Letter of Credit Definition, Types & Parties Involved

Letter of Credit Definition, Types & Parties Involved 

Letter of Credit:

Letter of Credit widely used to make payment for domestic and international trading. Letter of credit also known as a documentary credit.Letter of Credit basically non-funded credit given by issuing bank on behalf of the buyer (Importer)

Letter of credit undertaking by issuing bank as committed to place a certain amount of money to goods seller (exporter/beneficiary) under both parties (Exporter & Importer) pre-agreed conditions. With the documentary credit, the seller no depends on buyer willingness to pay, moreover he can get funds if the goods shipped properly as depicted clause (terms) on letter of credit 

A key principle underlying letter of credit (L/C) is that banks deal only with the documents, not the goods. The decision to pay under a letter of credit will be based on whether the documents presented to the bank in accordance with the terms and conditions of the letter of credit

Letter of Credit_Sample copy

Types of Letter of Credit:

1. Revocable Letter of Credit

A revocable letter of credit can be canceled or amended for any reason, at any time by the issuing bank without any prior notification to the seller.  Very rare cases this sort of LC used in international trade and not considered satisfactory for the exporters but has great benefits to Importer. It must be indicated in LC that the credit is revocable. If there is no such indication on the L/C, it should be considered as irrevocable.

2. Irrevocable Letter of Credit

A revocable letter of credit can be canceled or amended without the agreement among issuing bank, the confirming bank, and the beneficiary. This credit is a firm undertaking by the issuing bank to make payment to the beneficiary against the stipulated documents are presented to Negotiating bank or the issuing bank & that’s the terms & condition of the credits are complied with UCPDC. In terms of confirmation an Irrevocable Letter of Credit can be two types as below;

• Confirmed Letter of Credit: By adding confirmation to the Letter of Credit the corresponding bank undertakes the to honor the documents that conform to the terms & condition of the credit & presented before the LC expiry date.

• Un-Confirmed Letter of Credit: Such cases advising bank simply advising bank advise the beneficiary that the credit has opened. It does not itself provide any firm undertaking to pay & obligation to honor documents presented by the beneficiary

4. Sight Credit of Credit  (At sight LC)

Sight credit states that the payments would be made within the shortest possible time by the issuing bank upon presentation of corrected documents. Even though receiving payment through is fairly quick, that doesn’t mean that it is instant. The exporter’s/seller’s bank will first review all of the submitted documents to confirm that they meet all of the requirements of the letter of credit. This may take a few business days.

5. Usance LC ( Deferred LC) 

This type of LC is called a usual example letter of credit, it states that payment is to be made at the allowable period of time. With a usance, LC payment is made long after the required documents are presented. This could be 30, 60, 90 or 180 days after the documents are presented. This type of credit really helps the buyer to get the goods in hand, sell the goods to end consumer & make money to pay to the exporter. Most of the Usance LC is preferred where a buyer and a seller have a close & long term business relationship. Both parties(buyer & seller) must agree on the interest rate for usance period

6. Back to Back Letter of Credit 

Back to back credit is a new credit open by beneficiary bank in favor of another supplier by lien the original LC (Master LC). Under the Back to back concept beneficiary (exporter), original LC offers to his bank as the security of opening 2nd  credit which termed as Back to back letter of credit.

7. Transferable Letter of Credit

A transferable documentary credit is a type of credit under which the first party/beneficiary usually acts as a middleman & request to his bank to transfer credit in whole or in part to the second party/beneficiary. On LC clause should mention LC transferable to forward this to 2nd party, otherwise not possible to follow this transfer process through beneficiary bank 

During forward LC by the beneficiary bank should endorse 1st party commission percentage of the first beneficiary. The first beneficiary or middleman has rights to change the following terms and conditions (as reduce unit price, amount, shipment date) of the letter of credit during forwarding LC

Parties involved in Letter of Credit:

• Applicant: Applicant normally stands for the buyer or Importer of the goods, who will make payment to the seller. L/C is issued by the bank (issuing bank) at buyer request as following his instructions.

• Beneficiary: Beneficiary is normally stood for the seller (exporter) of the goods, who has to receive payment from the applicant(importer). A credit is issued in his favors to enable him to obtain payment on surrender of the stipulated document which is complied with the conditions of the L/c.

• Issuing Bank: The issuing bank is the one which opens a letter of credit and takes the responsibility to make the payments on receipt of the goods shipment documents from the beneficiary bank. The payment has to be made to the exporter within seven working days from the date of receipt of documents at their hand.

• Advising Bank: An Advising Bank provides advice to the beneficiary and takes the responsibility for sending the documents to the LC issuing bank. Advising Bank normally located in the country of the beneficiary(Exporter)

• Confirming Bank: Confirming bank adds confirmation or guarantee to the credit opened by the LC issuing bank. Add confirming bank undertaking the responsibility of delivered goods payment to the exporter. Confirming bank normally assign on the favor of exporter when the exporter not fully satisfied with the undertaking of the issuing bank. Confirming Bank normally located in the country of the importer of the goods

• Negotiating Bank:  Negotiating Bank is negotiating the documents which submitted to them by the exporter to release goods payment under the credit. Negotiating bank is the bank that verifies the shipped documents and confirms the terms and conditions under LC on behalf of the beneficiary to resolve any further discrepancies. On their negotiation process, they will claim for reimbursement as makes the payment to the beneficiary if all accordance with the terms and conditions of the letters of credit. 

• Reimbursing Bank: Reimbursing Bank is the bank authorized to honor the reimbursement claim settlement by the negotiating bank. reimbursement bank is often but not always, the issuing bank or issuing the bank has an account for further settlement of LC payment  

• Second Beneficiary: Second Beneficiary is the party who represent the original Beneficiary of credit. In this case, the credit belongs to the original beneficiary this must be is transferable as mentioned on LC. Normally secondary beneficiary could be goods manufacturer/shipper & original beneficiary is buyer agent

 Required documents required to open LC in Bangladesh:

The person or company who comes to open LC must be an importer. There are five types of importer:

• Commercial Importer
• Industrial importer
• Lease financing importer
• Public sector
• End-user

Generally, Importer must have the certificate IRC (import registration Certificate) from Office of the Chief Controller of Imports & Exports, Exceptions are, Public sector: Instead of IRC, they need a specific recommendation from concern ministry

LC importers should have the following Documents to import;

• Valid IRC or Equivalent certificate
• Valid trade license
• Indent/proforma invoice/Sales contact
• Membership certificate from Chamber of commerce or Trade Association
• TIN certificate (tax identification certificate)
• Income Tax paid certificate declaration of submission of income tax return
• Last 03 years audited/provisional balance sheet of company (For limited company)
• VAT license (value added tax)
• Application & agreement for the letter of credit with the stamp of T.K 150 duly filled up & signed by Importer
• Indent/proforma invoice/Sales contact duly signed with Chopped by both party (Importer& exporter)
• Insurance cover note with money receipt covering all risk for 110% of the LC value
• LCA form duly filled up & signed by Importer
• IMP form duly signed by the importer   
• In the case of import drug & medicines, required valid drug license
• In the case of import pharmaceuticals raw & packing materials, required the approval of the list of items with the corresponding amount from Director, Drug Administration
• In the case of the public sector, required attested copy of Government permission
• Any other document as required as per Import Policy ( public notice/ Chamber of commerce instruction)