Letter Of Credit and its types Letter of Credit is a letter from a bank guaranteeing that a buyers payment to a seller

will be received on time and for the correct amount. In the event that the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase. Letters of credit are often used in international transactions to ensure that payment will be received. Due to the nature of international dealings including factors such as distance, differing laws in each country and difficulty in knowing each party personally, the use of letters of credit has become a very important aspect of international trade. The bank also acts on behalf of the buyer (holder of letter of credit) by ensuring that the supplier will not be paid until the bank receives a confirmation that the goods have been shipped. Definitions of related terms: 1. Advising Bank: The Bank which advises a Letter of Credit to the Beneficiary at the request of the issuing Bank is known as the Advising Bank

2. Applicant: Applicant is the party on whose request the issuing bank issues a credit.

3. Beneficiary: Beneficiary is the party who is to receive the benefit (payment) of the LC. The consignee of an LC and the beneficiary may not be the same. The credit is issued in his favor.

4. Confirming bank: The Bank which adds confirmation to an LC is termed as Confirming Bank. It does so at the request of the issuing bank and taking authorization from the issuing bank.

5. Honour: Honour means act according to commitment of the LC.

6. Issuing bank: The bank which issues a credit is known as issuing bank.

7. Nominated Bank: The bank with which credit is available is termed as Nominated Bank of that credit. If no bank is mentioned in the credit as nominated bank, all banks are nominated bank.

8. Presentation: Presentation is either delivery of documents against an LC or the document itself.

9. Complying presentation: A presentation is said to be complying presentation when it is in accordance with:

the terms and conditions of the credit the applicable provisions of International Chamber of Commerce and international standard banking practice

10. Negotiation: A bank (Nominated Bank) is said to negotiate a document if it purchases a draft and/or documents under a complying presentation either by making advance or agreeing to advance funds to the beneficiary on or before the date on which reimbursement is due to the nominated bank . A draft drawn on a nominated bank can not be purchased by itself.

Types of Letter of Credit: 1. Confirmed Letter Of Credit: A confirmed letter of credit is typically used when the issuing bank of the letter of credit may have questionable creditworthiness and the seller seeks to get a second guarantee to assure payment.

2. Transferable Letter Of Credit: A letter of credit that permits the beneficiary of the letter to make some or all of the credit available to another party, thereby creating a secondary beneficiary. The bank issuing the letter of credit must approve the transfer. The letter of credit must state expressly that the credit is transferable.

3. Irrevocable LC: In this type of LC, Any changes (amendment) or cancellation of the LC (except it is expired) is done by the Applicant through the issuing Bank. It must be authenticated by the Beneficiary of the LC. Whether to accept or reject the changes depends on the beneficiary.

4. Deferred / Usance LC: It is kind of credit that won't be paid and assigned immediately after checking the valid documents but paying and assigning it requires an indicated duration which is accepted by both of the buyer and seller. In reality, seller will give an opportunity to the buyer to pay the required money after taking the related goods and selling them. Usance time can be between 30 and 180 days after the bill of lading date.

5. Sight Letter Of Credit: A letter of credit that is payable once it is presented along with the necessary documents. An organization offering a sight letter of credit commits itself to paying the agreed amount of funds provided the provisions of the letter of credit are met. A sight letter of credit is thus more on demand than some other types of letters of credit.

6. Straight LC & Negotiation LC: A negotiation letter of credit can be presented to any bank A straight letter of credit can only be paid in the country of the Paying Bank

7. Synthetic Letter Of Credit: A synthetic letter of credit is the one that is already pre-funded by the bank on the date of closing rather than when the funds are drawn as desired. All the cash that is accessible through the synthetic LOC are normally held in a credit linked deposit account until needed. Compared to an ordinary LOC, the synthetic LOC is a more liquid source of funds to the borrower because the funds borrowed via the synthetic LOC are given immediately. Therefore the proceeds are considered to be more secure because of the absence of the counterparty risk that could be brought about by the funds becoming unavailable.

8. Red Clause Letter if Credit: A specific type of letter of credit in which a buyer extends an unsecured loan to a seller. Red Clause Letters of Credit permit documentary credit beneficiaries to receive funds for any merchandise outlined in the letter of credit. These letters are commonly used by beneficiaries who act as purchasing agents for buyers in another country.

9. Back-To-Back Letter of Credit: Two letters of credit (LCs) used together to help a seller finance the purchase of equipment or services from a subcontractor. With the original LC from the buyer's bank in place, the seller goes to his own bank and has a second LC issued, with the subcontractor as beneficiary. The subcontractor is thus ensured of payment upon fulfilling the terms of the contract.