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How to Get a Letter of Credit (LC)

A letter of credit is essentially a promissory note from your bank for an exporter. It is used to build trust in business relationships, especially with internal business transactions. For instance, a foreign buyer might apply for a letter of credit from a seller’s bank (applicant) to send to the exporter’s bank (beneficiary).
The two banks in the transaction act as intermediaries, and the letter of credit is the contract used to document the transaction. The letter of credit should also detail document requirements, such as the bill of lading, consular invoice and insurance policy. The letter of credit will also contain an expiration date. All payments must be made and discrepancies resolved, prior to this date. The following will show you how to obtain a letter of credit for your business transactions.
It’s important to remember that a LC is an additional contract dealing with credit between the importer and exporter (also the issuing bank), and it’s separate from the original business contract between the importer and exporter.
Proper LC possesses the following basic components:
1. The Applicant – the party applying for the LC, usually the importer.
2. The Beneficiary – the party in whose favor the LC is issued, usually the exporter.
3. The Issuing Bank – the bank that issues the LC and assumes the obligation to make payment to the beneficiary.
4. Amount – the sum of money, usually expressed as a maximum amount of the credit and defined in a specific currency.
5. Terms – the requirements, including documents that must be met for the collection of the credit.
6. Expiry – the final date for the beneficiary to present against the credit.
The aforesaid are the necessary components of any LC for the credit to become valid, operable instrument.
In addition, LC comes in various forms that define their level of risk. For instance, a revocable LC allows the issuing bank (at the importer’s request) to amend or cancel the credit at any time without the approval of the exporter – it’s the most risky form.
In contrast, an irrevocable LC has terms and conditions that cannot be amended without the expressed consent of ALL parties (the importer, exporter, issuing bank).
Finally, the addition of a commitment by a bank other than issuing bank irrevocable LC honoring the payment of the credit results in a confirmed irrevocable LC provided the exporter meets all the terms and conditions of the credit.

Brief Instructions

    • 1

      Request a letter of credit from your bank. We will assume you are the buyer for the purposes of this article. After you (buyer) agree with the exporter on the terms of the sale, the specifics can be documented in the letter of credit.

    • 2

      Review the irrevocable letter of credit issued by the bank. This will include instructions (bill of lading) to the seller relating to shipment.

    • 3

      Wait for confirmation. Your bank will send the letter of credit to the exporter’s bank requesting confirmation. The exporter’s bank will now prepare a letter of confirmation to forward to the exporter along with the letter of credit.

    • 4

      Await confirmation from the exporter. The exporter will review the letter of credit and contact the freight forwarder to confirm the shipping date as specified in the terms of conditions in the agreement. Arrangements are made to deliver the goods to the appropriate port or airport.

    • 5

      Receive confirmation of goods received from the bank. Once the goods are received from the freight forwarder, your bank will notify you if additional documentation is needed in order to be in full compliance with the letter of credit.

    • 6

      Claim the goods. Once all documentation is in order, you (buyer) can claim the goods. A check (or draft) is then sent to the exporter’s bank from your bank at the time specified. The transaction is complete.

How Does a Letter of Credit (LC) Work?

As soon as the importer and exporter have concluded the a transaction that calls for payment under some form of a LC, the importer makes an application for the credit to the bank that will issue the credit either locally or in other country.
The importer will give the issuing bank instructions that cover some items as below:-
1. The full name, address and contact information of the beneficiary, usually the exporter.
2. A brief description of goods purchase involved, including the quantity, quality and unit price.
3. The method, place and form of shipment, the location of the final destination and other shipping issues e.g. transshipment, partial shipment etc.
4. The full description of the documents required e.g. the period of time after the documents are issued within which they must be presented for payment. In addition, the credit should specify if payment is to be immediate (at sight) or with some degrees of deferment (e.g. 3 days after acceptance).
5. Details of the LC e.g. including the amount (usually expressed as a maximum), the expiry date, how the credit will be made available and the transferability of the credit.
6. The type of credit-the revocable credit, the irrevocable credit or the confirmed irrevocable LC.
Upon approval of the credit application by the issuing bank, the LC is usually advised to the exporter, that is, the bank makes the exporter aware that a LC is opened.
Once the importer and exporter are satisfied that the credit is operable, the exporter ships against the commercial contract and presents the required documents and a draft (the instrument by which the exporter directs the importer to make payment) to the confirming correspondent or issuing bank.
Upon checking the documents for accuracy, the banks passes the documents onto the importer and makes payment against the draft to the exporter.

 

 

Tips & Warnings

  • A letter of credit may be irrevocable and therefore unable to be changed unless both parties agree. A revocable letter of credit is not advised, as it creates more risks for the exporter.
 This video teaches you how to import and use Letters of Credit into Prodoc.
http://www.youtube.com/watch?v=Dmk4S6nsAM0

 

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