Indian exports are proliferating every year. The contribution of exports in India’s GDP is rising continuously. To assist these exporters and ensure the payment guarantees to them, multiple International Banks offer the Letter of Credit facility.
If you are into the Import/Export business, you might know something about the Letter of Credit. If you don’t, no worries, we will cover every detail in this blog!
So let’s get started.
What is Letter of Credit?
Letter of Credit is a type of monetary guarantee offered by banks, primarily in international transactions (Import/Export Business). This Letter of Credit ensures a payment guarantee to the supplier. Businesses involved in Import and Export often deal with the unknown buyer. Due to the rising number of payment scams, it becomes critical to obtain the buyer’s assurance of the payment. This is where the Letter of Credit comes in.
It acts as an assurance of payment for the suppliers. In short, it is a form of credit guarantee.
How does it work?
The process is simple. The buyer obtains the Letter of Credit from the bank. This Letter ensures the on-time payment guarantee to the seller. Once the buyer starts receiving service or product, he/she/it must start releasing the payment as per the mutual agreement. In case, if the supplier fails to meet the payment terms, the bank is liable to pay the outstanding amount to the supplier.
Different types of Letter of Credits in India
- Credit on Sight
This is the most straightforward form of Credit. Here the seller can collect the fund from the lender by presenting the Bill of exchange. Here the fund is offered on the sight of the Bill of exchange and hence the name.
- Revocable Credit
As the name suggests, the lender reserves the right to alter the terms and conditions of the Letter or to cancel the Letter altogether. In such Credit, the lender is not bound to inform about the revocation or alteration in terms of Credit to the Supplier or Buyer.
- Irrevocable Credit
This type of Credit is exactly the opposite of the previous ones. Here, the lender cannot alter the terms and conditions of the Letter. In any case, the lender will have to oblige the commitment made through the Letter.
- Time Credit
Under this type of Letter, the Bill of exchange is paid after the agreed time between the lender and borrower. This means the Letter of Credit with time credit offers some window for the borrower to repay the amount, even after receiving the goods.
- Transferable Credit
Under this type of Credit, the beneficiary is allowed to transfer the Credit’s benefits to the third party with necessary formalities.
Features of Letter of Credit
Now let’s take a look at the different features of Letter of Credit:
- The lender (generally, banks) issue the Letter of Credit to the borrower against certain collateral. This collateral can be in the form of banks deposits or fixed deposits.
- The Letter of Credit is governed by the guidelines issued by the ICC (International Chambers of Commerce)
- The Letter of Credit must contain detailed information about the name of the seller, amount, date and quantity in case of products. In case there is even the slightest error in the detail of the buyer, lenders reserve the right to withheld the payment.
- Any discrepancies or defects in the goods will not affect the payment as the deal is done on the basis of documents only.
- The bank charges a small fee from the borrower for issuing the Letter of Credit.
Documents required to obtain the Letter of Credit
You will need the following documents to obtain the Letter of Credit from the banks.
- Certificate of Origin
- Commercial Invoice
- Bill of Exchange
- Financial Documents and Details of the buyer
- Health and Insurance certificates of the borrower
- Packing and Shipping Details
- Cargo receipts and Landing Airway bills
- Any other legal documents required in the buyer’s or seller’s country
How to get a Letter of Credit?
Now let’s take a look in how to get a Letter of Credit.
- The buyer will have to approach the bank to avail the Letter of Credit from the issuing bank.
- Next, the advising bank (Bank for the seller) will receive this Letter of Credit from the Issuing Bank. This bank performs a thorough inspection of the details mentioned in the Letter of Credit.
- Once the details are verified, the advising bank will assure the seller about the payment as it has received and verified the Letter of Credit’s details.
- After getting assurance, the seller ships the goods with all the necessary documents and will receive the Bill of landing.
- Once the buyer presents the Bill of Landing to the Nominated Bank, it will verify the order details and shipping documents. Once the Nominated Bank finds all the documents satisfactory, it will release the payment to the seller.
- Later, the Nominated Bank will forward the shipping & product details with the Issuing Bank to demand the payment.
- The issuing bank will forward all these documents to the buyer to verify whether the shipment and documents are agreed between the buyer and seller.
- Once the buyer confirms the details and pays the outstanding amount to the Issuing Bank, the same is deposited with the Nominated Bank.
Letter of Credit is an essential instrument that protects exporters from any financial issues while conducting Business with foreign entities. This facility iron-outs the process, benefits buyers and sellers equally and helps them grow.
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