with economical or political instability or if you are unfamiliar with the Issuing Bank, you should require that the L/C be confirmed by a first-class bank. If L/C is confirmed, the confirming bank is liable for the payment. Transferable L/CTransferable L/C is a perfect financial tool for middlemen to secure their margin without involving any funds. It allows dealing with more than one beneficiary. When a transferable L/C is issued in your favour, you can transfer it to your seller and use it as a payment. L/C "can be transferred only if it is expressly designated as "transferable" (UCP 600, Article ). Transferable L/C must correspond with the original L/C, "with the exception of:- the amount of the L/C,- any unit price,- the expiry date,- the last date for presentation of documents,- the period for shipment,any or all of which may be reduced or curtailed." (UCP 600)
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