Letter of Credit Issuance Process - An Important Trade Finance Instrument
What Is A Letter Of Credit?
To put it simply, a letter of credit is a piece of document issued in an international transaction by an importer’s bank to guarantee an on-time payment to the exporter. Also known as Documentary credit, here the issuing bank promises to pay the exporter in the event the importer fails to pay or perform the Terms & Conditions of an LC agreement.
It acts as proof of the buyer’s creditworthiness to the exporter.
It assures exporters that they would get paid even if the buyer is incapable.
It transfers the risk of payment to the bank.
The issuing bank can deny the payment if anything suspicious is found in the data provided by the buyer.
What Type Of Letter Of Credit Can I Apply For?
A letter of credit is an important instrument in international trade finance being used to ease foreign payments and transactions among both importers & exporters. Looking at its importance, today banks & financial institutions are offering various types of LCs to ease foreign trade transactions.
Here they are as follows:
Irrevocable Bank Credit
Confirmed Letter of Credit
Back-to-Back Bank Credit Letter (LC)
Red Clause Payment guarantee letter
Non-transferable Payment guarantee letter
To know about these types in detail, go to our guide to Different Types of Letters of Credit. Read about them carefully and choose the most appropriate one according to your requirements.
How Does A Letter Of Credit Work?
An LC is used to minimize risks in international transactions among buyers & sellers who don’t know each other or are governed by different geographical, legal, or political rules & regulations. If you are also an importer looking for a letter of credit to request a purchase order, here is how you can apply for it:
An importer or buyer approaches his/her bank and requests to issue an LC in the favor of the exporter. The bank is known as an opening or issuing bank.
As the next step, the LC is sent to the advising bank (exporter’s bank) by the issuing bank to verify the authenticity of the letter such as name, product details, date & time of payment, etc.
Once the advising bank is satisfied, it forwards the LC to the exporter assuring him to initiate the shipment of goods.
After receiving LC, the exporter ships the ordered goods as per the details mentioned by the buyer in the documentary credit. The seller issues the Bill of Lading to its bank as proof of shipment of goods.
The advising bank checks the Bill of Lading and sends it to the issuing bank to request payment.
The issuing bank verifies if all the Terms & Conditions have been met by the exporter. After getting satisfied, it obtains payment from the buyer and sends it to the exporter.
Check out our detailed guide to Letter of Credit and get the desired solution for your every related query.
Take an example:
ABC Ltd requests a purchase order to XYZ Ltd through the issuance of LC.
For this, ABC approaches its bank and gets an LC issued in the favor of XYZ after completing all the PR (Purchase Requisition) & PO (Purchase Order) requirements.
After receiving LC, XYZ Ltd ships the goods and presents documents to its bank ie Advising bank.
Advising bank sends it to ABC’s bank requesting payment. ABC releases the payment and transfers it to XYZ's bank.
Is A Bank Guarantee & Letter Of Credit The Same?
Many traders dealing in international transactions often believe a BG and an LC to be the same but it's not. So, what is the difference? The main difference is that in a documentary credit, the issuing bank will compensate the exporter if the importer defaults. But in the case of BG, the bank will pay the seller if the transaction is not going as per plan.
Let’s understand the Difference Between a Bank Guarantee And a LC in a better way with our detailed blog.
How To Apply For A Letter Of Credit From Emerio Banque?
You will be glad to know that Emerio Banque follows a digital path and accepts all the queries related to the issuance of letters of credit online.
Here is the step-by-step guide:
User Requests for PR - When an importer & exporter agree to trade together through an LC, the importer/user goes to our official site and makes a Purchase Request.
PO is Generated - Concerning PR, a PO ie. Purchase Order is generated by the user concerning all the details and Terms & Conditions such as Freight, Types of Goods, Mode of Payment, Date & Time of Payment, Custom Duty, etc.
LC Request - Upon completion of PO, the next step is to send us an LC request in the favor of the seller with all the information. Now an LC Request is created in our system with a transaction no. ###############
Opening of LC -After receiving LC, we generate the LC number with the start & end date of it. Users are free to edit the information mentioned in our LC opening through the transaction number. (Transaction numbers are the unique keys that show a financial transaction within a company code).
Acceptance is Granted - When the acceptance of LC is granted, users can change the status from draft to accept. Keep one thing in mind the payment date can be changed but before the settlement.
LC is Settled -After receiving the LC, exporters are expected to ship the goods and deliver the Bill of Lading to their bank to further forward it to the importer’s bank. The importer then releases the payment to the exporter as per the date & time mentioned in the LC agreement. By using a transaction number, the users can settle the LC after acceptance.
Settlement of Payment - On the date of payment, a particular account entry is generated in our system under accrued liability account/contingent liability followed by an entry for acceptance of payment.
Foreign Vendor Invoice is Generated - Users now Enter Incoming Invoices concerning the Purchase Order.
Foreign Vendor Is Paid - As the next step, the users now enter Post with Clearing in our online process to settle the vendor’s payment from the treasury partner bank account.
Payment to Bank A/C - For Credit Management or Post Payment, users now use the code.
Stock In Transit Is Recorded - By using the respective code, users can book the stock in transit in our system.
Local Vendors Are Paid/Goods Receipt - The process ends with paying all the charges of import in the import’s country and receiving goods as per the standards.
Want to apply for a letter of credit with Emerio Banque, send your query now!!
A letter of credit is a safer option for exporters in case the importer goes bankrupt or defaults in paying. Since the risk of payment is transferred to the bank, the exporter can freely ship the goods and conduct a trade worldwide.