Importance of Letter of Credit in Export l business

Published On: Sun, Oct 09, 2022

Importance of Letter of Credit in Export l business-featured-image

It is very important to give credit  payment terms to a buyer for any successful business.  Buyer expects maximum credit period for making payment.  As in  local trader in International business also most of the transactions are confirmed under “Credit Payment Terms’.  In this case the exporter is going to face huge financial loss if the buyer does not  make payment.  Here comes the importance of Letter of Credit.

Letter of Credit  of credit is a guarantee  from buyer’s bank to an exporter  guaranteeing payment against an exports if the exporter fulfils the terms and conditions stipulated in the Letter of Credit. Hence most of the international business are finalized in the credit payment terms against a Letter of credit. In the beginning each and every bank put the terms and conditions in the Letter of credit as per their convenience and interest. So bank officers all over the world find it very difficult to understand and negotiate documents under a letter of credit. Hence the need for  uniformity in the letter of credit terms and conditions come under discussion and finally Uniform Customs and Practice for Documentary credit (UCP 500)  a standardized form for Letter of Credit come into practice with effect from the year 1994. It is followed by banks all over the world now.

In India most of the public sector banks and leading commercial banks deals with letter of credit transactions. These banks who deals in international business are known as authorized dealers as they have permission from RBI for dealing in foreign exchange. Eg:- State Bank of India ;Bank of India . South Indian Bank ; Federal Bank etc.

At Guiders Education we teach our students in detail about what is a letter of credit and how to understand various types of Letter of Credits and prepare export documents as per letter of credit.

A Letter of Credit  protect interest of both buyer and seller. For an exporter it guarantees the payment and for an importer it guarantees the right quality and quantity of goods are shipped in right time.

A letter of credit contains documentary terms and conditions on par with Purchase contract between the exporter and the importer.  A letter of credit can be paid At Sight, or at a later date as confirmed during the negotiation of Order between exporter and importer and which is mentioned on the letter of credit like ”At 30  days from acceptance “(time draft), or” 30 days from the B/L Date”(Date draft).

Now let us discuss the parties involved in a Letter of Credit

Parties of a Letter of Credit:-

  1. Applicant:-  The overseas buyer  is one who applies to his bank for opening a L/C and hence called applicant in a L/C transaction.
  2. Beneficiary:-  The exporter who gets the benefit of a L/C (payment) is called beneficiary in a L/c.
  3. Issuing Bank:-  The importer’s bank who opens the L/c is called issuing bank.
  4. Advising Bank:-  A n advising bank is the branch of issuing bank in exporter’s country or a bank representing issuing bank in exporter’s country  which intimates the beneficiary about L/C.
  5. Confirming bank:- A confirming  bank is a bank in exporter’s country which adds its promise to pay to that of a foreign bank or issuing bank. A  L/C which is not confirmed are advised through a local bank are called advised letter of credit.

Next we will discuss various types of Letter of credits.

Types of Letter of Credit:-

  1. Revocable Letter of Credit

A revocable Letter of credit can be amended or cancelled by the issuing bank at any time without consent of the beneficiary at the request or instruction of the applicant. There is no security of payment in a revocable letter of credit. The words “ This credit is subject to cancellation without the notice” or “Revocable credit” or “revocable documentary credit” are usually indicated on the L/C.

  1. Irrevocable Lettter of credit:-

An irrevocable letter of credit cannot be amended or cancelled without the consent of the issuing bank, confirming bank if any and the beneficiary. The payment is guaranteed by the bank if the credit terms and conditions are fully met by the beneficiary. The words “Irrevocable documentary credit” or “Irrevocable credit”may be indicatedin the L/C.

  1. Confirmed Irrevocable Letter of Credit:-

An irrevocable letter of credit opened by an issuing bank whose authenticity has been confirmed by the advising bank or any local banks in beneficiary country is known as Confirmed Irrevocable Letter of Credit . Thewords “We confirm the credit and hereby undertake…. Or “We add our confirmation to this credit and hereby undertake…” normally are included in the L/C. In aconfirmed letter of credt, the exporter or the importer pays an extra charge called the confirmation fee which my vary from bank to bank. It may written on the L/c that the confirmation fee and other charges outside the seller’s country are on the buyer’s account.

  1. Unconfirmed Irrevocable Letter of Credit:-

An irrevocable letter of credit opened by a foreign bank which is not confirmed by advising bank or a local bank in beneficiary country is known as unconfirmed irrevocable letter of credit.

  1. Restricted Negotiable Letter of Credit:-

In a restricted negotiable letter of credit, the negotiation of the shipping documents and payment to the beneficiary is restricted to a specific nominated bank by the issuing bank.

  1. Freely Negotaible Letter of Credit:-

In a freely Negotiable Letter of credit, the authorization from the issuing bank to negotiate the shipping documents and making payment to the beneficiary is not restricted to aspecific bank.

  1. Revolving Letter of credit:-

When a L/C used for multiple shipments within an year by enhancing the amount and and extending the validity period it is known as a revolving L/C. This types of L/Cs are used for usedfor multiple range of goods to a buyer in an years time.

A letter of credit gives confidence for an exporter about receiving payment against an exports and for buyer it gives confidence about the quality ; quantity and timely shipment of  his Ordered goods.

A student of Guiders academy ,after the completion of  the diploma course in Shipping and Logistics Management would be confident about handling various documentations and procedures involved in international business and it helps him or her to get placements in leading organizations.