This article will start from the concept of letter of credit and the logic of operation, detailed introduction to the use of letter of credit operation process, as well as the seller as a foreign trade salesman in the process should consider the details. I hope it will be helpful to everyone.
What is a letter of credit?
A letter of credit is a written document issued by the importer's bank on behalf of the importer. With a letter of credit, the exporter is assured that the sending bank will pay the exporter for international trade. The importer is the applicant for the letter of credit and the exporter is the beneficiary. In a letter of credit, the issuing bank promises to pay the said amount according to an agreed schedule and specified documents.
The guiding principle of a letter of credit is that the issuer pays only on the basis of the documents submitted, without them personally guaranteeing the transportation of the goods. There is no reason for the bank to refuse payment if the documents presented are in accordance with the terms and conditions of the letter of credit.
What is the operational logic of a letter of credit?
Letter of credit is a common form of payment in trade. The issuing bank can act on the request and instruction of the applicant (importer) or on its own behalf. Under a letter of credit arrangement, the issuing bank may make payment to the beneficiary (i.e., the exporter) (or in the order of the payer). Alternatively, the issuing bank may accept a bill of exchange issued by the exporter. The issuing bank may also authorize the advising bank or designated bank to pay or accept the draft.
Operating Process of Letter of Credit
The whole process under a letter of credit includes four main steps:
Step 1-Issuance of Letter of Credit
After both parties have reached an agreement on the contract and the use of the letter of credit, the importer applies for the issuer bank to open a letter of credit with the exporter as the beneficiary. The letter of credit is sent from the issuing bank to the advising bank. The latter is usually located in the exporter's country or even the exporter's bank. The advising bank (confirming bank) verifies the authenticity of the letter of credit and forwards it to the exporter.
Step 2 - Delivery of Goods
Upon receipt of the letter of credit, it is expected that the exporter will verify it, fulfill its requirements, and begin the process of shipping the goods.
Step 3-Provision of documents to the confirming bank
After shipment of the goods, the exporter (either alone or through a freight forwarder) submits the documents to the advising/confirming bank.
Step 4-Settlement of payment by the importer and title to the goods
The bank then sends them to the issuing bank and pays, accepts or negotiates the amount, as the case may be. The issuing bank verifies the documents and obtains payment from the importer. It sends the document to the importer, who uses it to take ownership of the shipment.
Frequently asked questions about using letters of credit.
The basic reason foreign trade companies use letters of credit is that they guarantee payment. However, in order to receive payment, the documents presented must comply with the terms of the letter of credit. In order to fulfill the requirements, it is necessary to check the letter of credit before shipment. The following are the details that need to be checked when using a letter of credit.
1. Is the company name spelled correctly and is the address correct?
A foreign trading company may have more than one address associated with it. the address shown in the LC (which may be your company's head office) may not be the address shown on the document. Make sure both parties agree, or the bank will call you to confirm.
2. Do you need to confirm the letter of credit? If so, confirm that it is acceptable to the bank?
If you are not happy with the buyer's country or the issuing bank, you may need to confirm it. You also need to make sure you are happy with the bank and get confirmation from them.
3. Is the amount and currency of the letter of credit correct?
Are the amount and currency consistent with the sales contract? If the credit is for the amount specified, it's fine. The most you can draw is one penny of the LC value. If you use a similar "approximate" expression in the LC amount, it will automatically have a plus or minus 10% margin.
4. Is the contract term acceptable?
When do you want to pay? If payment is to be made when the letter of credit is issued, a draft is required. If you agree to a certain payment term, the bill of exchange should correctly reflect the correct payment date.
5. Is the product description correct?
This is one of the very strict questions in a bank audit. The description of the product on the invoice must exactly match the description on the letter of credit. If the letter of credit is misspelled, you must either misspell it on the invoice or amend the letter of credit.
6. Are the shipping details correct?
Does the shipping method match your sales contract? Is the port of loading/unloading airport acceptable? Are negotiable and non-negotiable bills of lading handled correctly? These critical issues need to be corrected in the LC.
7. Can you meet the delivery date?
If this date falls on a weekend, delivery must still be made by this date; it will not be automatically postponed to the next business day.
8. Are the insurance instructions correct?
As the seller, are you going to provide the insurance, or is the buyer responsible for this detail? Is this in line with international trade terms?
9. Is the expiration date acceptable? Will it expire in your country?
If the day falls on a weekend or the banks are closed, then you must submit your documents before the next banking day.
10. Does the letter of credit contain a reimbursement instruction?
If not, payment will not be made until the documents reach the issuing bank's counter, unless special arrangements have been made by your bank. Is this acceptable?
11. Are bank charges paid by the correct party?
It is common for both buyer and seller to pay their own bank charges. Is this agreed and clearly stated in the letter of credit?
12. Is the letter of credit subject to UCP 600?
If a letter of credit is issued in SWIFT format (the standard format used in many international banking transactions, including the issuance of letters of credit), the issuing bank automatically agrees to place its letter of credit under UCP 600. Any other format, and not mentioning UCP 600, and you should probably modify the LC.
Execution of the letter of credit
After checking the letter of credit, if you are satisfied that everything is acceptable, you can proceed with the shipment.
However, if there is a problem with the letter of credit, some decisions have to be made: to correct the operation in order to be on the safe side or to continue the shipment after knowing the problems and discrepancies. Or is the letter of credit so bad that you should consider canceling the order? In this case, you should talk to management within the company.
Related Q&A: What is a letter of credit? What is a letter of credit? A letter of credit is a document used by a bank to guarantee the buyer's or importer's ability to pay.? In international trade activities, the buyer and seller may not trust each other, the buyer is concerned about the prepayment, the seller does not ship the goods according to the contract requirements; the seller is also worried about the shipment or submission of shipping documents after the buyer does not pay. Therefore, the need for two banks as the buyer and seller as a guarantor, on behalf of the collection and delivery of documents, to bank credit instead of commercial credit. Banks in this activity is the tool used in the letter of credit. Can be seen, the letter of credit is a bank conditional guarantee of payment of the certificate, become a common settlement of international trade activities. In accordance with the general provisions of this settlement, the buyer will first deposit the purchase price of the bank, the bank to open a letter of credit, notify the off-site seller's account bank to the seller, the seller in accordance with the terms of the contract and the letter of credit to ship the goods, the bank on behalf of the buyer to make payment. Letter of credit method has three characteristics: First, the letter of credit is not dependent on the contract of sale, the bank in the review of the single emphasizes the letter of credit and the underlying trade is separated from the written form of certification. The second is that the letter of credit is paid on the basis of the bill, not subject to the goods. As long as the documents match, the issuing bank should be unconditional payment. Third, the letter of credit is a kind of bank credit, it is a kind of bank guarantee documents.