Letter of Credit – Guide on Types, Process, Example

To put it in simple terms, letter of credit is a piece of document that serves as instruction of guaranteed payment from the buyer to the seller. Also known as a documentary credit, a letter of credit is issued by the bank and acts as a promise of timely payment to the seller.

If the buyer supposedly fails to perform his due obligation, then the bank pays the seller on behalf of the buyer who in turn repays the bank. This is a brief summation of the letter of credit process.

Types of Letters of Credit

There are mainly four types of letter of credit examples.

1. A revocable letter of credit
2. Revolving letter of credit
3. A standby letter of credit
4. Irrevocable letter of credit

Letter of credit pdf can be easily found online, which helps distinguish between each type.

How Does a Letter of Credit Work?

The letter of credit process has certain steps that need to be followed:

1. The buyer must first approach the bank and request to issue a letter of
2. An advising bank, generally an international bank on behalf of the seller who will receive the letter of credit sample that has been sent by the bank of the buyer. The job of the advising bank is to authenticate and check the information in the letter of credit
3. After authenticating, the advising bank proceeds to reassure the seller that his money will be processed as now it is a matter of transaction that will be taken over by the concerned
4. After the purchased items are shipped by the buyer, the seller receives a bill of landing for he has exported the purchased articles to the
5. From here the banks take over as landing bill is sent to the bank on a charge of negotiations which in turn check the exported goods and finally after inspection pay the
6. The shipping documents are then shared with the issuing bank, and the nominating bank makes the
7. The issuing bank proceeds to disclose all documents with the buyer and with the approval of all documents bring in order as per the buyer’s information; the purchased articles are
8. Finally, the buyer makes the payment to the issuing bank, which in turn forwards the payment to the negotiating bank.

Typically, a letter of credit supports a seller or a beneficiary in an exchange agreement wherein the bank will make sure that the seller receives the amount either from the purchaser or from the issuing bank itself. This letter of credit    arrangement also assists a purchaser in certain cases such as the purchaser making a payment to the seller for an order and the seller not delivering the order on time. In such a situation, with the help of a letter of credit, the purchaser will get paid with the money that was spent by him or her. Hence, this way, the purchaser will get a refund.

When the purchaser receives the payment, the payment will be a penalty incurred by the seller or the beneficiary that did not deliver the consignment of goods on time.

With the help of this refund amount, the buyer can purchase from another party.

The bank that grants the Letter of Credit has to be a regular banker of the opener and should also be known to the beneficiary.

The Overseas Letter of Credit should always be advised through an Indian Bank, preferably it should be confirmed.

The individual has to check the bank charges, whether to openers account or the beneficiaries account. Generally, the buyer and the seller has to pay the bank charges in the respective countries that include the LC confirmation charges. The Letter of Credit has to mention the expenses that are on account of the applicant and which on account of the beneficiary.

The individual has to check if the freight is prepaid or to pay according to the contract.

Advantages of letter of credit

1. A letter of credit gives the trade partners an ability to transact with unknown partners or in newly established trade It helps in expanding their business quickly into new geographies.
2. A letter of credit is safer for the seller or exporter in case the buyer or importer goes bankrupt. Since the creditworthiness of the importer is transferred to the issuing bank, the bank must pay the amount as agreed in the letter of credit. Thus, a letter of credit insulates the exporter from the importer’s business
3. A letter of credit is highly Both the trading partners can put in terms and conditions as per their requirements and arrive at a mutual list of clauses. It can also be customized from one transaction to another with the same trading partners.
4. In the case of a dispute between the trading partners, a letter of credit accounting allows the exporter to withdraw the fund as agreed upon in the letter of credit and resolve the disputes later in The beneficiary’s
5. right to the full amount is described in the phrase ‘pay now, litigate later by the courts.

Disadvantages:

1. A letter of credit adds to the cost of doing Banks charge a fee for providing this service, and it can increase steeply if the parties want to put some additional features
2. A letter of credit poses a material fraud risk to the The bank will pay the exporter upon looking at the shipping documents and not the actual quality of goods. Disputes can arise if the quality is different from what was agreed upon.
3. A letter of the credit life cycle has an expiration date, and therefore the exporter has a time limit within which he will have to deliver the goods by all means. At times, this haste creates a mess.