Letter of credit slide share_

Letter Of Credit
Letter Of Credit

Definition
Definition
 A document issued by a financial institution
A document issued by a financial institution
on behalf of a buyer stating the amount of
on behalf of a buyer stating the amount of
credit the buyer has available, and that the
credit the buyer has available, and that the
institution will honor drafts up to that amount
institution will honor drafts up to that amount
written by the buyer. It gives the buyer the
written by the buyer. It gives the buyer the
prestige and financial backing of the issuing
prestige and financial backing of the issuing
institution and satisfies the requirements of
institution and satisfies the requirements of
the seller in completing the transaction. The
the seller in completing the transaction. The
accepting institution has a prior agreement as
accepting institution has a prior agreement as
to how the buyer will pay for the drafts as
to how the buyer will pay for the drafts as
they are presented.
they are presented.
 A commitment, usually by a bank on behalf of
A commitment, usually by a bank on behalf of
a client, to pay a beneficiary a stated amount
a client, to pay a beneficiary a stated amount
of money under specified conditions.
of money under specified conditions.

Parties involved in LC transaction
Parties involved in LC transaction
 The
The Applicant
Applicant is the party that arranges for
is the party that arranges for
the letter of credit to be issued.
the letter of credit to be issued.
 The
The Beneficiary
Beneficiary is the party named in the
is the party named in the
letter of credit in whose favor the letter of
letter of credit in whose favor the letter of
credit is issued.
credit is issued.
 The
The Issuing or Opening Bank
Issuing or Opening Bank is the
is the
applicant’s bank that issues or opens the
applicant’s bank that issues or opens the
letter of credit in favor of the beneficiary and
letter of credit in favor of the beneficiary and
substitutes its creditworthiness for that of the
substitutes its creditworthiness for that of the
applicant.
applicant.

Parties involved in LC transaction (Contd..)
Parties involved in LC transaction (Contd..)
 An
An Advising Bank
Advising Bank may be named in the letter of
may be named in the letter of
credit to advise the beneficiary that the letter of
credit to advise the beneficiary that the letter of
credit was issued. The role of the Advising Bank is
credit was issued. The role of the Advising Bank is
limited to establish apparent authenticity of the
limited to establish apparent authenticity of the
credit, which it advises.
credit, which it advises.
 The
The Paying Bank
Paying Bank is the bank nominated in the
is the bank nominated in the
letter of credit that makes payment to the
letter of credit that makes payment to the
beneficiary, after determining that documents
beneficiary, after determining that documents
conform, and upon receipt of funds from the issuing
conform, and upon receipt of funds from the issuing
bank or another intermediary bank nominated by the
bank or another intermediary bank nominated by the
issuing bank.
issuing bank.
 The
The Confirming Bank
Confirming Bank is the bank, which, under
is the bank, which, under
instruction from the issuing bank, substitutes its
instruction from the issuing bank, substitutes its
creditworthiness for that of the issuing bank. It
creditworthiness for that of the issuing bank. It
ultimately assumes the issuing bank’s commitment to
ultimately assumes the issuing bank’s commitment to
pay.
pay.

Letter of Credit Process
Letter of Credit Process

Commercial Letter of Credit Flow
1.
1. Applicant approaches Issuing/ Opening Bank with
Applicant approaches Issuing/ Opening Bank with
LC application form duly filled and requests Issuing
LC application form duly filled and requests Issuing
Bank to issue a Letter of Credit in favour of
Bank to issue a Letter of Credit in favour of
Beneficiary.
Beneficiary.
2.
2. Issuing Bank issues a Letter of Credit as per the
Issuing Bank issues a Letter of Credit as per the
application submitted by an Applicant and sends it
application submitted by an Applicant and sends it
to the Advising Bank, which is located in
to the Advising Bank, which is located in
Beneficiary’s country, to formally advise the LC to
Beneficiary’s country, to formally advise the LC to
the beneficiary.
the beneficiary.
3.
3. Advising Bank advises the LC to the Beneficiary.
Advising Bank advises the LC to the Beneficiary.
4.
4. Once Beneficiary receives the LC and if it suits his/
Once Beneficiary receives the LC and if it suits his/
her requirements, he/ she prepares the goods and
her requirements, he/ she prepares the goods and
hands over them to the carrier for dispatching to
hands over them to the carrier for dispatching to
the Applicant.
the Applicant.
5.
5. He/ She then hands over the documents along with
He/ She then hands over the documents along with
the Transport Document as per LC to the
the Transport Document as per LC to the
Negotiating Bank to be forwarded to the Issuing
Negotiating Bank to be forwarded to the Issuing
Bank.
Bank.

(Contd..)
(Contd..)
6. Issuing Bank reimburses the Negotiating Bank with
6. Issuing Bank reimburses the Negotiating Bank with
the amount of the LC post Negotiating Bank’s
the amount of the LC post Negotiating Bank’s
confirmation that they have negotiated the
confirmation that they have negotiated the
documents in strict conformity of the LC terms.
documents in strict conformity of the LC terms.
Negotiating Bank makes the payment to the
Negotiating Bank makes the payment to the
Beneficiary.
Beneficiary.
7. Simultaneously, the Negotiating Bank forwards the
7. Simultaneously, the Negotiating Bank forwards the
documents to the Issuing Bank to be released to the
documents to the Issuing Bank to be released to the
Applicant to claim the goods from the carrier.
Applicant to claim the goods from the carrier.
8. Applicant reimburses the Issuing Bank for the
8. Applicant reimburses the Issuing Bank for the
amount, which it had paid to the Negotiating Bank.
amount, which it had paid to the Negotiating Bank.
9. Issuing Bank releases all documents along with the
9. Issuing Bank releases all documents along with the
titled Transport Documents to the Applicant.
titled Transport Documents to the Applicant.

Types of Letters of Credit
Types of Letters of Credit
 Revocable
Revocable
 Irrevocable
Irrevocable
 Unconfirmed
Unconfirmed
 Confirmed
Confirmed
 Transferable
Transferable
 Assignment of Proceeds
Assignment of Proceeds
 Revolving
Revolving
 Standby
Standby

Settlements Under a Letter of
Settlements Under a Letter of
Credit
Credit
 All commercial letters of credit must
All commercial letters of credit must
clearly indicate whether they are
clearly indicate whether they are
payable by sight payment, by deferred
payable by sight payment, by deferred
payment, by acceptance, or by
payment, by acceptance, or by
negotiation. These are noted as formal
negotiation. These are noted as formal
demands under the terms of the
demands under the terms of the
commercial letter of credit.
commercial letter of credit.

Settlements Under a Letter of Credit (Contd..)
Settlements Under a Letter of Credit (Contd..)
 In a
In a sight payment
sight payment, the commercial letter
, the commercial letter
of credit is payable when the beneficiary
of credit is payable when the beneficiary
presents the complying documents and if the
presents the complying documents and if the
presentation takes place on or before the
presentation takes place on or before the
expiration of the commercial letter of credit.
expiration of the commercial letter of credit.
 In a
In a deferred payment
deferred payment, the commercial
, the commercial
letter of credit is payable on a specified future
letter of credit is payable on a specified future
date. The beneficiary may present the
date. The beneficiary may present the
complying documents at an earlier date, but
complying documents at an earlier date, but
the commercial letter of credit is payable only
the commercial letter of credit is payable only
on the specified future date.
on the specified future date.

Settlements Under a Letter of Credit
Settlements Under a Letter of Credit
(Contd..)
(Contd..)
 An
An acceptance
acceptance is a time draft drawn on, and
is a time draft drawn on, and
accepted by, a banking institution, which promises to
accepted by, a banking institution, which promises to
honor the draft at a specified future date. The act of
honor the draft at a specified future date. The act of
acceptance is without recourse as it is a commitment
acceptance is without recourse as it is a commitment
to pay the face amount of the accepted draft.
to pay the face amount of the accepted draft.
 Under negotiation, the
Under negotiation, the negotiating bank
negotiating bank, a third
, a third
party negotiator, expedites payment to the
party negotiator, expedites payment to the
beneficiary upon the beneficiary’s presentation of the
beneficiary upon the beneficiary’s presentation of the
complying documents to the negotiating bank. The
complying documents to the negotiating bank. The
bank pays the beneficiary, normally at a discount of
bank pays the beneficiary, normally at a discount of
the face amount of the value of the documents, and
the face amount of the value of the documents, and
then presents the complying documents, including a
then presents the complying documents, including a
sight or time draft, to the issuing bank to receive full
sight or time draft, to the issuing bank to receive full
payment at sight or at a specified future date.
payment at sight or at a specified future date.

Advantages of Letter of Credit
Advantages of Letter of Credit
1.
1. The beneficiary is assured of payment as
The beneficiary is assured of payment as
long as it complies with the terms and
long as it complies with the terms and
conditions of the letter of credit.
conditions of the letter of credit.
2.
2. The credit risk is transferred from the
The credit risk is transferred from the
applicant to the issuing bank.
applicant to the issuing bank.
3. The beneficiary minimizes collection time as
3. The beneficiary minimizes collection time as
the letter of credit accelerates payment of
the letter of credit accelerates payment of
the receivables.
the receivables.
4. The beneficiary’s foreign exchange risk is
4. The beneficiary’s foreign exchange risk is
eliminated with a letter of credit issued in
eliminated with a letter of credit issued in
the currency of the beneficiary’s country.
the currency of the beneficiary’s country.

Risks involved
Risks involved
1. Since all the parties involved in Letter of Credit deal
1. Since all the parties involved in Letter of Credit deal
with the documents and not with the goods, the risk
with the documents and not with the goods, the risk
of Beneficiary not shipping goods as mentioned in
of Beneficiary not shipping goods as mentioned in
the LC is still persists.
the LC is still persists.
2. The Letter of Credit as a payment method is costlier
2. The Letter of Credit as a payment method is costlier
than other methods of payment such as Open
than other methods of payment such as Open
Account or Collection
Account or Collection
3. The Beneficiary’s documents must comply with the
3. The Beneficiary’s documents must comply with the
terms and conditions of the Letter of Credit for
terms and conditions of the Letter of Credit for
Issuing Bank to make the payment.
Issuing Bank to make the payment.
4. The Beneficiary is exposed to the Commercial risk on
4. The Beneficiary is exposed to the Commercial risk on
Issuing Bank, Political risk on the Issuing Bank’s
Issuing Bank, Political risk on the Issuing Bank’s
country and Foreign Exchange Risk in case of Usance
country and Foreign Exchange Risk in case of Usance
Letter of Credits.
Letter of Credits.

Reference
Reference
 (http://www.teachmefinance.com/Financial_Terms/le
(http://www.teachmefinance.com/Financial_Terms/le
tter_of_credit.html)
tter_of_credit.html)
 http://en.wikiversity.org/wiki/Letters_of_Credit/Resou
http://en.wikiversity.org/wiki/Letters_of_Credit/Resou
rces
rces.
.
 International Trade:Financial Services for Importers
International Trade:Financial Services for Importers
and Exporters, JP Morgan/Chase Bank, 2000.
and Exporters, JP Morgan/Chase Bank, 2000.
 Financial management By Prasanna chandra
Financial management By Prasanna chandra
 International financial management By VK.Bhalla
International financial management By VK.Bhalla
 Fundamentals of corporate finance By Ross
Fundamentals of corporate finance By Ross
Westerfield Jordan
Westerfield Jordan

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