1) Letters of credit, also known as documentary credits, provide a compromise between a seller's desire for prepayment and a buyer's desire for open accounts. 2) Letters of credit work because they are regulated by the ICC and are irrevocable unless stated otherwise, transferring payment risk from the buyer to the buyer's bank. 3) A letter of credit is a written commitment from an importer's bank to pay an exporter upon presentation of stipulated documents, such as invoices and transport documents.

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CreditCraft
Letters of Credit
a.k.a. Documentary Credits
The way to win-win
Presented by
Brian Ward MICM, CICP

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CreditCraft
Seller Buyer
In an ideal world - prepayment
Seller perspective

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CreditCraft
Seller Buyer
In an ideal world – open account 180 days
Buyer perspective

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CreditCraft
Seller Buyer
In the real world – letter of credit at 60 days
Compromise needed

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Why ask your buyer for a letter of credit?
» The buyer country risk is higher risk than supports open
account terms
» Buyer’s creditworthiness is unknown to the seller
– Country filing requirements are inadequate to support credit
decisions
» You move the credit risk from buyer to buyer’s bank

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Why do letters of credit work?
» Regulation
– Documentary Credits ( Letters of Credit) are covered by ICC
Uniform Customs & Practice (UCP600)
(International Chamber of Commerce)
» They are irrevocable unless specifically stated as
otherwise (revocable)
– One party in the transaction cannot unilaterally change any
term or condition of the LC.
– The exporter must specifically accept any amendment.

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What is a letter of credit?
» A letter of credit is a written undertaking from the
importer’s bank to pay for the exporter’s goods or
services, provided the exporter presents documents as
stipulated by the credit.

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CreditCraft
How is a letter of credit communicated?
» A letter of credit is communicated by the Issuing
(overseas bank) to the U.K.(advising bank) via SWIFT.
» Society for Worldwide Interbank Financial
Telecommunication supplies secure messaging services
and interface software to wholesale financial entities.
» Once received and validated by the Advising bank, that
bank forwards the full text of the LC by mail and/or email
to the Exporter (Beneficiary)

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Stipulations
Which? Where? When?
» Which documents to present
– Invoice and transport documents etc.
» Where the documents should be presented
– The bank to which the exporter delivers the documents
» When to present the documents
– Deadline to present the documents
These conditions/stipulations will all be stated on the LC

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CreditCraft
When do Letters of Credit work best?
» The overseas bank is a strong bank
» Seller and buyer agree mutually acceptable terms and conditions
for the LC in advance
» The Letter of Credit calls for an Ocean Bill of Lading to be
produced
» Documents for presentation are kept to a minimum

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Basics
» If you don’t get your documentation absolutely consistent
with the conditions of the letter of credit and if you don’t
present your documents within the time limits laid down,
you will not get paid under the terms of the credit
» Banks are required to check your documents for exact
compliance with the terms of the credit
» Banks are required to check your documents for
consistency between documents

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CreditCraft
Exporter (beneficiary)
Importer (applicant)
Documents
UK Bank(advising/nominated
bank) Overseas Bank(issuing bank)

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CreditCraft
Documentary Credits / Letters of Credit Routing
Issuing bank Buyer sends details
forwards original Customer/Buyer to issuing bank
documents to buyer 1
9
Issuing bank
check documents if Issuing bank
clean authorise opens LC and
payment to advising sends to
Issuing
bank Advising bank
bank
8 2
Advising bank
checks documents & Advising bank
Pays if nominated or checks details &
forwards LC to seller
forwards to issuing (may add
Advising
bank confirmation)
or
7 3
confirming
bank
Seller forwards Seller ships order
documents to as per LC details
advising bank 4
6 Seller
B/Ls, Invoices, Bills of Exchange,
packing lists, insurance certs, certs of
analysis, legalisation etc
5

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Certainties
» Your bank cannot advise a Letter of Credit to you unless
they have first authenticated the swift message
» Your customer does not want discrepancies on
presentation
– Buyer has already paid for the LC (in cash or credit) and he
wants the material

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CreditCraft
Why add confirmation?
Belt and braces
» Political and/or banking stability is in question
– We may ask a “first class Western bank” to add their
confirmation to a letter of credit issued by another bank
• This moves risk from an unknown bank to a known
party
» Default on payment would be catastrophic to seller

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CreditCraft
Other forms of letters of
credit
– Standby letter of credit- this can be used to
underwrite open account business so that we
are not bound by onerous conditions in a
letter of credit

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Other forms of letters of
credit
– Revolving letter of credit –
– this is suited to repetitive business where the
letter of credit may be renewed in relation to
time or value
• Where an importer needs repetitive shipments of
similar or same value they can open a revolving
credit which replenishes the value of the credit as it
pays out, in this way the importer caps his
utilisation of his credit line at his bank
• The exporter should benefit from easier compliance
on presentations as the documents required will be
very similar each time

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Other forms of letters of
credit
» Red clause/advance payment —
– Red clause DCs contain a clause (traditionally written in red
ink) authorising the nominated bank to advance a proportion
of the value of the DC to the beneficiary before shipping
documents are presented. This enables the beneficiary to
purchase raw materials or to pay other costs (eg,
transportation) prior to receiving full payment, once
conforming documents have been presented.

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Other forms of letters of
credit
» Back-to-Back
– This is where a DC is issued on the back of, and against the
security of, another DC (the Master DC) on the understanding
that reimbursement will stem from the documents presented
under the Master DC. Both DC’s cover the shipment of the
same goods. You will need to arrange for a DC facility with
your bank if you are planning to use Back-to-Back DCs.

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CreditCraft
Other features of letters of credit
» Confirmation
– The seller can arrange to have a first class bank to add their
confirmation to a letter of credit moving risk from buyers
bank to a U.K. Bank.
» Silent confirmation
– The seller can arrange to have a first class bank to add their
confirmation to a letter of credit without the buyer’s
knowledge
» Discounted LC
– Letters of credit may be discounted or sold for settlement by
the bank today although the term of payment is long e.g.
180 days

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CreditCraft
Who normally pays the bank charges on LCs
Buyer (Applicant) Seller (Beneficiary)
» Costs in buyers country » Costs outside buyer’s
– Opening charge country
– LC Commission – Advising costs
– Amendment costs – Confirmation costs
– Discrepancy fees
– Discounting fees (if used)

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Why and when a win-win with LCs
Seller Buyer
» Security of a bank underwriting » Access to credit where it may
the trade not otherwise be available
» Security of a Western bank » Confidence that goods have
underwriting the trade if been shipped as per contract
required » The higher the LC value the
» Can give seller advantage over lower the cost versus cash
competition calling for pre- interest payments
payment » The longer the credit period
» Cash planning with confidence the lower the cost versus cash
» Where credit term is long LC interest payment
can be discounted for early » Benefit from interest rate
payment differentials between buyer’s
country and U.K.