L/C-Credit of Credit
L/C-Letter of Credit is very common payment term in international business. The letter of credit replaces high-risk commercial credit with bank credit, and regulates transactions in international trade, reducing the risks for buyers and sellers.
To operate a letter of credit requires the rich knowledge and experience on international trade and international transportation (including sea, air and land transportation).
However, fraud against sellers by unscrupulous merchants using letters of credit also occurs often.
Therefore, it is very important to be familiar with the knowledge of letters of credit and let professional staff operate L/C.
Below article provides the essential knowledge about L/C. High recommended to contact a L/C expert before opening or negotiating a L/C.
1. What is L/C payment method? What are the characteristics?
L/C is LETTER OF CREDIT. Letter of credit is a certificate that banks conditionally guarantee payment and has become a common settlement method in international trade activities. According to the general provisions of this settlement method, the buyer first deposits the payment in the bank, and the bank opens a letter of credit, and informs the seller in the other place to open the bank to inform the seller. The seller delivers the goods in accordance with the terms of the contract and the letter of credit, and the bank pays on behalf of the buyer.
The letter of credit method has three characteristics:
- The letter of credit is not attached to the sale and purchase contract. When reviewing the bill, the bank emphasizes the verification in written form that the letter of credit is separated from the basic trade.
- The letter of credit is for payment against documents, not the goods. As long as the documents match, the issuing bank should pay unconditionally.
- Letter of credit is a kind of bank credit, it is a kind of guarantee document of the bank.
After understanding the L/C payment method, how do sellers conduct transactions? The following editor introduces the specific transaction process.
2. L/C transaction process
- The first step: the buyer and seller stipulate in the trade contract to use documentary credit for payment.
- Step 2: The buyer informs the local bank (issuing bank) to open a letter of credit in which the seller is the beneficiary.
- Step 3: The issuing bank requests another bank to notify or confirm the letter of credit.
- Step 4: The advising bank informs the seller that the letter of credit has been opened.
- Step 5: After the seller receives the letter of credit and ensures that it can fulfill the conditions specified in the letter of credit, the goods will be shipped.
- Step 6: The seller submits the documents to the designated bank. The bank may be the issuing bank or the payment, acceptance or negotiation bank specified in the credit.
- Step 7: The bank reviews the documents in accordance with the letter of credit. If the documents meet the requirements of the letter of credit, the bank will make payment, acceptance or negotiation in accordance with the requirements of the letter of credit.
- Step 8: The bank other than the issuing bank sends the documents to the issuing bank.
- Step 9: After the issuing bank verifies that the documents are correct, it shall reimburse the bank that has paid, accepted or negotiated in accordance with the letter of credit in the form agreed in advance.
- The tenth step: the issuing bank submits the bill after the buyer has paid, and then the buyer receives the goods against the bill.
Refer to the above letter of credit transaction process plus this flowchart to understand the letter of credit payment flowchart more clearly.png
3. The content and principles of L/C letter of credit
Contents of the credit:
A description of the credit itself, such as its type, nature, validity period and expiry place
The requirements for the goods are described according to the contract
Requirements for transportation
The requirements for documents, namely cargo documents, transportation documents, insurance documents and other related documents.
The issuing bank’s obligation to guarantee payment to the beneficiary and the holder of the draft
Most of the foreign certificates are marked with a note: “Unless otherwise specified, this certificate is processed in accordance with the International Chamber of Commerce “Uniform Customs and Practices for Documentary Credits”, ICC Publication No. 600 (“ucp600″).”
Inter-bank wire transfer claim clause (t/t reimbursement clause)
Three principles of letter of credit:
- The independent abstract principle of letter of credit transactions;
- The principle of strict compliance with the letter of credit;
- Principle of Exception for Letter of Credit Fraud
4. What are the types and types of letters of credit?
Letters of credit are classified according to different standards. The editor has sorted out the main classification standards and types of letters of credit.
According to whether the draft under the letter of credit is accompanied by a shipping document, it is divided into:
- Documentary letter of credit
- Clean credit
Taking the responsibility of the issuing bank as the standard, it can be divided into:
- Irrevocable letter of credit
- Revocable letter of credit
According to whether another bank guarantees the payment, it can be divided into:
- Confirmed letter of credit
- Non-confirmed letter of credit
According to the payment time, it can be divided into:
- Sight letter of credit
- Usance letter of credit
- fUsance Credit Payable at Sight
According to whether the right of the beneficiary to the letter of credit can be transferred, it can be divided into:
- Transferable letter of credit
- Non-transferable letter of credit
Revolving letter of credit:
Back-to-back letter of credit (reissue letter of credit)
Anticipatory credit/Packing credit
Standby letter of credit
5. the advantages and disadvantages of L/C
Let’s analyze the advantages and disadvantages of L/C letter of credit payment together.
The way of payment by letter of credit is gradually formed in the process of the development of international trade and the participation of banks in international trade settlement. It is a settlement method in which the bank pays the seller for the buyer when the documents match, and its biggest advantage is to use bank credit as a guarantee for payment.
When a letter of credit is used for settlement, the beneficiary (exporter)’s collection is guaranteed, especially when the exporter does not know the importer well, and the advantage of the letter of credit is more significant when the importing country has foreign exchange control.
The letter of credit makes the financial burden of both parties more balanced. For exporters, after the goods are shipped, they can immediately sell the documents to the exporting bank to obtain payment for the goods, and they can also use the letter of credit as a package loan. Therefore, the financial burden is much lighter than the cash on delivery and collection; for the importer In other words, generally only a part of the deposit is required when issuing a license, and the full amount is paid when the receipt is obtained. The financial burden is also much lighter than the advance payment. Of course, L/C payment also has the following disadvantages:
The payment time limit of L/C
The letter of credit is negotiated upon order, that is, all original documents are reviewed by the advising bank and delivered to the issuing bank or negotiating bank by express delivery, and the negotiating bank conducts negotiation after reviewing the documents. Therefore, there is a situation where the company advances the full payment, usually the advance period is between 20-30 days. Therefore, some companies are also discouraged from large amounts of credit unless the profit margin is large.
Payment security of L/C
The payment of the letter of credit is guaranteed by the creditworthiness of the issuing bank/reimbursing bank, and the reimbursing bank is only responsible for the negotiation documents, so as long as the negotiation documents are okay, the payment will be made. The security of the payment of the credit of the banks in Europe and the United States and other developed countries It is almost 100%. However, due to wars, foreign exchange control, bank credit and other issues in Africa and South Asia, there are situations where banks have not paid and placed orders, so the security of payment by the letter of credit is poor.
The controllability of L/C
The operation of the letter of credit is more troublesome, and the requirements for delivery, documents, etc. are strict, and there are many restrictive clauses (for example, all documents are required to display the letter of credit number, ship permit requirements, etc.). First of all, strict verification is required. If it is not good for the seller or difficult to meet the required terms, the customer is required to change the certification. Because the requirements of each letter of credit are different, one vote is required for one discussion, so I won’t elaborate on it here.
Prone to fraud
Since the letter of credit is a self-sufficient document, the relevant bank only deals with the characteristics of the documents. If the beneficiary forges a matching document or makes a fake document with no goods at all, the importer will become the victim. Although in theory the importer can demand compensation from the exporter in accordance with the sales contract, or even resort to law, it is often difficult to resolve transnational disputes.
There are many links, which are not only time-consuming, but also expensive. Links such as document review also require strong technicality, which increases the cost of the business. Of course, if the letter of credit does not need to be amended or the negotiating bank believes that there are no discrepancies in the documents, there is no need to pay this fee, but it is rarely encountered in actual operation, so this money is almost impossible to save. However, the issuing fee and confirmation fee are up to the seller. As for the specific fees, as each bank has different charging standards, please check with the advising bank about the specific fees. The handling fee is higher.
6. Matters needing attention for payment by L/C
With the use of letter of credit settlement, importers bear greater risks than exporters, and overall it is more beneficial to exporters. So what should the foreign trade seller do after receiving the letter of credit?
We must first determine whether we accept this letter of credit. One is to consider the credit of the issuing bank, and the other is to check whether the terms of the letter of credit are consistent with the contract, such as product name, quantity, delivery date, etc. If it does not comply with the contract and the terms are unacceptable, contact the other party to change it in time. certificate.
It should be noted that as a banking business, the letter of credit is independent of the sales contract. If the terms of the letter of credit are inconsistent with the contract, and you ship in accordance with the contract, instead of strictly following the terms of the letter of credit, the documents are inconsistent, and the issuing bank can refuse to pay, and appeals based on the terms of the contract are invalid .
If you feel that the issuing bank is not sufficiently creditworthy, you can ask the buyer to contact the issuing bank to confirm the letter of credit with a major international bank or a domestic bank. After confirmation, the confirming bank is obligated to pay. In short, you cannot accept letters of credit issued by banks you don’t trust, especially those from third world countries. If you are unsure about the credit of the issuing bank, you can consult your account opening bank.
After confirming the receipt of the letter of credit, the goods shall be prepared and shipped in accordance with the terms of the letter of credit. The goods are handed over to the freight forwarder, and the agent is taken, and the bill of lading together with the invoice is taken to the advising bank (the foreign issuing bank must notify the issuance and modification of the letter of credit through the domestic freight bill of lading. After the initial verification, the notifying bank will send the documents to the issuing bank, and the issuing bank will settle the payment after the verification is correct.
When the issuing bank’s letter of credit pays, it only accepts the bill but not the goods. The buyer or the issuing bank cannot refuse to pay due to the quality of the goods; similarly, if the seller’s documents are inconsistent with the terms of the credit, the actual goods cannot be Payment is required for compliance. That is to say, the conditions for payment by the issuing bank are and only that the contents contained in the invoice, bill of lading and other documents that may be involved are exactly the same as the terms of the letter of credit, that is, “the documents match, the bills match”, otherwise, The issuing bank may refuse to pay and cause losses.