How does a letter of credit work in imports and exports?

A letter of credit is favorable for both parties because it gives the buyer the chance to establish his ability to repay and negotiate longer payment terms by having a bank back the trade transaction. It also gives the seller the assurance that he will receive his funds upon fulfillment of the terms of the trade agreement.

A letter of credit is a transactional agreement, and the parties may agree to modify or change the conditions at any time. An unconditional guarantee of payment upon demand or at a specific time is required for a letter of credit to be considered negotiable.

Both revocable and irrevocable letters of credit are available. A revocable letter of credit cannot be confirmed, therefore the obligation to pay can be canceled at any time. In an irrevocable letter of credit, all parties are in control; it cannot be amended or modified without everyone’s approval.

A letter of credit may be given or transferred, and the receiver can also perform this function. No matter how many times the beneficiary assigns or transfers the LC, it will always be valid.

Only when the beneficiary shows all drafts and required documentation will he be eligible to receive the payment upon maturity of the letter of credit from the issuing bank.

How does it work?

An LC is a contract that allows the issuing bank to act independently or at the request and direction of the applicant (importer). The issuing bank may make a payment to the beneficiary (or on their behalf) under an LC agreement (that is, the exporter). As an alternative, the exporter’s bills of exchange or drafts may be accepted by the issuing bank. Bills of exchange may also be paid or accepted by advised or nominated banks with permission from the issuing bank.

Expenses involved with an LC

When it comes to LC, there are different fees and reimbursements involved. Most of the time, all parties manage the payment under the letter of credit. Banks may charge the following fees:

opening costs, such as the upfront commitment fees and the usance fees that are payable throughout the LC’s predetermined duration.

At the end of the LC period, withdrawal expenses are due. They consist of an advisory fee imposed by the advising bank, reimbursements made to the bank by the applicant for liabilities arising under a foreign law; the fee of the confirming bank; and bank costs made to the issuing bank.

There are eight players taking part in this procedure. Read the full article …

Steps of LC

The four main steps of the LC process are as follows:

Step 1: Importer and exporter agreement

The buyer agrees to place a purchase order with the seller for the goods and agrees to receive payment via a letter of credit. Both parties agreed on terms and conditions and prepared the draft of the agreement.

Step 2: LC approval

After the parties to the trade have agreed on the terms of the contract and the use of the LC, the importer requests that the issuing bank issue an LC in the exporter’s favor. The advising bank receives the LC from the issuing bank. The latter is normally located in the exporter’s country and might even be their bank. The advising bank (confirming bank) sends it on to the exporter after confirming the LC’s authenticity.

Step 3: Delivery of goods

After receiving the LC, the exporter is required to confirm it to their satisfaction and start the process of shipping the products.

Step 4: Submitting documents to the confirming bank

Following the shipment of the goods, the exporter submits the documents to the advising/confirming bank, either personally or through the freight forwarders.

Step 5: Transfer of the goods and the completion of the importer’s payment

The bank then sends them to the issuing bank, where the amount is paid, accepted, or negotiated as applicable. The issuing bank confirms the documents and collects money from the importer. It delivers the documents to the importer, who uses them to take possession of the delivered goods.

Step 6: Custom clearance from the buyer country’s port

The goods are cleared by the buyer from the shipping line and moved to a warehouse or factory.

Writer: Shakir Ali Rajput: Global Trade Professional, For additional information, please contact me at WhatsApp (00971) 543785186 or shakir.ali@evolution.pk email address.