Regulatory Procedure

HOW TO OPEN A LETTER OF CREDIT

Small and Medium Enterprises Development Authority

Ministry of Industries & Production
Government of Pakistan
www.smeda.org.pk
HEAD OFFICE
4th Floor, Building No. 3, Aiwan-e-Iqbal Complex, Egerton Road,
Lahore
Tel: (92 42) 111 111 456, Fax: (92 42) 36304926-7
helpdesk@smeda.org.pk

REGIONAL OFFICE REGIONAL OFFICE REGIONAL OFFICE REGIONAL OFFICE

PUNJAB SINDH KPK BALOCHISTAN

3rd Floor, Building No. 3, 5TH Floor, Bahria Ground Floor Bungalow No. 15-A
Aiwan-e-Iqbal Complex, Complex II, M.T. Khan Road, State Life Building Chaman Housing Scheme
Egerton Road Lahore, Karachi. The Mall, Peshawar. Airport Road, Quetta.
Tel: (042) 111-111-456 Tel: (021) 111-111-456 Tel: (091) 9213046-47 Tel: (081) 831623, 831702
Fax: (042) 36304926-7 Fax: (021) 5610572 Fax: (091) 286908 Fax: (081) 831922
helpdesk.punjab@smeda.org.pk helpdesk-khi@smeda.org.pk helpdesk-pew@smeda.org.pk helpdesk-qta@smeda.org.pk

August 2015
Regulatory Procedure HOW TO OPEN A LETTER OF CREDIT

Table of Contents

1. DISCLAIMER..................................................................................................................... 3
2. INTRODUCTION OF SMEDA......................................................................................... 4
3. ROLE OF LEGAL SERVICES CELL, SMEDA ............................................................ 5
1 LETTER OF CREDIT (L/C) .............................................................................................. 5
2 PARTIES INVOLVED IN LETTER OFCREDIT ........................................................... 6
2.1 Buyer / Importer (herein after called The Applicant).................................................. 6
2.2 Seller / Exporter (herein after called The Beneficiary) ............................................... 6
2.3 The Issuing Bank ............................................................................................................ 6
2.4 The Advising Bank ......................................................................................................... 6
3 STEP BY STEP PROCEDURE TO OPEN AL/C ............................................................ 6
4 FORMS AND TYPES OFL/C ............................................................................................ 8
4.1 Revocable L/C ................................................................................................................ 8
4.2 Irrevocable L/C ............................................................................................................... 8
4.3 Confirmed L/C ................................................................................................................ 8
4.4 Transferable L/C ............................................................................................................. 8
4.5 L/C payable at sight ........................................................................................................ 8
4.6 L/C payable on the maturity date .................................................................................... 8
5 INFORMATION THAT AN L/C MUSTHAVE ............................................................... 9
6 CONFIRMATION OFL/C.................................................................................................. 9
7 DOCUMENTS THAT MAY BE STIPULATED IN AN L/C ........................................ 10
8 CASH MARGIN RESTRICTION ON IMPORT L/C ................................................... 10
9 TIPS TO MINIMIZE RISKS ........................................................................................... 10
10 ANNEXURES .................................................................................................................... 12
10.1 Annexure - I ................................................................................................................ 12
10.2 Annexure -II ................................................................................................................ 13

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Regulatory Procedure HOW TO OPEN A LETTER OF CREDIT

1. Disclaimer
Information in this document is provided only for general information purpose and on an "as
is" basis without any warranties of any kind. Use of this information is at the user's sole risk.
SMEDA assumes no responsibility for the accuracy or completeness of this information and
shall not be liable for any damages arising from its use.

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Regulatory Procedure HOW TO OPEN A LETTER OF CREDIT

2. Introduction of SMEDA

The Small and Medium Enterprises Development Authority (SMEDA) was established with
the objective to provide fresh impetus to the economy through the launch of an aggressive
SME development strategy. Since its inception in October 1998, SMEDA had adopted a
sectoral SME development approach. A few priority sectors were selected on the criterion of
SME presence. In depth research was conducted and comprehensive development plans were
formulated after identification of impediments and retardants. The all-encompassing sectoral
development strategy involved overhauling of the regulatory environment by taking into
consideration other important aspects including finance, marketing, technology and human
resource development.

After successfully qualifying in the first phase of sector development SMEDA reorganized its
operations in January 2001 with the task of SME development at a broader scale and enhanced
outreach in terms of SMEDAs areas of operation. Currently, SMEDA along with sectoral
focus offers a range of services to SMEs including over the counter support systems, exclusive
business development facilities, training and development and information dissemination
through a wide range of publications. SMEDAs activities can now be classified into following
broad areas:

Creating a Conducive Environment; includes collaboration with policy makers to devise

facilitating mechanisms for SMEs by removing regulatory impediments across numerous
policy areas

Cluster/Sector Development; comprises formulation and implementation of projects for SME

clusters/sectors in collaboration with industry/trade associations and chambers

Enhancing Access to Business Development Services development and provision of services

to meet business management, strategic and operational requirements of SMEs.

SMEDA has so far successfully formulated strategies for sectors including fruits and
vegetables, marble and granite, gems and jewelry, marine fisheries, leather and footwear,
textiles, surgical instruments, transport and dairy. Whereas the task of SME development at a
broader scale still requires more coverage and enhanced reach in terms of SMEDAs areas of
operation.

Along with the sectoral focus a broad spectrum of services are now being offered to the SMEs
by SMEDA, which are driven by factors such as enhanced interaction amongst the
stakeholders, need based sectoral research, over the counter support systems, exclusive
business development facilities, training and development for SMEs and information
dissemination through wide range of publications.

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Regulatory Procedure HOW TO OPEN A LETTER OF CREDIT

3. Role of Legal Services Cell, SMEDA

The Legal Services Cell (LSC) is a part of Business& Sector Development Services Division of
SMEDA and plays a key role in providing an overall facilitation and support to SMEs. The LSC
provides guidance based on field realities pertaining to SMEs in Pakistan and other parts of the
world.

LSC believes that information dissemination to SMEs on the existing regulatory environment is of
paramount importance and plays a pivotal role in their sustainable development.

In order to facilitate SMEs at an individual level LSC has developed user-friendly systems, which
provide them detail description of the laws and regulations including processes and steps required
for compliance.

The purpose of this document is to provide SMEs either individuals or companies with information
pertaining to Letter of Credit. Entrepreneurs interested in enhancing their understanding about the
procedures and rights can also use the document. For convenience of the readers sample of various
forms, instructions on how to fill up the forms and important addresses are also included.

1 Letter Of Credit (L/C)

A letter of credit (L/C) is a bank's promise to pay to the exporter all the agreed value ofthe
consignmentonbehalfoftheforeignimporter,providedthattheexporterhascomplied with all the
terms and conditions of theL/C.

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Regulatory Procedure HOW TO OPEN A LETTER OF CREDIT

L/C is the most commonly used medium used for payment ininternational trade and is used to
protect the interests of both the exporter and importer. Using L/C as a mode of paymenthelps to
minimize the risk of transaction. L/C also adds toensure,to both buyer and seller,that the goods
will be shipped within the time stipulatedand the payment shall be made on time without undue
delay.

2 Parties Involved in Letter ofCredit

2.1 Buyer / Importer (herein after called TheApplicant)
The Applicant means the importer (buyer) who requests a bank to issue a Letter ofCredit.

2.2 Seller / Exporter(herein after called The Beneficiary)

The Beneficiary means the exporter (seller) who finally ships the goods and receives the
paymenton fulfillment of terms and conditions laid down in theLetter of Credit.

2.3 The Issuing Bank

Theissuingbank( I m p o r t e r s B a n k ) issuestheL/Candmakesthepaymentonbehalfof importer
as per the terms and conditions prescribed in L/C. The exporter maynegotiate with the buyer to
select a particular bank (if possible) for issuance of the L/C and may askthe Advising Bank if it
has a corresponding bank in the buyer's country and suggest thatbank to the buyer as the
issuingbank.

Itisnotnecessarythattheissuingbankshallbethesamebankwherethebuyerorthe
sellerhasacommercialaccountitcanbeanyotherbank, mutually agreed upon bytheimporterand
exporter.

2.4 The Advising Bank

Advising bank is usually in the country of the seller. The Advising Bank advisesthe exporter /
seller / beneficiary that an L/C is received fromthe issuing bank and provides information
ontermsandconditionsoftheL/C.Theadvisingbankisnotresponsibleforany payment underL/C.

3 Step by Step Procedure to Open AL/C

The chart below shows how participants are involved in the process of openingand
payment of L/C:

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Regulatory Procedure HOW TO OPEN A LETTER OF CREDIT

TheApplicant 5 TheBeneficiary

2
6 4

3
The IssuingBank The AdvisingBank
7

1. TheApplicant(buyer) andtheBeneficiary(seller)
negotiatetermsandconditionsoftheL/Cas per the agreement they have made.
2. The Applicant applies to the Issuing Bank to issue the L/C on an applicationform.
3. The Issuing Bank requires the following documents from theapplicant:
a) Formal contract between the importer andexporter.
b) ProFormaInvoice or Contract or Purchase Order(a
documentthroughwhichtheexporterinformstheimporter about the kind and
quantities of goods being sent, their value, time ofshipment and
importantspecifications).
c) Insurance Policy with premium paid receipt.

After inspecting all these documents the bank issues the L/C and forwards it to the
Advising Bank through SWIFT (Society for Worldwide Interbank Financial
Telecommunication) or Mail.

4. The Advising Bank checks the apparent authenticity of the L/C and advisesthe L/C to
theBeneficiary.
5. TheBeneficiarychecksiftheL/Ccomplieswiththeformalcontractandifall
termsandconditionsspecifiedintheL/Ccanbesatisfied. The Beneficiaryshipsthegoodsto
theimporter.
6. The Beneficiary assembles the documents specified in the L/C, checksthe documents for
discrepancies with the L/C, draws the draft (if it is Sight or Usance L/C as No Draft or
Bill of Exchange is required in case of Deferred Payment L/C)and presents thedraft and
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Regulatory Procedure HOW TO OPEN A LETTER OF CREDIT

the documents to the AdvisingBank

7. The Advising Bank inspects the draft and the documents against termsand conditions of
the L/C and forwards them to the IssuingBank
8. TheIssuingBankchecksifthedocumentscomplywiththeL/Candmakesa payment
immediately (if the L/C is available by sight) or on a certain date (ifL/C is available by
deferredpayment)

4 Forms and Types ofL/C

Letter of Credit is a conditional bank guarantee of payment for suppliedgoods, conditional means
that to get paid you have to present the documents, whichshould strictly comply with the terms
and conditions specified in the L/C. It is important tonote that banks only deal with the
documents involved in L/C and not with the goodsor merchandise.

Following are the most commonly used forms and types of an L/C:

4.1 Revocable L/C

ArevocableL/CmaybeamendedorcancelledbytheIssuingBankatanymomentand without prior
notice to the Beneficiary. This form of L/C is not much acceptable inexport proceedsarrangement.
4.2 Irrevocable L/C
An irrevocable L/C cannot be amended or cancelled without prior notice to andtheconsent of the
parties involved. Any amendment in irrevocable L/C causes delays and extracost
totheimporterandexporter.It is importantthat an L/Cindicateswhether it is revocable or
irrevocable, in the absence of such indication the L/C shall be deemed to be irrevocable.
4.3 Confirmed L/C
When goods are exported to a country with economical or political instability or ifthe exporter /
seller is unfamiliar with the Issuing Bank, he may require from theimporter that the L/C be
confirmed by a bank of international repute. If L/C is confirmed,the
confirmingbankbecomesliable for thepaymentincasetheissuingbankrefuses to pay against the L/C.
4.4 Transferable L/C
Transferable L/C is a perfect financial tool for middlemen to secure their margin without
involving any funds. It allows dealing with more than one beneficiary. When a transferable L/C is
issued in ones favor, he can transfer it to any seller and use it as a payment.
4.5 L/C payable at sight
"Payable at sight" means that exporter / seller be paid "immediately" (in fact, it may take up to
10-12 days) after presentation of the documents stipulated in the L/C to the IssuingBank or to the
Confirming Bank if it wasconfirmed.
4.6 L/C payable on the maturity date
Ifdeferredpaymentwasagreed,exporterwillbepaidonthematuritydateindicatedin the L/C after
presentation of the documents stipulated in the L/C to the Issuing Bank.The date is specified on
the L/C document from which the deferring period starts (e.g. 30/60/90/120days from or after

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Regulatory Procedure HOW TO OPEN A LETTER OF CREDIT

date of receipt ofdocuments or transport documents).

5 Information that an L/C MustHave

It is essential for the importer and exporter to be absolutely sure that the L/C wasprepared
correctly and there is no legitimate ground for refusal of payment under the L/C. Therefore the
L/C must contain the below mentioned informationcorrectly.It is important that the L/C should be
in a language understandable to all, preferably English.
a) Applicant's full name andaddress
b) Beneficiary's full name andaddress
c) Issuing Bankdetails
d) Advising Bankdetails
e) Form and type of credit (e.g. irrevocable,transferable etc.)
f) Issue date
g) Expiry date
h) The latest date of shipment (usually with words "no laterthan")
i) Expiry date for presentation ofdocuments and Presentation Period.
j) Amount payable underL/C
k) Currency ofpayment
l) Port of loading
m) Port of discharge
n) Terms ofdelivery
o) Indication of the payment of the freight (Freight Prepaid/FreightCollect)
p) Allowances for partial shipment or trans-shipment ifneeded
q) Type of payment availability (e.g. at sight, on the maturitydate)
r) Description of goods (must correspond with the description given in the Pro
FormaInvoice)
s) List of documents required for thepayment
t) Accountability for bankcharges

6 Confirmation ofL/C
Theconfirmation of theL/Cbyanotherbank-theConfirmingBank-meansthatifthe
IssuingBankrefuses to make thepayment,theConfirmingBankisresponsible for this payment. If
you are dealing with a buyer from a country with an unstable politicalor economical situation,
always ask for the confirmation of theL/C.
Thebest-casescenarioiswhentheAdvisingBankconfirmstheL/C. If theAdvising Bank does not
agree to confirm the L/C, ask the bank to recommend you another bank to be the
ConfirmingBank.

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Regulatory Procedure HOW TO OPEN A LETTER OF CREDIT

Thereareadditionalcharges for theconfirmationoftheL/C,whichdependontherisk involved in

dealing with the particular country. The responsibility to pay for the confirmation is negotiable
and usually is paid by the importer. However, if it wasn't agreedpriortotheissuance of the
L/C,importeris the onewhowillpayforthisservice.
7 Documents That May Be Stipulated in anL/C
Before the L/C is issued, the importer and exporter negotiate on documents which are to
beincludedintheL/Candwhichare not.Itisalwaysadvisable to keepthe list asshortas possible. It is
not necessary to mention all documents required by the contract in theL/C. Usually the exporter is
required to present a commercial invoice, a transportdocument and an insurance
policy(certificate).
The list ofadditionaldocumentsdependsontheagreement made betweensellerandthe buyer.Usually
the buyerwillincludedocumentsneeded for thecustomsclearance.The list may include:

Certificate oforigin
Certificate ofquality
Weightcertificate
Pre-shipment inspectioncertificate
Packingdeclaration
Packinglist
Fumigationcertificate
Insurance certificate,etc.
8 Cash Margin Restriction on Import L/C
In Pakistan the importer needs to fulfill the cash margin requirement for issuance of Import L/C
by an issuing bank. In cash margin requirement the importer (buyer)shall deposit a certain
amount to the issuing bank against the total value of L/C, withoutbeing withdrawn until the
realization of terms and conditions of L/C.
Cashmarginpercentage onimportofitemsvaries periodically in accordance with the directions of
the State Bank of Pakistan as per BPRD Circulars issued at various times. For current references,
please refer to annexures at the end of the document.
9 Tips To MinimizeRisks
Acarefulattention to thefollowingconsiderations,by the importerandexporter,may minimize the
risks involved in L/Ctransactions:
1- Prior to the issuance of the L/C, negotiate exactly what documents must bepresented to
thebank.
2- Try to agree to present as few documents as possible and to keep the descriptionsas simple
as possible.
3- Once issued, the L/C can only be altered or cancelled by consent of allparties.
4- Remember that L/C is a bank-to-bank agreement and is not a substitute for thecontract

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Regulatory Procedure HOW TO OPEN A LETTER OF CREDIT

between seller and thebuyer.

5- The importer should be sure that he is in a position to provide the bank withall documents
stipulated in the L/C intime.
6- Always indicate L/C as"irrevocable".
7- Check the additional conditions and be sure that you are able to meetthem.
8- If the exporter has any doubts that the Issuing Bank may fail to make a payment, forany
political or economic reason, in this case the L/C must be confirmed by the Advising Bank
or by any other bank, whose confirmation will be accepted by the AdvisingBank.
9- If there are any discrepancies and the L/C has to be amended, do not ship goodsbefore
these amendments aremade.
10- Specify how many original documents and how many copies are to bepresented.
11- The description of goods stipulated in the L/C must correspond with the description given
in the invoice. If the invoice states "100% Fruit Juice" and the L/C states "Pakistani Fruit
Juice", it is enough for the bank to refuse the payment and this decision will most likely be
supported by the court.
12- L/C may require a "clean" transport document. That means the document,which bears no
clause or notation that expressly declares a defective condition of the goods and/or
thepackaging.

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Regulatory Procedure HOW TO OPEN A LETTER OF CREDIT

10 Annexures

10.1 Annexure - I
BPRD Circular Letter No. 08 of 2009 March 09, 2009

The Presidents/Chief Executives,

All Banks

Dear Sir/Madam,

Minimum Margin Restriction on Import Letters of Credit

Please refer to BPRD Circular Letter No.05 of 2009 dated March 03, 2009 on the captioned subject.

It has been decided to waive the condition of cash margin requirement on HS Code 0713 (Leguminous Vegetables,
Dried Shelled).

Banks are advised to comply with the above mentioned instructions immediately. However, the other instructions on
the subject will remain unchanged.

Please acknowledge receipt.

Yours sincerely,

Sd/-

(Syed Irfan Ali)

Director

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Regulatory Procedure HOW TO OPEN A LETTER OF CREDIT

10.2 Annexure -II

BPRD Circular No. 12 of 2009 June 12, 2009

The Presidents/Chief Executives,

All Banks

Minimum Margin Restriction on Import Letters of Credit

Please refer to BPRD Circular Nos.06 and 11 dated May 22, 2008 and August 27, 2008 respectively and
subsequent Circular Letters on the captioned subject.

It has been decided to withdraw cash margin restriction for opening of import letters of credit with immediate
effect.

Please acknowledge receipt.

Yours sincerely,

Sd/-
(Muhammad AkhtarJaved)
Senior Joint Director

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