Letter of Credit

Letter of Credit (LC) is a credit limit that is used majorly by businesses engaged in international trade. It acts as a payment guarantee offered by Bank/NBFCs to exporters. Letter of Credit is a payment instrument in which Banks/NBFCs offer monetary guarantee to enterprises that are engaged in the import and export businesses, in case of payment delays or any default.

Enterprises operating businesses overseas often deal with unknown suppliers so they require assurance of payment before performing any business transaction. Therefore, Letter of Credit acts as a financial instrument that offers payment assurance to the suppliers or exporters dealing in sales and purchase of goods and services.

Letter of Credit is issued by the Bank to the Buyer in order to secure the timely payment by the buyer to the seller. It acts as a guarantee on behalf of the buyer that he/she pays the full amount to the seller, as per the defined timeline or on time. If in case the buyer is unable to repay the amount to the seller on time, then the bank will pay on the buyer’s behalf to the seller.

Features:

1. Credit on Sight

In this type of credit, an entrepreneur can present a bill of exchange to the lender with a sight letter and can take the funds instantly on the basis of a letter of sight. A sight letter of credit is considered to be the most instant letter of credit that can be availed immediately.

2. Time Credit

Bill of exchange that is paid after an agreed time period between the lender and the borrower is known to be time credit. A certain time period is involved in this type of credit. Letter of Credit defining time credit allows a borrower with some days to repay the amount, only after receiving the goods.

3. Standby Letter of Credit (SBLC)

Standby Letter of Credit (SBLC) is a credit mechanism in which an importer can get foreign currency funds internationally by providing the issuance of SBLC from the domestic bank that guarantees payment to the international bank if the borrower fails to repay the amount before the due date.

4. Revocable Credit

Revocable credit is a type of letter of credit in which the terms and conditions of this type of LC can be amended or canceled by the issuing bank. It is not important for the issuing bank to tell beneficiaries about any change in the letter of credit.

5. Irrevocable Credit

Irrevocable Credit is a type of LC in which the terms and conditions cannot be amended or canceled by the issuing bank. The bank has to obey the directions or commitments mentioned in the letter of credit.

6. Transferable Credit

Transferable credit, as the name suggests is a type of Letter of credit in which the beneficiary can transfer his/her rights to third parties. The terms and conditions may differ as per the trade and industry.

Step 1: The applicant or the buyer approaches the desired bank for the issuance of a letter of credit. This bank is known as an opening or issuing bank.

Step 2: There will be an advising bank (mostly an international bank) for the beneficiary or seller that will receive the Letter of Credit issued by the issuing bank of the buyer. Further, the advising bank will check the authenticity of the letter of credit by checking the name, product details, etc.

Step 3: Advising bank will share the letter of credit with the seller by keeping him/her rest assured that the money shall be received, as banks are now involved in this process.

Step 4: Post seller assurance, the goods will be shipped as per the details mentioned by the buyer or applicant. The seller will now receive the bill of lading as the seller has already exported the goods.

Step 5: The buyer shall now present the Bill of Lading to the Nominated or the Negotiating bank (International bank) where the bank will check all the shipping documents, and whether all goods were shipped as per the instructions. Finally, the nominating bank will do the payment to the seller or exporter.

Step 6: Further the nominating bank will share the shipping documents with the issuing bank and will demand payment.

Step 7: Issuing bank will further share the documents with the buyer, seeking approval on whether all documents the correct, as per the buyer’s information, and if all the products are shipped or not.

Step 8: The buyer now does the payment to the issuing bank and further the issuing bank sends the payment to the nominated or negotiating bank.

Below stated are the documents required to apply for a Letter of Credit:

• Duly filled application form with passport-sized photographs
• KYC of the applicant, co-applicants, partners, directors (Passport, Voter ID card, Aadhar Card, Driving License, etc.)
• Bill of Exchange
• Commercial Invoice
• Certificate of Origin
• Health and Insurance certificates – Original
• Buyer’s Financial Documents
• Packing, Shipping, and Transport Documents
• Landing airway bills, cargo receipts, etc.
• Related Commercial documents – Certificate of Inception
• Official Documents required by the buyer’s/seller’s country
• Any other document required by the lender

Bank Guarantee (BG) is much more similar to Letter of Credit but there is one major difference between them is that the process of the letter of credit will proceed even if the buyer defaults in payment. However, in the case of a BG, the bank reduces the loss incurred, if the transaction is not performing as per plan.

The loan is a lump sum amount borrowed to be repaid in a defined period of time in the form of EMIs. Letter of Credit is a credit or loan limit sanctioned by a bank to the borrower in which the borrower has an option of withdrawing small portions from the total sanctioned limit. With a loan, there is no guarantor whereas, in the case of a letter of credit, the bank becomes the guarantor for the buyer.

To get a letter of credit, certain documents are to be provided by the consumer to the issuing bank (Indian Bank). This letter guarantees the seller that the payment shall be made in case the buyer is unable to pay. The bank is at risk if this happens but there is also an advisory bank (Indian Bank) at the rescue that pays on behalf of issuing bank.

It is commonly divided into two categories, such as Commercial and Standby Letter of Credit. Wherein commercial is considered as a primary instrument and standby letter of credit is secondary.