What is a Letter of Credit?

A Letter of Credit

For the simplicity of international trade transactions and the removal of potential risk, letters of credit (LC) are often used in international practice.

Importers and exporters have access to a variety of LCs.Banks issue LC in accordance with their own capacities and with the assistance of internationally renowned first-class institutions. So, bank employees offer full consultation assistance on LC information and LC type selection based on customer demands.

In addition to this, LC for international trade operations is only one of the trade financing services that Banks provide.

What is a letter of credit (LC)?

A letter of credit (LC) is a bank service that guarantees payment of the amount specified in the letter of credit to the seller in accordance with instructions from the buyer, execution of other criteria outlined in the letter of credit, and submission of relevant documents.

As a result, the bank (issuer) will facilitate the transfer of funds to the seller’s account following the transfer of ownership of the products delivered by the seller to the buyer and the submission of the documents verifying the fulfillment of other LC criteria.

Efficiency of LC

Following the efficiency of LC includes :

1. The buyer and seller contact the bank for an LC issue.

2. A particular account is opened with the bank for payments.

3. The buyer transfers the amount specified in the contract to this account with the bank.

4. The buyer submits a document confirming the transfer of ownership over delivered goods, and then the bank transfers the funds from the special account to the seller’s account.

5. If the required documents are not submitted within the time period specified in the contract, the bank will transfer the funds from the special account to the seller’s account.

Benefits of LC

Following are the benefits of LC to the Buyer includes:

• Reducing the buyer’s risk of financial loss.
• Payment is made when the seller’s contract requirements are met.
• Transfer ownership of items transported to the purchaser according to the letter carrier’s schedule and other conditions.

Following are the LC benefits for the seller includes:

• Purchaser’s separate payment guarantee (subject to fulfillment of contractual obligations)
• The option to receive payment before delivering the goods to the buyer.
• The opportunity to negotiate complex commercial deals.

Basic LC types

The names of LC types are presented in English because of their common use within international collaborations.

1. Irrevocable LC

This LC cannot be canceled or changed without the beneficiary’s (seller’s) approval. In addition to this, LC shows the bank’s (the issuer’s) complete obligation to the other party.

2. Revocable LC

 Without the beneficiary’s prior consent, the bank (issuer) may cancel or modify this LC type at the customer’s request. After the LC is revoked, so the bank won’t owe the beneficiary any money.

3. LC in standby

 This LC allows the seller and the buyer more flexible collaboration opportunities and is more similar to a bank guarantee. In the event that the buyer doesn’t meet their payment obligations to the seller, the bank will guarantee the LC.

4. LC confirmed

This LC type is verified by any bank, in addition to the bank guarantee of the LC issuer, including the seller’s bank. Regardless of whether the bank issuing the LC (issuer) made a payment, the bank confirms the LC remains responsible for its responsibilities.

5. Unverified LC

Payment of this LC shall be made only by the bank issuing the LC.

6. Transferable LC

With this LC, the seller is permitted to transfer a portion of the letter of credit to another party (ies). This LC saves time and money by avoiding the need to open several LCs for different parties, which is particularly useful when the seller is not the only maker of the items and buys some parts from other parties.

7. Back to Back LC

This LC type takes the first letter of credit into account when deciding whether to issue the second LC. According to the instructions of the buyer, an LC is opened in favor of the intermediary and using this LC and the intermediary’s instructions, a second LC is formed in favor of the seller of the products.

8. Payment At Sight LC

In accordance with this LC, payment is paid to the seller immediately (or within 7 days, at most) upon the submission of the required documents.

9. Deferred Payment LC

According to this LC, payment to the seller is given at a later date specified in the letter of credit rather than at the time the documents are presented. But this payment in favor of the seller under this LC is often made after the buyer receives the goods.

10. Red Clause LC

Before shipping the goods and submitting the documents, the seller has the right to request an advance from the LC for a certain amount. This clause is known as a “red clause” because it is typically printed in red to emphasize the “advance payment” aspect of the credit.

Writer: Shakir Ali Rajput: Global trade professional

contact: WhatsApp (00971) 543785186 or shakir.ali@evolution.pk