Letter of credit (Documentary Credit) refers to a written undertaking made by the importer’s bank to the exporter that the payment shall be made to him provided the shipment is sent by him in strict compliance with the term and conditions of the export contact. The terms and conditions of the export contact from part of the letter of credit and are known as the terms and condition of the letter of the credit.
The essential characteristic of the letter of credit is that it relies on the doctrine of the strict compliance for release for payment to the exporter against the draft (s) drawn by him. The banks do not deal in goods; they deal in document. As such, the importer has to specify to the bank the document which it should examine as an evidence to the effect that the exporter has sent the shipment in strict compliance with the terms and conditions of the exporter contact.
Contents of Letter of Credit
A letter of credit generally contains the following information:
1. Complete and correct name and address of the beneficiary i.e., the exporter.
2. Complete and correct name and address of the applicant i.e., importer
3. Type of the letter of credit/documentary credit.
4. Amount of letter of credit.
5. How the credit shall be available e.g., by payment, deferred payment, acceptance or negotiation.
6. The name of the drawee of the draft and the tenor of the draft.
7. Description of goods, quantity of the items and the unit price.
8. List of document required to be submitted by the beneficiary.
9. Port of discharge and the place of final destination.
10. Term of delivery i.e., FOB, CFR, CIF etc.
11. Status of transhipment i.e., whether allowed or not.
12. Status of partial shipment i.e., whether allowed or not.
13. The last date of sending shipment.
14. Time period for the presentation of documents for the negotiation by the beneficiary after the dispatch of the shipment.
15. The date and place of expiry of the letter of the credit.
16. Transfer of the letter of credit allowed or not.
17. Mode of advice of the letter of credit i.e., by mail or teletransmission.
Precaution taken by the beneficiary on receipt of letter of Credit
An exporter should scrutinize the letter of credit carefully before proceeding to execute the export order. He should examine the following point to insure that:
1. The letter of credit appears to be valid letter of credit. He can consult his banker for this purpose.
2. The type of letter of credits and its term and conditions are as per the agreed term and the condition of the export contract.
3. All the term and condition are acceptable and can be complied with. It should be ensure that the letter of the credit does not include any condition that is unacceptable or cannot be compiled with.
4. The documents required under the Letter of credit can be obtained and represented for negotiation.
5. The description of the goods, quantity and the unit price are as per the export contact.
6. There is no clause in the letter of credit that requires payment of cost or charges not agreed to with the importer.
7. The last date for sending shipment and the time allowed for the presentation of the documents are acceptable.
8. The port of loading and the port of discharge are as per the export contact.
9. The responsibility for the insurance of the goods has been clearly stated.
Kinds Of Letter Of Credit
There are various kinds of letter of credit depending upon the features added to it as desired by applicant. The different kinds of the Letter of credit are as follows:
1. Sight or Usance letter of credit
2. Confirmed or unconfirmed letter of credit
3. Negotiable letter of credit
4. Revolving letter of credit
5. Red clause letter of credit
6. Green clause letter of credit
7. Transferable letter of credit
8. Back to back letter of credit
9. With recourse or without recourse letter of credit
10. Standby letter of credit
Settlement Of Payment Under Letter Of Credit
The procedure for the settlement of payment against the export shipment sent under a letter of credit depends upon the payment mode stated in the letter of credit. Generally, the sequence of steps involved in this procedure in as follows:
1. The beneficiary (exporter) sends the shipment as per the terms and conditions of the credit.
2. The exporter collects the required set of documents and draws the bill of exchange as per the requirements of the credit.
3. The set of documents as stated in (2) above are presented by the exporter to his bank, called beneficiary’s bank.
4. The beneficiary’s bank forwards these documents to the issuing bank
5. The issuing bank scrutinizes the documents and if the same are found to be non discrepant, then it sends the remittance to the beneficiary’s bank for its onward credit to the beneficiary. But in case the documents are found to be discrepant then the issuing bank may approach the applicant to decide the course of action it would take in regard to the discrepant set of documents. The possible options are rejection of documents; ignoring the discrepancies and making payment to the beneficiary or sending documents to the beneficiary for removal of the discrepancies. The issuing bank would follow one of the options as desired by the applicant.
Advantages of letter of credit
Letter of credit is beneficial to both the exporter and the importer as it facilitates the conduct of export-import transaction. The various benefits of letter of credit are as follows:
1. The exporter is assured of payment as there is a written promise by the importer’s bank to make the payment if the shipment is sent in strict compliance of the terms and conditions of the letter of credit.
2. The exporter is able to obtain advance from the bank to finance the credit needs to send the shipment.
3. The importer can negotiate a lower price for the goods and deferred payment terms by offering payment against letter of credit as desired by the exporter.
4. The letter of credit eliminates the commercial risk to payment since the payment is assured by the bank which has opened the irrevocable letter of credit. The payment to the exporter is not affected by the willingness and capability of the buyer to make the payment.
5. The letter of credit mode of payment enables the importers to expand the sources of supply because the exporters are always willing to supply goods against the letter of credit.