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A Report On

Letter Of Credit

Prepared For
Hassan

How To Open

Sir Mumtaz

Prepared By

Abdul Latif

Roll No

1204101

DATED

8th April, 2015

S.No

Topic

Page
No

01

Executive summary

01

02

Introduction

02

03

Letter of credit

03

04

How to open L/C

04

05

Characteristics Of Letter Of Credit

05

06

Documents call for under L/C

07

07

Standard form of documentation

08

08

Intr. Trade payment methods

09

09

Risk in L/C transaction

10

10

Conclusion

12

11

Appendix (A)

13

12

Appendix (B)

14

13

Bibliography

15

14

Index

16

TABLE OF CONTENTS

EXECUTIVE SUMMARY
A letter of credit is a method of securing payment to a vendor. When a
seller asks a buyer to obtain a letter of credit, it means the seller would like
to ensure payment for a product he sells to that customer. Typically letters
of credit are issued by a bank. The most common forms are standby letters
of credit for domestic transactions and documentary letters of credit for
international transactions.
Letter of credit is a payment method in international trade which is used by
almost all sectors from textile to machinery, food manufacturing to
construction, oil trading to customer goods. You may assume that there are
big differences exist on letter of credit application process for all these
different sectors. But this is not correct. You have to follow similar
procedures when opening a letter of credit regardless of the sector you may
be located.
Two types of L/C is wideley used around the globe which is Revocable L/C
and Irrevocable L/C and the following parties are involved in letter of
credit; Applicant of L/C, L/C issuing bank, beneficiary party, advising bank,
confiming bank, negotiating bank and second beneficiary. Typically, the
documents a beneficiary has to present in order to receive payment include
a commercial invoice, bill of lading, and documents proving the shipment
was insured against loss or damage in transit. However, the list and form of
documents is open to imagination and negotiation and might contain
requirements to present documents issued by a neutral third party
evidencing the quality of the goods shipped, or their place of origin.

INTRODUCTION
When you hear the phrase letter of credit, it might be natural to think it
would refer to a document verifying that you are creditworthy, but that isn't
the case. a letter of credit is a document issued by a third party that
guarantees payment for goods or services when the seller provides
acceptable documentation. letters of credit are usually issued by banks or
other financial institutions, but some creditworthy financial services
companies, like insurance companies or mutual funds, might issue letters
of credit under certain circumstances.
The purpose of this report is to get deeper knowledge of the procedure to
open letter of credit. In this regard we were advised to visit any bank and
collect the relevant information regarding Letter of Credit. We have visited
the Habib Metro Bank ( Bahudarabad Branch).The branch manager was
really co-operative and he gave us not only his precious time but also his
valuable and practical insights on Letter of credit as he has years of
experience in this feild.
This report helped us a lot and a great addition in our knowledge.Now we
are fimiliar with procedure of opening letter of credit .

LETTER OF CREDIT
DEFINITION:
A conditional guaranty of payment made by a bank to the name of
beneficiary granting that payment will be made provided that the term of
credit are made. This term will state that the beneficiary must submit
satisfied document to a stated bank at a certain date.

DEFINITION ACCORDING TO ENCYCLOPAEDIA:


L/C. A binding document that a buyer can request from his bank in order to
guarantee that the payment for goods will be transferred to the seller.
Basically, a letter of credit gives the seller reassurance that he will receive
the payment for the goods. In order for the payment to occur, the seller has
to present the bank with the necessary shipping documents confirming the
shipment of goods within a given time frame. It is often used in
international trade to eliminate risks such as unfamiliarity with the foreign
country, customs, or political instability.

TYPES OF L/C:
There are two types of Letter of Credit.
1) Revocable L.C
The Revocable L.C can be amended and cancel without the exporter
permission on knowledge.
2) Irrevocable L.C
An Irrevocable L.C cannot amended and cancel without the
permission or knowledge of the exporter.

HOW TO OPEN LETTER OF


CREDIT
A business called the InCosmetika from time to time imports goods from a
business called ACME, which banks with the ABC Bank. InCosmetika holds an
account at the Commonwealth Bank. InCosmetika wants to buy $500,000 worth
of merchandise from ACME, who agrees to sell the goods and give InCosmetika
60 days to pay for them, on the condition that they are provided with a 90-day
letter of credit for the full amount. The steps to get the letter of credit would be as
follows:
The Commonwealth Bank sends a copy of the LC to the ABC Bank, which
notifies ACME that payment is available and they can ship the merchandise
InCosmetika has ordered with the full assurance of payment to them.
On presentation of the stipulated documents in the letter of credit and
compliance with the terms and conditions of the letter of credit, the
Commonwealth Bank transfers the $500,000 to the ABC Bank, which then
credits the account of ACME for that amount.
Note that banks deal only with documents required in the letter of credit and
not the underlying transaction.
Many exporters have mistakenly assumed that the payment is guaranteed
after receiving the LC. The issuing bank is obligated to pay under the letter of
credit only when the stipulated documents are presented and the terms and
conditions of the letter of credit have been met.

CHARACTERISTICS OF
LETTER OF CREDIT
NEGOTIABILITY
Letters of credit are usually negotiable. The issuing bank is obligated to pay not only
the beneficiary, but also any bank nominated by the beneficiary. Negotiable
instruments are passed freely from one party to another almost in the same way as
money. To be negotiable, the letter of credit must include an unconditional promise
to pay, on demand or at a definite time. The nominated bank becomes a holder in due
course. As a holder in due course, the holder takes the letter of credit for value, in
good faith, without notice of any claims against it. A holder in due course is treated
favorably under the UCC.
The transaction is considered a straight negotiation if the issuing bank's payment
obligation extends only to the beneficiary of the credit. If a letter of credit is a straight
negotiation it is referenced on its face by "we engage with you" or "available with
ourselves". Under these conditions the promise does not pass to a purchaser of the
draft as a holder in due course.

REVOCABILITY
Letters of credit may be either revocable or irrevocable. A revocable letter of credit may
be revoked or modified for any reason, at any time by the issuing bank without
notification. A revocable letter of credit cannot be confirmed. If a correspondent bank
is engaged in a transaction that involves a revocable letter of credit, it serves as the
advising bank.
Once the documents have been presented and meet the terms and conditions in the
letter of credit, and the draft is honored, the letter of credit cannot be revoked. The
revocable letter of credit is not a commonly used instrument. It is generally used to
provide guidelines for shipment. If a letter of credit is revocable it would be
referenced on its face.

The irrevocable letter of credit may not be revoked or amended without the
agreement of the issuing bank, the confirming bank, and the beneficiary. An
irrevocable letter of credit from the issuing bank insures the beneficiary that if the
required documents are presented and the terms and conditions are complied with,
payment will be made. If a letter of credit is irrevocable it is referenced on its face.

TRANSFER AND ASSIGNMENT


The beneficiary has the right to transfer or assign the right to draw, under a credit
only when the credit states that it is transferable or assignable. Credits governed by
the Uniform Commercial Code (Domestic) maybe transferred an unlimited number
of times. Under the Uniform Customs Practice for Documentary Credits
(International) the credit may be transferred only once. However, even if the credit
specifies that it is nontransferable or nonassignable, the beneficiary may transfer
their rights prior to performance of conditions of the credit.

SIGHT AND TIME DRAFTS


All letters of credit require the beneficiary to present a draft and specified documents
in order to receive payment. A draft is a written order by which the party creating it,
orders another party to pay money to a third party. A draft is also called a bill of
exchange.
There are two types of drafts: sight and time. A sight draft is payable as soon as it is
presented for payment. The bank is allowed a reasonable time to review the
documents before making payment.
A time draft is not payable until the lapse of a particular time period stated on the
draft. The bank is required to accept the draft as soon as the documents comply with
credit terms. The issuing bank has a reasonable time to examine those documents.
The issuing bank is obligated to accept drafts and pay them at maturity.

DOCUMENTS CALLED FOR


UNDER L.C
FINANCIAL DOCUMENTS
Bill of Exchange, Co-accepted Draft

COMMERCIAL DOCUMENTS
Invoice, Packing list

SHIPPING DOCUMENTS
Transport Document, Insurance Certificate, Commercial, Official
or Legal Documents

OFFICIAL DOCUMENTS
License, Embassy legalization, Origin Certificate, Inspection Cert ,
Phyto-sanitary Certificate

TRANSPORT DOCUMENTS
Bill of Lading (ocean or multi-modal or Charter party), Airway bill,
Lorry/truck receipt, railway receipt, CMC Other than Mate Receipt,
Forwarder Cargo Receipt, Deliver Challan...etc

INSURANCE DOCUMENTS
Insurance policy, or Certificate but not a cover note. Pre shipment
packing list.

STANDARD FORMS OF
DOCUMENTATION
When making payment for product on behalf of its customer, the issuing bank
must verify that all documents and drafts conform precisely to the terms and
conditions of the letter of credit. Although the credit can require an array of
documents, the most common documents that must accompany the draft include:

COMMERCIAL INVOICE
The billing for the goods and services. It includes a description of merchandise,
price, FOB origin, and name and address of buyer and seller. The buyer and seller
information must correspond exactly to the description in the letter of credit.
Unless the letter of credit specifically states otherwise, a generic description of the
merchandise is usually acceptable in the other accompanying documents.

BILL OF LADING
A document evidencing the receipt of goods for shipment and issued by a freight
carrier engaged in the business of forwarding or transporting goods. The
documents evidence control of goods. They also serve as a receipt for the
merchandise shipped and as evidence of the carrier's obligation to transport the
goods to their proper destination.

WARRANTY OF TITLE
A warranty given by a seller to a buyer of goods that states that the title being
conveyed is good and that the transfer is rightful. This is a method of certifying
clear title to product transfer. It is generally issued to the purchaser and issuing
bank expressing an agreement to indemnify and hold both parties harmless.

LETTER OF INDEMNITY
Specifically indemnifies the purchaser against a certain stated circumstance.

Indemnification is generally used to guaranty that shipping documents will be


provided in good order when available.

INTERNATIONAL TRADE
PAYMENT METHODS
ADVANCE PAYMENT
where the buyer parts with money first and waits for the seller to forward the
goods

DOCUMENTARY CREDIT
subject to icc's ucp 600, where the bank gives an undertaking (on behalf of
buyer and at the request of applicant ) to pay the shipper ( beneficiary ) the
value of the goods shipped if certain documents are submitted and if the
stipulated terms and conditions are strictly complied.
here the buyer can be confident that the goods he is expecting only will be
received since it will be evidenced in the form of certain documents called for
meeting the specified terms and conditions while the supplier can be confident
that if he meets the stipulations his payment for the shipment is guaranteed by
bank, who is independent of the parties to the contract.

DOCUMENTARY COLLECTION
subject to icc's urc 525, sight and usance, for delivery of shipping documents
against payment or acceptances of draft, where shipment happens first, then
the title documents are sent to the [collecting bank] buyer's bank by seller's
bank [remitting bank], for delivering documents against collection of
payment/acceptance

DIRECT PAYMENT
where the supplier ships the goods and waits for the buyer to remit the bill
proceeds, on open account terms.

RISKS SITUATION IN LC
TRANSACTION
FRAUD RISKS
The payment will be obtained for nonexistent or worthless merchandise against
presentation by the beneficiary of forged or falsified documents.
Credit itself may be forged.

RISKS TO THE APPLICANT


Non-delivery of Goods
Short Shipment
Damaged in transit
Foreign exchange
Failure of Bank viz Issuing bank / Collecting Bank

SOVEREIGN AND REGULATORY RISKS


Performance of the Documentary Credit may be prevented by government
action outside the control of the parties.

LEGAL RISKS
Possibility that performance of a Documentary Credit may be disturbed by legal
action relating directly to the parties and their rights and obligations under the
Documentary Credit

FORCE MAJEURE AND FRUSTRATION OF CONTRACT


Performance of a contract including an obligation under a Documentary
Credit relationship is prevented by external factors such as natural disasters
or armed conflicts

RISKS TO THE CONFIRMING BANK


If Confirming Banks main risk is that, once having paid the Beneficiary, it
may not be able to obtain reimbursement from the Issuing Bank because of
insolvency of the Issuing Bank or refusal of the Issuing Bank to reimburse
because of a dispute as to whether or not payment should have been made
under the Credit.

RISKS TO THE ISSUING BANK


Insolvency of the Applicant
Fraud Risk, Sovereign and Regulatory Risk and Legal Risks

RISKS TO THE REIMBURSING BANK


No obligation to reimburse the Claiming Bank unless it has issued a
reimbursement undertaking.

RISKS TO THE BENEFICIARY


Failure to Comply with Credit Conditions
Failure of, or Delays in Payment from, the Issuing Bank
Credit Issued by Party other than Bank

RISKS TO THE ADVISING BANK


The Advising Banks only obligation, if it accepts the Issuing Banks
instructions is to check the apparent authenticity of the Credit and advising
it to the Beneficiary

CONCLUSION
A letter of credit is a method of securing payment to a vendor. When a
seller asks a buyer to obtain a letter of credit, it means the seller would like
to ensure payment for a product he sells to that customer. Typically letters
of credit are issued by a bank. The most common forms are standby letters
of credit for domestic transaction and documentary letters of credit for
international transactions.

APPENDIX(A)
Letter Of Credit: A letter of credit is a document from a bank guaranteeing that
a seller will receive payment in full as long as certain delivery conditions have been met.
In the event that the buyer is unable to make payment on the purchase, the bank will
cover the outstanding amount.

Letter Of Indemnity: It is the document by which two parties to a


misrepresentation against third parties settle their differences in advance should a third
party in the future make a valid claim as a result of the misrepresentation.
request to present these documents to the buyer for payment, indicating

Documentary Credit: The documentary credit is one of the most secure


payment methods in international trade, offering the exporter a conditional payment
guarantee from the importer's bank.
forward documents related to the export of goods to the buyer's bank with a

Irrevocable L/C: An irrevocable letter of credit cannot be changed or


Commercial Invoice : A commercial invoice is a document used in foreign trade. It is
used as a customs declaration provided by the person or corporation that is exporting an
item across international borders.

Deferred Payment: temporary postponement of the payment of an


outstanding bill or debt, usually involving repayment by instalments.
Documentary collection: A process, in which the seller instructs his bank to

Bill Of Lading: A detailed list of a ship's cargo in the form of a receipt given by
cancelled unless everyone involved agrees. Irrevocable letters of credit provide more
security than revocable ones.

Revocable L/C: A revocable letter of credit can be changed or cancelled by the


bank that issued it at any time and for any reason.
Sight Payment: A payment due on demand. An at sight payment will require the party
receiving the good or service to pay a certain sum immediately upon being presented
with the bill of exchange.

APPENDIX(B)

BIBLIOGRAPHY
www.smedia.org
www.wikipedia.org
www.businessdictionary.com

www.investopedia.com

INDEX
Documentary collection
Documentary Credit:
Irrevocable L/C
Issuing Bank
Commercial Invoice
Deferred Payment
Letter of credit:
Letter of Indemnity
Revocable L/C:
Sight Payment