Letter of Credit Risk and operations

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2. Table of contents
 Origin of LC
 Definition of LC
 Elements in LCs
 Importance of LCs
 Terms commonly used in LCs
 Legal principles
 Types of LCs
 Risks in import LCs
 Documents in LCs
 Common defects in documents
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3. Letter of Credit - Origin
 The name "letter of credit" came from the
French word "accréditation", a power to do
something
 Origin is from Latin "accreditivus", meaning
trust.

4. Letter of Credit - Definition
 A letter from a bank guaranteeing that a
buyer's payment to a seller will be received on
time and for the correct amount.
 The bank will make full or part of the
purchase price (shortfall) in case the buyer
defaults to make payment.
 In today’s competitive world banks face
increasing competition.

5. Letter of Credit - Definition
 ICC in the Uniform Custom and Practice for
Documentary Credit (UCPDC) defines L/C as:
 "An arrangement, however named or
described, whereby a bank (the Issuing bank)
acting at the request and on the instructions
of a customer (the Applicant) or on its own
behalf :
 Is to make a payment to or to the order third
party ( the beneficiary ) or is to accept bills of
exchange (drafts) drawn by the beneficiary.

6. Letter of Credit - Definition
 Authorized another bank to effect such
payments or to accept and pay such bills of
exchange (draft).
 Authorized another bank to negotiate against
stipulated documents provided that the terms
are complied with.

7. Letter of Credit - Elements
 A payment undertaking given by a bank
 On behalf of a buyer
 To pay a seller for a given amount of money
 On presentation of specified documents
representing the supply of goods / services
 Within specified time limits
 Documents must conform to terms and
conditions set out in the letter of credit
 Documents to be presented at a specified
place

8. Why Letters of Credit are
important
 Nature of international dealings.
 Distance between seller and buyer.
 Differing laws of various countries.
 Difficulty to know each party personally.
 To break the deadlock between the buyer and
seller.

9. Terms commonly used in LCs
 Sight LC - requires payment to be made
immediately to the beneficiary upon
presentation of the correct documents.
 Time or date LC - specifies when payment is
to be made at a future date.
 Negotiation - giving of value for draft(s) or
document(s) by the bank authorized to
negotiate, with the nominated bank.

10. Terms commonly used in LCs
 Presentation – Submission of documents
against LC or the document itself
 Complying presentation – When the
presentation is as per the
 terms and conditions of credit
 applicable provisions of UCP
 international standard banking practice
 Confirmation— a definite undertaking from
the confirming bank to honor or negotiate a
complying presentation in addition to that of
the issuing bank.

11. Terms commonly used in LCs
 Letter of Credit— an irrevocable commitment
of the issuing bank to honor a complying
presentation
 Honor - to act according to commitment of
the LC. Based on type of facility presentations
are honored in various ways
 making payment at sight for sight LC
 paying at maturity for deferred payment LC.
 accepting a Draft drawn by the beneficiary and
paying at maturity for deferred acceptance LC

12. Legal principles - LCs
 Payment obligation is independent from the
underlying contract of sale or any other
contract in the transaction {article 4(a) of
UCP}.
 Banks deal with documents only - not
concerned with the goods (article 5 of the
UCP).

13. Legal principles - LCs
 The “principle of strict compliance” to be
applied. Hence, if the documents tendered
under the credit deviate from the language of
the credit the bank is entitled to withhold
payment.
 General legal maxim de minimis non curat lex
is not applicable in this field. De minimis is a
Latin expression meaning about minimal
things.

14. Types of LCs
 There are broadly two types:
 Commercial Letter of Credit
 primary payment mechanism
 Standby Letter of Credit
 secondary payment mechanism

15. Types of LCs
 Standby Letter of Credit assures the
beneficiary of the performance of the
customer's obligation.
 The beneficiary is able to draw under the
credit by presenting evidence that the
customer has not performed its obligation.
 The bank is obligated to make payment if the
documents presented comply with the terms
of the letter of credit.
 Standby letters of credit are issued by banks
to stand behind monetary obligations.

16. Types of LCs
 Import/Export LC – Same LC is import LC for
importer and export LC for exporter.
 Revocable—The buyer and the bank are able
to manipulate the LC or make corrections
without informing from the seller. According
to UCP 600, all LCs are Irrevocable.
 Irrevocable—Any amendments or
cancellation of the LC is done by the applicant
through the issuing Bank. It must be
authenticated and approved by the
beneficiary.

17. Types of LCs
 Confirmed—An LC is said to be confirmed
when a second bank adds its confirmation to
honor a complying presentation at the
authorization of the issuing bank.
 Unconfirmed—Does not require the other
bank's confirmation.

18. Types of LCs
 Transferrable—The exporter has the right to
make the credit available to one or more
subsequent beneficiaries.
 Untransferable—A credit that seller cannot
assign all or part of to another party.

19. Types of LCs
 Deferred / Usance— A credit that is not
paid/assigned immediately after presentation, but
after an indicated period that is accepted by both
buyer and seller.
 At Sight—A credit that the issuing bank
immediately pays after inspecting the carriage
documents from the seller.
 Red clause - L/C that carries a provision which
allows a seller to draw up to a fixed sum from the
paying bank in advance of the shipment or before
presenting the prescribed documents.

20. Types of LCs
 Back to Back—A pair of LCs in which one is to
the benefit of a seller who is an agent. In that
event, a second credit is opened for another
seller to provide the desired goods. Generally
this is used by trading houses.
 A revolving LC is issued when the seller
sends regular shipments to a particular buyer
as part of long-term supply contract. Once the
buyer reimburses the amount paid to seller by
the issuing bank, the LC amount is reinstated.

21. Risks in import LC
 The financial standing of the importer
 Goods
 Exporter risk
 Country risk
 Foreign exchange risk

22. Documents in LCs
 Bill of Exchange
 Invoice, packing list
 Shipping documents
 License
 Embassy legalization
 Origin certificate
 Inspection certificate
 Insurance policy