LETTER OF CREDIT & ITS TYPES

Compiled by :-SHAHADAT HOSEN CHOWDHURY

QUALITEX INDUSTRIES (BD) LTD.

What is letter of credit ?

A letter of credit (L/C) is a signed instrument embodying an undertaking by the banker of a buyer to pay a certain sum of money to his seller on presentation of documents evidencing shipment of specified goods subject to compliance with the stipulated terms and conditions.

Parties involved in letter of credit

Seller or a beneficiary who is to receive moneyBuyerIssuing Bank, whom the buyer is a client, andAdvising bank, whom the seller is a client.

How letter of credit works?

Types of Letter of creditIrrevocable versus Revocable L/C Confirmed Irrevocable versusUnconfirmed Irrevocable L/C Transferable versus Non-transferable L/C Restricted Negotiable versus Freely Negotiable L/C Revolving L/C Back to back L/CRed Clause L/CGreen Clause L/CDeferred Payment L/CUsance L/C

Irrevocable versus Revocable L/C

Revocable L/C may be cancelled or modified without prior notice by the issuing bank to the beneficiary.

An Irrevocable L/C does not suffer from such disadvantage and it is ,therefore , widely accepted.

Confirmed Irrevocable versus Unconfirmed Irrevocable L/C

An irrevocable letter of credit (L/C) opened by an issuing bank whose authenticity has been confirmed by the advising bank and where the advising bank has added its confirmation to the credit is known as confirmed irrevocable letter of credit.

An irrevocable letter of credit (L/C) opened by an issuing bank in which the advising bank does not add its confirmation to the credit is known as an unconfirmed irrevocable letter of credit.

Transferable Vs non-transferable Letters of Credit

Credit specifically states it is ‘transferable’. ‘Transferable’ , ‘transmissible’ and ‘assignable’ convey the same meaning Used generally when the business is transacted through middlemanOriginal credit is in favour of middleman , who asks for the transfer of credit to the manufacturer or the actual supplierIt may be available in whole or in part to another beneficiaryThe letter of credit that was transferred to second beneficiary is called TRANSFERRED CREDIT

Restricted Negotiable Vs Freely Negotiable Letters of Credit

Credits which do not specify any particular bank who is authorized to negotiate, etc. are unrestricted or open or general creditL/c will indicate “this credit is not restricted to any bank for payment” or such similar wordsWhen any specific bank is authorized to pay, accept or negotiate the credit it is called restricted or special

Revolving Letter of Credit When a letter of credit (L/C) is specifically designated "revolving letter of credit", the amount involved when utilized is reinstated, that is, the amount becomes available again without issuing another L/C and usually under the same terms and conditions.The revolving L/C may be used in shipments of a wide range of goods to a buyer within a period of time (several months to one year usually).

Back-to-back L/CBack-to-back L/C is a type of L/C issued in case of intermediary trade. Intermediate companies such as trading houses are sometimes required to open L/Cs by supplier and receive Export L/Cs from buyer.

Back-to-back L/CBack-to-back credits are usually requested by middle persons who do not have sufficient credit available at their banks to open their own L/Cs to the ultimate suppliers. Under a back-to-back L/C the middle person will ask a bank to issue a second L/C in favor of the ultimate supplier, while using the L/C issued by the buyer as collateral.

When one L/C is used as security to obtain the issuance of a second L/C covering the same transaction, and when all terms and conditions of both credits are identical, except for amounts and dates in the second L/C which must be smaller and earlier, the arrangement is defined as a back-to-back L/C.

Red Clause Letter of CreditA beneficiary may require financing in order to complete the manufacture or purchase of merchandise to be sold. A red clause L/C (use of the term "red" is derived from the traditional practice of writing the clause identifying this option in red ink) helps the beneficiary achieve this. Upon instruction from the buyer, the issuing bank authorizes the confirming bank to make a cash advance to the beneficiary against the beneficiary's written guarantee that the documents evidencing shipment will be presented in compliance with the credit terms.

Red Clause Letter of Credit

Should the beneficiary fail to ship the goods or meet the credit requirements, the paying bank looks to the issuing bank to obtain reimbursement of the amount of the advance plus the interest charges on the advance. The issuing bank then charges the account of the buyer--who may or may not have received the goods.

Green Clause L/C

A clause in a letter of credit enabling the seller to receive pre-shipment advances against a collateral represented by, for example, warehouse receipts/warrants. It is commonly used in the export of agricultural commodities, where the company may raise funds to harvest new crops for export by pledging available stocks as collateral.

Standby Payment L/C

Standby L/Cs differ from commercial L/Cs; they do not usually cover shipments of goods, but more often services or performance. The standby L/C is not secured by underlying merchandise as is usually the case with conventional L/Cs. In this respect, the standby L/C is much like an unsecured loan and requires careful advance scrutiny by the issuing bank.

If the seller performs his or her obligation, there will be no need for the buyer to draw against the standby letter of credit which supports the obligation.

Cont..Standby letters of credit are commonly used to--

* assure the refund of advance payments;

* support the obligation of a successful-bidder to accept a contract and to perform under the terms of the contract (i.e., in lieu of bid or performance bond);

* back up bonds issued by insurance companies; and

* stand behind a monetary obligation under a promissory note or another like commitment (rental payments, etc.).

Usance L/C

Under a Usance L/C, the payment's) will be due some time in the future, and such payment's) will be evidenced by Bills of Exchange drawn by the exporter on the Opening Bank. These Bills of Exchange will become negotiable instruments, and may well be discounted to provide the exporter with immediate payment.

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