LETTER OF CREDIT

(L/C)

Budiman Arif (AK 6D)

Definition of Letter of Credit
(L/C)
 A written commitment to pay,
by a buyer's or importer's
bank (called the issuing bank)
to the seller's or exporter's
bank (called the accepting
bank, negotiating bank, or
paying bank).
 Parties involved in L/C
transaction:
 The Applicant is the party that arranges for the letter of credit
to be issued.
 The Beneficiary is the party named in the letter of credit in
whose favor the letter of credit is issued.
 The Issuing or Opening Bank is the applicant’s bank that
issues or opens the letter of credit in favor of the beneficiary
and substitutes its creditworthiness for that of the applicant.
 An Advising Bank may be named in the letter of credit to
advise the beneficiary that the letter of credit was issued. The
role of the Advising Bank is limited to establish apparent
authenticity of the credit, which it advises.
 The Paying Bank is the bank nominated in the letter of credit
that makes payment to the beneficiary, after determining
that documents conform, and upon receipt of funds from the
issuing bank or another intermediary bank nominated by the
issuing bank.
 The Confirming Bank is the bank, which, under instruction from
the issuing bank, substitutes its creditworthiness for that of
the issuing bank. It ultimately assumes the issuing bank’s
commitment to pay.

 Typically the documents
requested in a Letter of Credit
 Financial Documents
 Bill of Exchange, Co-accepted Draft
 Commercial Documents
 Invoice, Packing list
 Shipping Documents
 Transport Document, Insurance Certificate, Commercial,
Official or Legal Documents
 Official Documents
 License, Embassy legalization, Origin Certificate,
Inspection Certificate, Phytosanitary certificate
 Transport 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 documents
 Insurance policy, or Certificate but not a cover note.
Letter of Credit Process:
  The example: You want to buy $50,000 worth of radios from Seoul
Manufacturing, which agrees to sell the merchandise and gives you
60 days to pay it with the condition that you provide them with a 90
days letter of credit for the full amount. The steps to get the LC would
be as follows:


 1)You go to First American Bank and request a $50,000 letter of credit

with Seoul Manufacturing as a beneficiary.
 2)The bank goes through its underwriting process. Although the bank is
not advancing money, they are extending credit on your behalf and
are taking on a contingent liability. If your company qualifies from a
credit standpoint the LC is issued.
 3)Even if your company does not qualify for credit, you can still get an LC
if you are willing to put cash collateral CD secured letters of credit
are very common for small business .
 4)The bank sends a copy of the letter of credit to First Seoul Bank, which
lets the vendor knows and the merchandise is shipped.


 The letter of credit will indicate that payment shall be made as soon as
Seoul Manufacturing can present proof of shipping.
 If the letter of credit that your vendor requires is not tied to a particular
transactions, but they are asking for a guarantee that makes sure
that you will not default. They are probably asking for a Stand-By
letter of credit or a Revolving letter of credit. These types of LCs
are usually for a longer term. Usually a year and are the vendor’s
guarantee that they will get paid.
TYPES OF LETTERS OF CREDIT

 Irrevocable
 Unconfirmed
 Confirmed
 Standby Letters of Credit
 Revolving Letter of Credit
 Transferable Letter of Credit
 Back-to-Back Letter of Credit


LC

Advantages of Using Letters of
Credit
 For Exporters


 Guaranteed payment upon presentation of the documents specified
in the terms of the letter of credit.
 Reducing the production risk, first of all, for the situations when the
buyer cancels or changes his order.
 The ability to structure the delivery schedule according to the
exporter's interests.
 The chance to obtain financing for production or purchase of goods
(pre-export finance).
 The chance to get financing in the period between the shipment of
the goods and receipt of payment (especially, in case of delayed
payment).
 The buyer cannot refuse to pay due to a complaint about the goods.
 The importer must raise any complaints/claims about the delivered
goods separately from the letter of credit, which provides the
exporter with a significant advantage in resolving such issues.

Advantages of Using Letters of
Credit
 For Importers


 The possibility to structure the payment plan in the

contract according to the importer's interests.
 Certainty that the payment will be made only upon
presentation of the documents confirming shipment of
the goods.
 The use of a letter of credit allows the importer to avoid or
reduce pre-payment.
 The seller must fulfill all terms of the contract, as indicated
in the letter of credit (shipment of the goods, meeting
delivery terms on stock, amount, and deadlines) in
order to receive the payment.
 Having opened a letter of credit, the importer proves his
ability to pay and can count on more favourable
payment terms in the future.

 Disadvantages of Using
Letters of Credit
 For Exporters

 Strict compliance is required for payment.  Unless all
the documents are 100% compliant with the terms
and conditions of the L/C the bank will not issue
payment.
 Still subject to political risk of the country the L/C is
issued from
 Subject to the financial strength and stability of the
Issuing bank
 More cumbersome - requires a high level of expertise
to successfully navigate the process
 More expensive than other methods of payment
 Receiving, negotiating, and other fees associated
with L/C can be expensive.The paperwork can be
very time consuming and cumbersome to produce

 Disadvantages of Using
Letters of Credit
 For Importers


 Tie up the business credit line

 Unless currency-hedging strategies are utilized,
the actual cost of the goods can increase do
to vulnerability to currency fluctuations.
 Costs involved with issuing, negotiating, and
other fees (like amendments), can make L/C
expensive.
 Sellers bank control the shipping documents
 The goods shipped may not conform (inferior
quality for example) to the order (remember
L/C’s are strictly about documents and are
separate from the actual goods).  Unless the
seller “makes good” the only recourse is
through legal proceedings.
 Risk situations in Letter of
Credit transactions
 Fraud 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 Risks
 Performance of the Documentary Credit may be
prevented by government action outside the control of the
parties.
 Legal 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
 Risk situations in Letter of
Credit transactions
 Force 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 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 Bank
 Insolvency of the Applicant, Fraud Risk, Sovereign and
Regulatory Risk and Legal Risks
 Risks to the Reimbursing Bank
 no obligation to reimburse the Claiming Bank unless it
has issued a reimbursement undertaking.
 Risk situations in Letter of
Credit transactions
 Risks 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 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 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
 Risk situations in Letter of
Credit transactions
 Risks 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
 Other Risks in International Trade
 ~ A Credit risk riskfrom change in the credit of an
opposing business.
 ~ An Exchange risk is a risk from a change in the foreign
exchange rate.
 ~ A Force majeure risk is 1. a risk in trade incapability
caused by a change in a country's policy, and 2. a risk
caused by a natural disaster.
 ~ Other risks are mainly risks caused by a difference in
law, language or culture. In these cases, the cargo might
be found late because of a dispute in import and export
dealings.
Thank You