Letter
of credit (L/c) is the most preferred payment
option for exporters. Compared to other payment
options, L/c has many safeguards for sellers and
at the same time assurance for buyers. It is usually
issued by larger banks and contain a promise to
pay a seller (beneficiary) upon receipt of goods
by a buyer if certain conditions outlined in the
letter have been met.
What is Letter of Credit ?
Letter of Credit or (L/c) is a legal document
to arrange payment between a buyer(importer) and
seller (exporter). The bank, as intermediary,
ensures security for both parties, giving the
exporter confidence that the importer is capable
of paying for the goods while assuring the importer
that payment will be made to the exporter only
after the terms outlined in the letter of credit
have been met.
Analysis of typical L/c Transaction
Though a L/c can have great many variations (please
see later part of this article) - for simplicity
and ease of understanding, I have made a simple
step-by-step description of a typical L/c transaction.
- Step 1 After successful negotiation
on price, specification, quality etc, Buyer
selects a seller and places order for specified
goods
- Step 2 Seller accepts the
order
- Step 3 Buyer and Seller agrees
on terms and conditions of the sale. Buyer instructs
its bank to open a L/c incorporating previously
agreed terms of sale
- Step 4 The buyer's bank prepares
a Letter of Credit (L/c), including all instructions
to the seller's bank concerning the shipment
and sends the L/c to the seller's bank, requesting
confirmation. The seller may request confirmation
from a confirming bank for added security.
Note: There are often
delays at above two steps for various reasons
like buyer does not have sufficient funds or
seller requests change in L/c terms. Amendments
are issued to incorporate changes in L/c terms.
- Step 5 The Seller's bank
prepares a letter of confirmation to forward
to the seller along with the L/c. The seller
reviews carefully all conditions in the L/c
specially shipment schedule in consultation
with his freight forwarder.
- Step 6 The seller arranges
the goods and hand over to freight forwarder
for delivery at appropriate port or airport.
- Step 7 Once goods are loaded/shipped,
the forwarder completes necessary documentation
and hand them over to the seller. The seller
then presents the documents to his bank, informing
full compliance with terms and conditions of
L/c.
- Step 8 The seller's bank
reviews the documents. If they are in order,
the documents are airmailed to the buyer's bank
for review and passing necessary documents to
buyer. The buyer gets the documents needed to
claim the goods.
- Step 9 The buyer's bank returns
accepted draft and informs buyer. Buyer pays
bank.
- Step 10 The seller's bank
gets payment and pays seller.
The letter of Credit Ensures that:
Payment to the seller will only be made after
the terms of the L/c have been met. The documents,
which have been reviewed by the bank's experienced
staff, are in order. The seller is assured of
the buyer's ability to pay and, as a result, a
better price and more advantageous terms of payment
may be offered.
Is Letter of Credit 100% Safe for Exporters ?
The answer is - yes and no. Yes, if you follow
all L/c instructions. No, if you overlook certain
pitfalls.
For detail discussion on potential pitfalls in
L/c payment and how to secure your position as
seller - please read following article published
in past issue of FAIDA
Letter of Credit - How to secure your payment
Be aware of potential traps in L/c payment
FAIDA Vol II, Issue 7; July 11' 2001
(please see Related Links below)
Various Kinds of L/c and its Lingo
For information on various kinds of L/c and meaning/implication
of technical terms - please read following article
published in past issue of FAIDA
More on Letter of Credit - Closer look at some
key terminology
FAIDA Vol II, Issue 8; July 18' 2001
(please see Related Links below)
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