Legal & Regulatory Aspects of Banking - Letters of Credit Unit - 12 : Letters of Credit (LC) The Simplest form of payment in a business transaction is payment by cash , and then comes payment by cheques, drafts , TC etc. However , all these modes require proximity and element of trust between buyer and seller . In International Trade , the buyer and seller are miles apart, having different legal system and each unaware of the other's financial position. In such cases, it would be preferable that both the parties deal through their bankers . However, in this method seller should have confidence that the buyer would pay for the goods either immediately or at an agreed period of time . In case the seller is not satisfied, he may ask for an assurance from a banker .One of the method of achieving assurance in international trade is by completing the transaction through system of LC.
Parties to LC: i) Applicant -Buyer -Importer -Opener ii) Issuing Bank iii) Beneficiary - Exporter Seller iv) Advising Bank v) Negotiating Bank ( Nominated / Paying Bank ) vi) Confirming Bank vii) Reimbursing Bank
Types of LC: a) Acceptance of Credit b) Irrevocable Credit c) Confirmed Credit d) With Recourse and Without Recourse Credits e) Transferable Credits f) Back-To-Back Credits g) Anticipatory LC
Documents Under a LC : 1. Bills of Exchange 2. Invoice 3. Transport Documents 4. Bills of Lading 5. Airway Bill 6. Post Parcel Receipt and Courier Receipt 7. Insurance Documents 8. Other Documents
A Letter of credit is a form of guarantee given by banks on behalf of its customer. Parties to a Letter Of Credit Applicant-Buyer-Importer-Opener : He is the person who applies to bank for Letter of Credit Issuing Bank : The bank which opens the Letter Of Credit on the request of applicant/Buyer. Beneficiary-Exporter-Seller : The person who is entitled to receive the benefit under Letter of Credit. Advising Bank / Notifying Bank : The bank in the Beneficiary/Exporters Country through which the letter of credit is advised to the beneficiary. Negotiating Bank : The bank in the Beneficiary/Exporters Country which negotiate the bills (i.e. make payments on the bills drawn by the seller and accepts the documents.) If the LC specifies a bank then that bank is the Negotiating Bank and is also called the Nominated Bank / Paying Bank. If the LC however does not specify the bank, than any bank can be negotiating bank. Confirming Bank : The advising bank is only required to advise the credit to the beneficiary. If however in addition to advising the credit the advising bank were to confirm it, then the advising bank will also become confirming Bank. Reimbursing Bank : It is the bank which is appointed by the Issuing Bank to make reimbursement to the Negotiating, Paying or confirming Bank. Types of Letter of Credit Acceptance Credit : Ordinary Letters of Credits are usually sight credits, i.e. immediate payment should be made of the bills drawn by the beneficiary. Such letters of credit under which usance bills can be drawn is an Acceptance Credit or Time Credit. Revocable Credit : A revocable LC is a credit that can be amended / cancelled by the issuing bank without prior notice to the beneficiary. However, if any negotiating bank has acted on the credit prior to receipt of the notice of amendment/cancellation then the issuing bank is bound to reimburse the negotiating bank. Irrevocable Credit : is a credit that can neither be amended nor cancelled without the consent of the beneficiary. Confirmed Credit : If a bank advising the credit to beneficiary adds its own confirmation to the credit, then the credit would be called a confirmed credit. Only irrevocable credit can be confirmed With Recourse and without Recourse Credits : when beneficiary draws a bill under a LC he is liable if the drawee fails to make payment. These kind of bills are called recourse LCs. The beneficiary can exclude liability by adding to the bill following words “without recourse” Transferable Credits : As such the rights under an LC cannot be transferred and is vested in the beneficiary. A transferable credit is one under which the beneficiary can transfer his rights to third parties. Unless specifically stated an LC is not transferable. Back-To-Back Credits : The beneficiary in whose favour an LC is issued uses the same to obtain another credit from his (beneficiary’s ) bank in favor of the supplier. There are three banks involved in this type of LC. (Issuing Bank, Advising Bank, Third bank which issued an ancillary credit against the security of the original credit. Anticipatory Letter of CreditRed Clause Letter of credit - In a usual LC transaction the beneficiary will be entitled to receive payment only on his handing over the documents and bills drawn under the LC to the negotiating bank. However in certain credits the beneficiary will be entitled to get and advance of the price. These credits contains a “Red Clause” which authorises an intermediary bank to make an advance to the beneficiary before shipment. Green Clause Letter Of Credits –This is refinement of the “Red Clause”. This type of LC not only permits preshipment advance but also permits advances to the exporter to cover storage at the port of shipment.The Red Clause and Green Clause credit are called Anticipatory Credits. Revolving Letter of Credit : In this type of credit though amount is fixed, it can be renewed as soon as the earlier bills have been paid.
Documents Under a Letter Of Credit Bill of Exchange : In a LC transaction the rights to draw a bill is conferred only on the beneficiary. The bill amount should be within the limit fixed in the Letter of credit. Invoice : All the details mentioned in the invoice must tally with those mentioned in the Letter of credit. Revocable Credit Where the credit terms can be unilaterally altered or cancelled by the issuing bank. Revolving Credit Where the amount is fixed but can be utilised again and again as and when the earlier bills drawn are paid. Transferable Credit Where rights under an LC can be transferred to third parties. Red Clause Credit Where the beneficiary is entitled to advance payment before production of documents Green Clause Credit Credits where in addition to advance payment, the beneficiary is entitled to payment of storage / warehousing charges.