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Letter Of Credit(LC)
Document and undertaking issued by a bank

At the request of the applicant (buyer, importer)

In favor of a beneficiary (seller, exporter) Substitutes the banks name and credit risk for that of the applicant (buyer, importer) Guarantees payment of a customers draft up to astated amount for a specified periodif certain conditions are met

Parties Involved in a Letter of Credit

Applicant

Reimbursing Bank

Beneficiary

Confirming Bank

Issuing Bank

Advising Bank

Nominated Bank

Importance of LC
For Exporter
Dependence on credit worthiness of a bank instead of importer If the credit is confirmed by a bank in the exporter's country, the exporter is neither subject to commercial nor to country risk If the credit is irrevocable, it cant be cancelled without the exporters consent and notice of revocation can be rejected byte exporter if received after shipment The documents and therefore the goodwill not be released until payment or commitment to payment is made (In terms of LC) Where credit has been allowed the accepted bill of exchange can be used to obtain the finance

For Importer
Importer can negotiate better terms as the exporter is assured of payment Importer is assured that no funds will be released unless title documents and received correct and in order Protection is provided under UCP for documentary Credit

Types of Letter Of Credit

Revocable
Irrevocable Confirmed Unconfirmed Transferable Nontransferable
give issuer the amendment or cancellation right of the credit any time without prior notice to the beneficiary cannot be amended or cancelled without the agreement of the credit parties

another bank adds its additional confirmation (or guarantee) to honor a complying presentation at the request or authorization of the issuing bank does not acquire the other bank's confirmation

exporter has the right to make the credit available to one or more subsequent beneficiaries seller cannot give a part or completely right of assigned credit to somebody or to the persons he wants

Types of Letter Of Credit(Contd)

Fixed
amount up to which one or more bills may be drawn by the beneficiary within the specified period of time is specified

Revolving
Back to Back

not the total amount up to which bills may be drawn but the total amount up to which bills drawn may remain outstanding at a time is specified

consisted of two separated and different types of LC

Red Clause

seller before sending the products can take the pre-paid and parts of the money from the bank

Opening Of A Letter Of Credit

Issuance of a letter of credit

Opening Of Letter Of Credit(Contd)

Documents presented for payment

1. Financial Documents : Bill of exchange, Co-accepted Draft 2. Commercial Documents : Invoice, packing list 3. Shipping Documents : Transport Document, Insurance Certificate, Commercial, Official or Legal Documents 4. Official Documents : License, Embassy legalization, Origin Certificate, Inspection Certificate, Phytosanitary certificate 5. Transport Documents : Bill of lading (ocean or multi-modal or Charter party), Airway bill, Lorry/truck receipt, railway receipt, CMC Other than Mate Receipt, Forwarder Cargo Receipt, Deliver Challan etc. 6. Insurance documents : Insurance policy, or Certificate but not a cover note.

Fees and Reimbursements

Opening charges
This would comprise commitment charges and usance charged to be charged upfront for the period of the L/C. The fee charged by the L/C opening bank during the commitment period is referred to as commitment fees. Commitment period is the period from the opening of the letter of credit until the last date of negotiation of documents under the L/c or the expiry of the L/c, whichever is later. Usance is the credit period agreed between the buyer and the seller under the letter of credit. This may vary from 7 days usance (sight) to 90/180 days. The fee charged by bank for the usance period is referred to as usance charges.

Retirement Charges
1. This would be payable at the time of retirement of LCs. LC opening bank scrutinizes the bills under the LCs according to UCPDC guidelines , and levies charges based on value of goods. 2. The advising bank charges an advising fee to the beneficiary unless stated otherwise the fees could vary depending on the country of the beneficiary. The advising bank charges may be eventually borne by the issuing bank or reimbursed from the applicant. 3. The applicant is bounded and liable to indemnify banks against all obligations and responsibilities imposed by foreign laws and usage. 4. The confirming bank's fee depends on the credit of the issuing bank and would be borne by the beneficiary or the issuing bank (applicant eventually) depending on the terms of contract. 5. The reimbursing bank charges are to the account of the issuing bank.

Regulatory Requirements
Trade Control Requirements The movement of good in Bangladesh is guided by a predefined set of rules and regulation. So, the banker needs to assure that make certain is whether the goods concerned can be physically brought in to Bangladesh or not as per the current EXIM policy. ISBP 2002 The widely acclaimed International Standard Banking Practice(ISBP) for the Examination of Documents under Documentary Credits was selected in 2007 by the ICCs Banking Commission. First introduced in 2002, the ISBP contains a list of guidelines that an examiner needs to check the documents presented under the Letter of Credit. Its main objective is to reduce the number of documentary credits rejected by banks. Exchange Control Requirements The main objective of a bank to open an Import LC is to effect settlement of payment due by the Indian importer to the overseas supplier, so opening of LC automatically comes under the policies of exchange control regulations. BAFEDA Guidelines Bangladesh Foreign Exchange Dealers' Association was formed in a bankers meeting held on August 12, 1993 in the Board Room of Rupali Bank Ltd. to help the development of an orderly inter-bank foreign exchange market in Bangladesh. BAFEDA has issued rules for import LCs which is one of the important area of foreign currency exchanges. It has an advantage over that of the authorized dealers who are now allowed by the Bangladesh Bank to issue stand by letter of credits towards import of goods.

Regulatory Requirements(Contd)
UCP 600 is the latest version of the rules that govern letters of credit transactions worldwide. UCP 600 is prepared by International Chamber of Commerces (ICC) Commission on Banking Technique and Practice. Its full name is 2007 Revision of Uniform Customs and Practice for Documentary Credits, UCP 600, and (ICC Publication No. 600). The ICC Commission on Banking Technique and Practice approved UCP 600 on 25 October 2006. The rules have been effective since 1 July 2007. It contain a total of about 39 articles covering the following areas, which can be classified as 8 sections according to their functions and operational procedures.

Risk Situations
Fraud Risks
The payment will be obtained for nonexistent or worthless merchandise against presentation by the beneficiary of forged or falsified documents. Credit itself may be forged

Sovereign and Regulatory Risks

Performance of the Documentary Credit may be prevented by government action outside the control of the parties

Legal Risks

Possibility that performance of a Documentary Credit may be disturbed by legal action relating directly to the parties and their rights and obligations under the Documentary Credit

Force Majeure and Frustration of Contract

Performance of a contract including an obligation under a Documentary Credit relationship is prevented by external factors such as natural disasters or armed conflicts

Risk To Parties
Non-delivery of Goods Short shipment Inferior Quality Early /Late Shipment Damaged in transit Foreign exchange Failure of Bank via Issuing bank / Collecting Ba Insolvency of the Applicant Fraud Risk, Sovereign and Regulatory Risk and Legal Risks

Applicant

Issuing Bank

Reimbursing Bank
No obligation to reimburse the Claiming Bank unless it has issued a reimbursement undertaking.

Beneficiary
Failure to Comply with Credit Conditions Failure of, or Delays in Payment from, the Issuing Bank

Minimizing The Risks

1. 2. 3. 4. 5. Prior to the issuance of the L/C, negotiate exactly what documents must be presented to the bank. Try to agree to present as few documents as possible and to have descriptions as simple as possible. Always include your requirements for the L/C in the pro-forma invoice. Once issued, the L/C can only be altered or cancelled by consent of all parties. Remember that L/C is a bank-to-bank agreement and is not a substitute for the contract between you and the buyer. Be sure that you are in a position to provide the bank with all documents stipulated in the L/C in time. Always indicate L/C as "irrevocable". Check the Additional Conditions and be sure that you are able to meet them. If you have any doubts that the Issuing Bank, for any political or economic reason, can fail to make a payment, the L/C must be confirmed by the Advising Bank or by any other bank, whose confirmation will be accepted by the Advising Bank. If there are any discrepancies and the L/C has to be amended, do not ship goods before these amendments are made.

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A Sample Of L/C