Letter of credit is a document which contains a legal promise by an importer/buyer through his bank to the exporter. It involves very less rick for the exporters and popular mode of payments. This system of payment become a premier choice of exporters. Under the letter of credit mode of payments, the importer's bank undertakes the the responsibility to pay the exporter under instructions from the importer, if exporter presents certain shipment and payments documents covering the goods within a specific period. The written undertaking of the importer's bank to the exporter is known as the Letter of Credit.
Letter of credit minimise or we can say eliminate the risk for an exporter. Exporter definitely get payment for his shipment so exporter ordinary requests the importer to arrange for a letter of credit. Another best advantage of letter of credit is that exporter will get payment from listed bank from his centre, after the shipment of goods he can present the bill of exchange and other documents.
In this system the bank undertakes the responsibility to pay or arrange to pay the exporter or representative of exporter, if provided conditions are fulfilled by exporters or representatives of exporters. The International Chamber of Commerce defines letter of credit "an arrangement however named whereby the issuing bank acting at the request and in accordance, with the restrictions of a customer, to make payment to or to the order of the beneficiary, or is to pay, accept or negotiate bill of exchange drawn by the beneficiary, or authorize such payments to be made or such draft to be paid, accepted or negotiated, by another bank, against stipulated documents and compliances with the stipulated terms and conditions."
Letter of credit is not only helpful for exporter but it is also highly suitable for importers. It helps importer to obtain more supportive documents and lower prices from the exporter. Further the importer has to be assured that the shipment will be made by the date specified in the letter of credit or else the credit may expire.
Parties Associated With Letter Of Credit:-
- Importer: Importer is always an initiator of this letter of credit. The letter of credit is opened at the request of importer.
- Issuing Bank: The bank of the importer's country is the issuer of letter of credit. The letter of credit is issued by importer's bank at the request of importer.
- The Beneficiary: Exporter or seller or representative who is working on behalf of exporter are known as beneficiary. The beneficiary is the party who's favour the letter of credit is issued.
Parties Concern With Letter Of Credit Transactions:-
- The Confirming Bank: This is the bank at the country of exporter. This bank guarantees the credit at the request of the issuing bank. It undertakes all the obligations of the issuing bank as a primary party of the credit and if issuing bank fails during the currency of t he credit. So the confirming bank is obliged to honour its commitment.
- Notifying Bank: At the request of issuing bank, the notifying bank notifies the beneficiary about the credit which has been opened to the beneficiary's favour. After the letter of credit has been confirmed, it advised the beneficiary as per law and contract.
- Paying Bank: As per the term name it is understood the term paying bank. The paying bank is the bank where the draft or bill of exchange has to be drawn. The paying bank may be or may not be the issuing bank or the confirming bank.
- Negotiating Bank: The negotiating bank has a major role in the transaction of letter of credit. It is the bank which pays or accept the drafts of the exporter. It is not important that the beneficiary has to visit the specific bank named in the credit. Beneficiary may visit any bank to present the drafts and related documents under the credit. If the bank agrees to negotiate the documents, it becomes the negotiating bank. By negotiating drafts, the negotiating bank becomes an endorsee. finally it become very helpful to get payments for exporter/ seller or beneficiary.
Different Types Of Letter of Credit:-
- Documentary Letter of Credit issued in the case of the draft must be accompanied by the documents specified in the letter of credit.
- Cash Credit issued to the exporter may drawn on a sight draft on the bank. The biggest advantage of this type of credit is that the beneficiary will receive cash for this draft as soon as the goods are ready for shipment and the relevant documents in proper order are presented to the bank.
- Clean Letter of Credit is negotiated against a clean draft.The clean draft is a draft without any document attached to it.
- Assignable Credit is the letter of credit in which beneficiary may transfer or assign his right to another beneficiary till the specified date and time or until its expiry.
- Non Assignable Credit is opposite to the assignable credit and beneficiary never transfer his right to any other party.
- Revocable Credit as its name this letter of credit may be revoked or cancelled at any time without the consent or notice to the exporter. So it is not protect the interest of exporter and also not very common in practice.
- Irrevocable Credit is opposite in the nature of revocable credit. In this credit the issuing bank under an obligation to make a payment if the terms of credit are satisfied. In this case bank issuing a letter of credit send it through its branch or correspondent bank located in the exporter's country with the request to add its conformation to the credit.
- Acceptance Credit is the letter of credit that the bank merely accept the drafts drawn by the exporter and after the acceptance of draft the draft become a bank acceptance and readily discounted and sold by the exporter to the accepting bank.
- Bank to Bank Credit is a secondary credit opened by a bank on behalf of beneficiary of an original credit in favour of domestic supplier.
- Red Clause Credit empowers the beneficiary to draw a predetermined value of letter of credit as soon as it established.
- Revolving Credit named as its character and advised to obviate the need for establishing new credit for each shipment when the transactions are more or less continuous.
Important Documents Attached With The Letter of Credit
- Commercial Invoice
- Insurance Policy
- Bill of Lading
- Certificate of Origin (if applicable)
- Certificate of Quality
- Certificate of weight