Letter of Credit-Types,

Procedure & Modalities

 Facilitating international trade is the most
important activity of international banking.

 Exporter (seller) and Importer (buyer) are two

important players in international trading
activity.
 Requirements of Exporter
and Importer
What the seller (exporter) wants
3) Contract fulfillment
(payment)
4) Convenience (of
Receiving payment in a
bank in his own country)
5) Prompt Payment
6) Expert Advice.
What the buyer (Importer) wants
3) Contract fulfillment (Goods)
4) Convenience of using an
intervening third party in
whom both have confidence,
such as a bank.
5) Credit -possibility of obtaining
finance.
6) Expert advice and assistance.
Letter of credit provides the mechanism to
fulfill the above requirements of exporters
and importers.
 Function of Letter of Credit:
Letter of credit is one of the methods of financing
international trade. Other methods-Open account
method. Documentary collection and Payment in
advance.
 Letter of Credit---Defined:
‘A letter of credit can be defined as an instrument issued
by a bank in which the bank furnishes its credit which
is both good and well known, in place of the buyer’s
credit, which may be good but is not so well known.
 A bank issues a letter of credit on behalf of one of its
customers authorizing an individual or firm to draw
draft (bill of exchange) on the bank or one of its
correspondents for the bank’s account under certain
conditions stipulated in the credit.

 Article 2 of the ICC, Uniform Customs and Practices,

brochure 500 defines a letter of credit as:
‘Any arrangement however named or described,
whereby a bank issues a letter of credit on behalf of a
customer the “Applicant “or on its own behalf,

 Is to make payment to or to the order of a third party

(the beneficiary) or is to accept and pay bills of exchange
(draft) drawn by the beneficiary or
 Authorizes another bank to effect such payment
or to accept and pay such bills of exchange
(draft) or

 Authorizes another bank to

negotiate against stipulated
documents, provided the terms
and conditions of the credit are
complied with.
 Bill of Exchange-(Draft)-
Defined
 “A bill of exchange is an instrument in writing
containing an unconditional order, signed by the
maker, directing a certain person, to pay on demand
or at a fixed or determinable future time a certain sum
of money only to or to the order of a certain person or
to the bearer of the instrument.”

 A bill of exchange drawn payable to bearer can not be

made payable on demand.
 Parties to a
Documentary Credit:
1) Applicant (opener of L.C)
2) Issuing bank (opening bank)
3) Advising bank
4) Beneficiary (exporter or seller)
5) Confirming bank.
6) Negotiating bank
7) Reimbursing bank
Modes of Payment of Letter
of Credit
i. Available by negotiation or

iii. Available by acceptance or

v. Available by sight payment or

vii. Available by deferred payments

Types of Documentary
Credits:
i. Revocable Letter of Credit
ii. Irrevocable Letter of Credit
iii. Irrevocable Confirmed Letter of Credit
iv. Revolving Credit
v. Transferable Letter of Credit
vi. Back to Back Letter of Credit
vii. Red Clause or Packing Credit
viii.Green Clause Letter of Credit
ix. Stand by Credit
 Issuing a Letter of Credit--
Procedure
i. L.C Application Form
ii. Indent Proforma invoice/Purchase Order
iii. Insurance cover note /Marine insurance policy
iv. Fixation of margin (depending on credit worthiness
of applicant & SBP instructions regarding margin
requirements)
v. Credit report of exporter
vi. Forward exchange booking (at request of importer)
vii. Selection of foreign correspondent/Advising bank.
viii. Transmission of letter of credit.
Inland Letter of Credit
i. L.C application form
ii. Performa Invoice, Indent/Order form
iii. Insurance Cover note
iv. Demand Promissory note
Procedure for inland letter of credit is same
as for international letter of credit. L.C is
opened in Pak rupees and advised through
local branch of issuing bank.
 Commonsense Rules For
Importer (buyer) &
Exporter (seller)
1) The instructions to the1) He should study the
issuing bank must be credit in depth and
clear, correct and request the changes at
precise. the earliest, if deemed
necessary.
3) The terms and 2) He should satisfy
conditions and himself that terms and
documents called for conditions and
should be in agreement documents called for
with sales contract. are in agreement with
sales contract.
 Commonsense Rules For
Importer (buyer) &
Exporter (seller)
1) Any examination/inspection of
goods prior to shipment or at
the evidenced by a document.
the issuer of such inspection
document must be stated in the
credit.
7) The credit should not call for
the documents which the seller
can not provide, nor set out
conditions that he can not meet.
1) When it is the time to present
the documents:
ii. He should present documents
conforming to the terms and
conditions as stipulated in the
credit.
iii. Present the documents within
the validity of the credit and
within the period as specified
in the credit.
4) He must remember that non-
compliance with terms
stipulated in the credit or
irregularities in the
documents, oblige the bank to
Documentary Credits:-
Advantages & Problems:
Advantages: Payment Secured (banks’
undertaking), Low risk, General acceptability,
Time saving instrument.

Problems: Country risk, opening bank’s low

rating, customers’ low rating, high charges etc.
How the exporter can minimize the problems
—By insisting for confirmed L.C.
Course of action when an exporter has Presented
documents which do not Conform to the credit:
c) Exporter may ask advising bank to send the
documents to issuing bank on collection basis.
d) Exporter can ask the negotiating bank to negotiate
the discrepant documents against indemnity or
guarantee of the exporter.
e) The advising bank can approach the issuing bank
for waiver of discrepancies.
 Flow chart - Letter of
Credit Process
Importer Exporter
(account party) (beneficiary)

Exporter’s bank
Importer’s Bank
(Adv,/
(issuing bank)
Confirming bank)