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LETTER OF CREDIT

CITD SEMINAR

Tuesday, June 22nd, 2004


Methods of Payment
Methods of Payment
 Cash in Advance

 Letters of Credit L /C

 Documentary
Collection
– Sight/Time Drafts
– aka D/P, D/A

 Open Account
– Risk mitigation:
» Export Credit Insurance
» Standby L/C’s
Cash in Advance
Importer pays Exporter prior to
shipment

Goods

Exporter Importer

 Exporter has no risk of non-payment


or non-acceptance
 Importer has risk that exporter will
not ship the goods as ordered
 Used occasionally for small
amounts, new customers, one-time
sales
Letters of Credit
Protects the interests of both
the Importer and the Exporter

L/C

 Exporter is assured payment


provided terms of L/C are met
 Importer is assured terms of L/C
have been met before she is
required to pay
 Used for larger amounts, higher
credit risks, sometimes mandated
Documentary Collections
Exporter routes documents through
banking channels, where they are
held for payment or acceptance

Exporter Exporter’s Importer’s Importer


Bank Bank

Goods

 Less costly than a L/C and avoids


tying up Importer’s line of credit
 Average of 2 - 4 weeks for
exporter to collect on a sight draft
 Consignment Issues
 Used for lower risk customers
Open Account
Exporter ships goods and bills the
importer for payment at sight or at
a future date

Invoice

Goods
net 30

 Importer has use of funds, no


product risk
 Exporter has risk of non-payment
 Risk can be shifted through credit
insurance, standby L/C’s
 Used for well-established customers
with good credit
Letters of Credit
Types of Letters of Credit
 Trade
– Import
– Export

 Standby
Definition of a Trade
Letter of Credit
 A letter addressed to a beneficiary
(exporter) by a bank (issuing bank)

 wherein the bank undertakes, on


behalf of an applicant (importer)

 to effect payment to the beneficiary


for merchandise shipped or
services performed

 provided that the beneficiary


presents the required documents in
compliance with the terms of the
letter of credit
Documents Common
to an Export L/C
 Commercial Invoice
 Packing List
 Bills of Lading
 Certificate of Origin
 Other Certificates: Quality,
Inspection
 Beneficiary Statements
1. Importer and Exporter
enter into a sales
agreement

Agreement
Exporter Importer
2. Importer applies for a
letter of credit with the
Issuing Bank

Importer

Application

Issuing
Bank
3. Issuing Bank advises
the letter of credit to
U.S. Bank, usually via
SWIFT

L/C

SWIFT

Letter of
Credit
Issuing
U.S. Bank
Bank
and advises L/C to
Beneficiary

Beneficiary

U.S.
Bank
5. Exporter prepares the
documents and ships
the goods

Goods

Exporter Importer

Goods
6. Exporter sends shipping
documents to U.S. Bank for
examination

Exporter

Documents

U.S.
Bank

FBM
7. Assuming clean
documents, U.S. Bank pays
exporter by debiting
Issuing Bank’s account or
upon receipt of funds from
a separate reimbursing
bank. Documents sent to
Issuing Bank.

Exporter

U.S. Documents Issuing


Bank Bank
8. Issuing Bank examines
documents and delivers to
importer against
payment. Importer
takes possession of
goods by presenting
documents.
Importer

Documents

Goods

Issuing
Bank
9. The exporter has been
paid, the importer has
their goods, the banks
have been reimbursed, and
the cycle is complete!
Goods

Exporter Agreement Importer

Letter of
Documents Application Documents
Credit

Letter of
Credit
U.S. Issuing
Documents
Bank Bank
Special Uses of
Letters of Credit
Bankers’ Acceptances
 On a time draft, the bank on
whom the draft is drawn commits
to pay the face amount at
maturity by stamping “Accepted”
across the draft .

 If the exporter wishes early


payment, the accepting bank
may discount the draft and pay
the exporter at sight.

 U.S. Bank can offer you very


competitive rates for BA’s if the
draft is drawn on us!
Standby Letter of Credit
Standby L/C’s are an
irrevocable commitment issued
by a bank for a stated time
period

to pay a beneficiary a stated


amount of money

upon presentation of specified


documents stating that the
applicant did not fulfill their
contractual obligations.
 Transferable Letters of Credit

– Often used by an export


intermediary to pay a vendor or
producer

– The L/C may be transferred only


once, but there may be several
partial ‘transferees’

– Vendor controls presentation of


documents to bank

– Intermediary may substitute his


own invoice and draft, but it still
may be difficult for the vendor
and buyer to remain unknown to
each other
 Assignment of Proceeds

– Similar to Transferable L/C in that it


is commonly used by an export
intermediary to pay a producer or
vendor

– Intermediary (beneficiary) controls


document presentation, not the
vendor, allowing him/her to keep
information on the vendor out of
the paperwork

– Vendor relies on intermediary for


proper presentation / performance
under the terms of the L/C before
funds will be remitted to them
Confirmations of
Export Letters of Credit
 Confirmed - A second bank,
usually in the exporter’s
country, guarantees the
obligation of the issuing bank,
providing an extra layer of
protection - especially
important if the country or the
issuing bank is considered
risky.
More on Confirmations ...
Gives the greatest degree of payment
protection and an immediate
payment source, provided the
documents are clean.

Added cost, normally to the exporter.


 Exporter must instruct the importer
to have the L/C issued with a request
for confirmation.

 The confirming bank makes a credit


decision based on the credit of the
issuing bank and the country risk.
Approval will depend also on
availability under an established line
of credit.
Adding a confirmation or
engagement to purchase
documents:
Goods

Exporter Agreement Importer

Letter of
Credit Application Documents

Documents

Letter of
Advising Credit
Issuing
Bank Bank
Confirm. Documents
Bank
Benefits of Letters of Credit
To the Exporter: To the Importer:
 Payment  Documentary
protection evidence that the
 Reliance on ordered goods
issuing bank’s have been
credit rather than shipped on time
buyer’s  Assurance that
 Rapid, local necessary
source of clearance
repayment, if documents will
payable at a U.S. be provided
bank  Payment deferred
until goods are
shipped and
documents
presented (use of
funds)