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What is Letter of Credit ? Types and Parties involved

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What is Letter of Credit ? Type and Parties involved

WHAT IS LETTER OF CREDIT?

L /C is an undertaking given by a Bank on behalf of its customer to pay a certain sum of money to a certain person ( Beneficiary ) on the fulfillment of certain terms and conditions as laid down in the letter of credit.


Or-It is an instrument issued by a Bank undertaking the payment on the fulfillment of certain terms and conditions as laid down in that letter of credit addressed to a beneficiary.

To be more precise, L / C is nothing but giving advances ( Investment ) to the customers.

TYPE OF L / C :

  • Clean / Open L / C
  • Documentary L /C

CLEAN / OPEN L / C :

Where there is no reference to the attachment of some papers / documents under an L / C it is called clean / Open L / C.

DOCUMENTARY L / C :

If the presentation of specified documents is obligatory / mandatory then the credit is called a documentary L/C.

In practice, the Bankers deal with the documentary credits.

CLASSIFICATION OF L / C :

L / C may broadly be divided in to two – (a) Revocable L / C & (b) Irrevocable L /C.

Revocable L / C :

It is that type of L / C which may be revoked / cancelled at any moment. There is no existence of this type of  L/C in the World. According to UCPDC, a revocable credit L/C may be amended or cancelled by the issuing bank at any moment and without prior notice to the beneficiary  before shipment of consignment against the L/C.

Irrevocable L/C: The L/C which cannot be revoked/cancelled/amended without the  consent of all the parties involved in a letter of credit is called irrevocable L/C.

Irrevocable L/C may either be Confirmed L/C or unconfirmed L/c:

Confirmed L/C : When an L/C is confirmed i.e. Add-confirmed is made by the 3rd Bank it is called Confirmed L/C. (Note – Add-confirmation is the additional guarantee given by the 3rd Bank in addition to that of L/C issuing Bank.)

Unconfirmed L/C : The L/C which is not add-confirmed by the 3rd Bank, it is called Unconfirmed L/C.

L/Cs may be classified further as under in accordance with their nature of use and purpose. So, documentary credit according to payment methods be –

  1. Sight credit
  2. Acceptance credit
  3. Deferred payment credit
  1. Sight Credit: If the payment terms stipulate the presentation of sight draft it is called sight credit and the beneficiary (the seller) receives payment against the credit upon presentation of the documents, if found otherwise in order. The negotiation bank after making payment to the exporter sends the documents to issuing bank
  2. Acceptance Credit (Credit covering time drafts) : In case of acceptance credit the exporter draws a time draft either on the issuing bank or on the importer or on another bank depending upon the credit terms. The payment date may be for example 90 days after the invoice date or the date of the transport document. When the documents have presented the drafts is accepted by the drawee for payment upon maturity in terms of credit.
  3. Deferred Payment Credit : The deferred payment credit differs only slightly from the acceptance credit in its effect on the beneficiary. The main difference is the lack of a draft. Upon presentation of the proper documents the bank so authorized (the issuing or confirming bank) issues a written promise to make payment on the due date).

PARTIES TO A LETTER OF CREDIT:

There are mainly 6(six) parties involved in a letter of credit which may be summed up as under:

  1. Opener: The applicant of L/C or the Importer / Buyer / L/C applicant.
  2. Opening Bank: The Bank opening the L/C i.e. the importer’s Bank / Buyer’s Bank.
  3. Advising / Notifying Bank: The bank advising the credit to the beneficiary.
  4. Beneficiary / Export / Seller : The exporter/supplier in favour of which the credit is opened/issued.
  5. Negotiating Bank : The Bank who negotiates/purchases documents of the exporter against the L/C opened and presents the documents to L/C opening Bank for payment.
  6. Reimbursing Bank : The Bank who makes payment to the beneficiary’s Bank (BBK) on behalf of or at the request of opening Bank on receipt of confirmation regarding compliance of credit terms from negotiating bank.
  7. Transferring Bank: In addition to the above, there may be another bank which may be termed as confirming Bank.
  8. Confirming Bank:

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What is Letter of Credit (L/C)? Types and Parties involved