Letter of Credit - Frequently Asked Questions & Answers
Here are some of the most commonly asked questions and answers on letters of credit:
1. What is a Letter of Credit?
A letter of credit is a legal written document issued by the importer/buyer’s bank in the favor of the exporter/seller to assure that the seller would be paid on-time by the buyer for their delivered goods & services. In the event of buyer defaults in fulfilling the terms & conditions of the contract or paying a certain amount in an ongoing trade transaction, the issuing bank will make the payment to the exporter. To put it in simple words, it serves as a commitment of guaranteed payment from the buyer to the seller.
2. Types of Letters Of Credit
1. Standby Letter of Credit (SBLC)
2. Credit on Sight LC
3. Time credit LC
4. Revocable and Irrevocable LC
5. Transferable and non-transferable LC
6. Usance Letter of Credit
7. Confirmed and Unconfirmed LC
8. Back to Back LC
9. Red Clause LC
10. Green Clause LC
11. Commercial Letter of Credit
12. Export/Import LC
13. Revolving Bank Credit Letter
14. Traveler's Letter of Credit
15. Time Credit/Acceptance Credit
3. Is the LC and Bank Guarantee the same?
A Letter of credit is a legal guarantee from a bank or financial institution regarding on-time payment to the exporter in the event of the buyer’s failure to perform terms & conditions or pay a certain amount for delivered goods & services.
A bank guarantee is a commercial instrument where the bank only pays the amount if the buyer does not fulfill the contractual obligations mentioned in the contract. To know more check out our detailed blog on "What is the difference between bank guarantee and letter of credit?"
4. How does a Letter of Credit work?
1. The applicant or buyer/importer applies to the issuing bank to issue an documentary credit (LC) in favor of the exporter/seller/supplier.
2. The advisory bank (exporter’s bank) receives the letter of credit issued by the issuing bank and further forwards it to the seller after checking the authenticity of the letter of credit.
3. The seller ships the goods as per the details mentioned in the contract and receives a bill of lading as evidence of shipped goods.
4. The seller now presents the bill of lading to the nominated or negotiating bank. After checking whether the goods were delivered as per the requirements, the bank pays the seller.
5. Now the negotiating bank forwards the shipping documents to the issuing bank to release the payment.
6. The issuing bank sends the shipping documents to the buyer and verifies the information for seeking approval.
7. The buyer makes the payment to the issuing bank and the bank further sends the payment to the negotiating bank.
5. Parties Involved In Letter Of Credit
1. Applicant/Buyer/Importer - Who purchases the goods or services and applies for documentary credit (LC).
2. Issuing Bank - Who issues documentary credit.
3. Beneficiary/Seller/Exporter - It is the person in the favor of whom a letter of credit is issued.
4. Advising Bank - It is also known as an exporter’s bank
5. Nominated Bank - An International bank in the exporter’s country to receive the documents.
6. Confirming Bank - The bank which provides an additional guarantee to the undertaking of the issuing bank.
7. Reimbursing Bank - It is the bank where the paying account is set up by the issuing bank.
8. Second Beneficiary - Who represents the original beneficiary in their absence.
6. What are the benefits of a Letter of Credit?
There are many benefits of availing letter of credit services some of them are here as follows
1. Serves as a credit certificate for the buyer
2. On-time payment to the seller.
3. A safe platform to expand overseas business
4. It can be customized as per the parties’ needs.
5. Shifts risk from the buyer to the issuing bank
6. Seller receives money on fulfilling terms
7. Involves a legal guarantor, thus the payment is secured.
7. Which types of risks are there in letters of credit?
1. Delayed payment or no payment
2. Non-delivery of ordered goods and services
3. Receipt of low-quality goods
4. Exchange rate of goods
5. Risks of change in foreign exchange rates
6. Fraud altering due to the flexible Bank Credit Letters
8. What are the bank’s charges for letters of credit?
The bank’s charges or interest rates for letters of credit can vary depending on the type, size, volume, or nature of the business as well as the buyer’s relationship with the bank, financial stability or types of goods, etc.
9. How Long Does It Take To Get A Letter of Credit?
The period to get a bank credit letter depends on the issuing bank that is offering the loan. Generally, the process takes approx 10-15 working days or it can extend to some more days in getting approval from the bank.
10. What documents are required to open a letter of credit?
1. Bill of Exchange
2. Bill of lading
3. Air waybill/Road/Rail transport documents etc.
4. Health and Insurance certificates
5. Certificate of origin
6. Commercial invoice
7. Packing list or inspection certificate
8. Importer’s financial documents
9. Certificate of inception etc.
11. What are the features of letters of credit?
1. Issued against collateral that may include importer’s fixed deposit and bank deposits etc as security.
2. Bank charges certain fees depending on the type of bank credit letter(LC)
3. Rules & regulations are issued by the International Chambers of Commerce (ICC).
4. The details of letters of credit must include the name of supplier, date, amount, product name and quantity, etc.
5. Banks can deny the payment if there are any mistakes in the details of LCs
12. Is a letter of credit a loan?
The loan is a lump sum amount that needs to be repaid in a pre-decided period while a documentary credit is a credit or loan limit issued by a bank to the buyer with an option of withdrawing small amounts from the total issued limit. Moreover, LCs involve a guarantor ie. Bank.
Recommended Read: Letter of Credit Guide
13. What is a letter of credit with an example?
Let’s assume, a Company XYZ purchases the goods worth $100,000 from an overseas supplier called Company ABC. On the demand of ABC, the Company XYZ approaches its Bank for issuing bank credit letters in the favor of ABC. After shipping goods, the Company ABC asks for the payment of $100,000 from XYZ’s bank by presenting shipping documents. The XYZ’s Bank pays company ABC, it turns out to Company XYZ to reimburse the issuing bank.
14. Who issues a letter of credit?
A letter of credit also known as documentary credit is a legal undertaking issued by an importer’s bank or a private institution to ensure timely and full payment to the exporter. If the importer defaults, it is reimbursed by the issuing bank.
15. What are LC terms of payment?
A documentary credit is a payment term, also known as a payment guarantee letter as it backs an international transaction with the involvement of a legal authority like Banks or Private financial institutions for both importers and exporters.
16. Who pays for a letter of credit?
Generally, both the parties to the contract i.e. Importers and Exporters pay for the charges of letter of credit. The charges include a pre-described percentage of the invoice value underwritten which can be from 0.1% to 2.0% of the commercial invoice value per month.
17. What is the cost of a letter of credit?
The lenders charge generally 2 percent along with the documentation fees which need to be paid by the borrower at closing or 2.5% for amounts below $50,000 in case of Standby LCs.
18.What is the LC limit?
The working capital limit for a bank credit letter agreement is decided based on the yearly consumption of raw material to be purchased. Bank verifies the sources of funds with the customer for the retirement of LC opened for buying capital goods.
19. What is LC 90 Days?
Issuance of a letter of credit can be LC 90 days, LC 60 days, or more rarely, LC 30 days. It simply stands for the funds promised in the bank credit letter (LC) are due in 90, 60, or 30 days.
20. What is LC 30 days?
LC 30 days means that the funds of bank credit letter (LC) are payable 30 days after BL. If the BL date is 1 June, the payment will be done on 1 July.
21. How can you tell a fake letter of credit?
You need to make sure that the LC agreement consists of the Date of Issue. It also includes flexibility to make shipment before the latest date of shipment, presentation of documents before the expiry date of documentary credit(LC), and verification of expiry location of bank credit letter.
22. What is LC opening?
A letter of credit is opened by the buyer’s bank at the request of the buyer.
23. Is a Letter of Credit Safe?
A letter of credit is a safe, reliable, and trustworthy trade finance instrument for both sellers and buyers. In case of the buyer defaults, the bank pays the seller. On the other hand, the buyer is assured of releasing payment to the seller only after fulfilling terms & conditions.
24. How do I get a bank letter of credit?
You need to contact your bank for the issuance of an LC. Or you can also approach private financial institutions offering these types of services.
25. Why do I need a letter of credit?
Letters of credit are essential payment guarantee letters for international transactions since they ensure exporters that the payment will be received on-time. It reduces the associated risk of non-payment for the delivered goods.
26. What is the difference between TT and LC?
LC means documentary credit, an instruction from the applicant to the issuing bank for paying the seller a sum of money after certain conditions are fulfilled. TT stands for Telegraphic Transfer, Telex Transfer or Wire Transfer, the transfer of funds from one bank account to another by electronic modes.
27. What is the LC expiry date?
The LC expiry date refers to the last date of submitting the exported documents with the bank for negotiation.
28. What is LC discounting?
It is a short-term credit facility provided by the bank to the seller after confirming the original documents.
29. How do I cancel my LC?
According to the rules of the documentary credit, it should be issued in an irrevocable form so that it cannot be canceled without the consent of the beneficiary.
30. Can a letter of credit be used as collateral?
Yes. A letter of credit is used as collateral by the seller on a loan or purchase.