Chapter Seven: Letters of

Credit
• Introduction: What is a Letter of Credit?

• Types:
 Revocable & Irrevocable Letter of Credit

Sight & Term Letter of Credit

Confirmed Letter of Credit

• Mechanics: How does a Letter of Credit transaction

work?
• Risk Analysis: Advantages & Disadvantages
 Letters of Credit
•It is a written undertaking by the Importer’s bank,
known as the Issuing Bank, on behalf of its customer.
•Importer (Applicant), promising to effect payment in
favour of the Exporter (Beneficiary) up to a stated sum
of money, within a prescribed time limit and
against stipulated documents.
•A key principle underlying L/C is that banks deal only
in documents and not in goods.
•The decision to pay under a Letter of Credit will be
based entirely on whether the documents presented
to the bank appear on their face to be in accordance
with the terms and conditions of the Letter of Credit.
•It would be prohibitive for the banks to physically
 Rules Governing Letters
Of Credit
• The Uniform Customs and Practice for Documentary Credits
(UCP) is a set of internationally recognized rules governing letters
of credit, issued by the International Chamber of Commerce
(ICC).
• ICC publishes internationally agreed-upon rules, definitions and
practices governing Letters of Credit
• It standardizes banking practices to ensure smooth international
trade transactions.
• UCP Ensures uniformity in handling documentary credits, reducing
misunderstandings and disputes.
• Used worldwide by banks, traders, and businesses in documentary
credit transactions.
• The lastest version of these rules was implemented in 2007 and is
referred to as the UCP 600,
• The letter of credit is independent of the underlying sales contract.
• Banks deal with documents, not goods, ensuring payment is based
on compliant documentation.
 Types of Letters of Credit
Basic Facts: Revocable/Irrevocable &
Sight/Term
Revocable Letter of • Letters of Credit may
Credit
be settled either by
• revoked without the sight or by acceptance:
consent of the
Exporter, meaning that • If payment is to be
it may be canceled or made at the time that
changed up to the time documents are
the documents are presented, this is
presented. referred to as a sight
• are very rarely used. Letter of Credit.
Irrevocable Letter of • If payment is to be
Credit: made at a future fixed
• cannot be canceled or time from the
amended without the presentation of
consent of all parties documents, this is
Types of Letters of Credit
Confirmed Letter of Credit
•Under a Confirmed Letter of Credit, a bank, called
the Confirming Bank, adds its commitment to that of
the Issuing Bank to pay the Exporter under the Letter
of Credit provided all terms and conditions of the
Letter of Credit are met.
•The Confirming Bank is usually located in the same
country as the Exporter.
•An Exporter would request a Confirmed Letter of
Credit if it does not consider the financial strength of
the Issuing Bank or the country in which it is located
to be acceptable risks.
 WHY HAVE A LETTER OF CREDIT?

IF I SHIP GOODS,
WILL YOU PAY?

IF I PAY, WILL YOU

SHIP THE GOODS?

SOLVES ISSUES OF MUTUAL MISTRUST BY USING

BANKS AS ARBITERS
NEGOTIATE L/C TERMS BEFORE ENTERING A
CONTRACT
 WHO ARE THE PLAYERS of LETTERS OF CREDIT?

IMPORTER
(Buyer) EXPORTER
CONTRACT (Seller)

Foreign Bank
Regions Bank L/C (Advising Bank)
(Issuing Bank)
(MAY CONFIRM)
 Mechanics of Letters of
Credit
How does a Letter of Credit work?
• The mechanics of a Letter of Credit are easily
understood when separated into the following
three steps:
» Issuance
» Flow of Goods
» Flow of Documents & Payment
 1. Issuance
• After the trading parties agree on 4
a sale of goods where payment is
made by Letter of Credit, the Advice
Importer requests that its bank /Confirmatio
(the Issuing Bank) issue a Letter of
Exporter/ n of the Advising/
Credit in favour of the Exporter Beneficiar Letter of Confirming
Credit.
(Beneficiary). y Bank
• The Issuing Bank then sends the
Letter of Credit to the Advising Request to
Bank. Contract
advise &
Negotiations possibly
• A request may be included for the
1 confirm the
Advising Bank to add its Letter of 3
confirmation. The Advising Bank is Credit
usually located in the country
Importer applies
where the Exporter does business for Letter of
and may be the Exporter’s bank, Credit.
but does not have to be.
Importe 2
• Next, the Advising/Confirming Issuing
Bank verifies the Letter of Credit r/ Bank
for authenticity and sends it to the Applican
Note: For the purpose of the Crash Course, the Advising Bank is also ac
Exporter. t
the Confirming Bank. However, the roles of advising and confirming th
Letter of Credit may be performed by two separate banks.
 2. Flow of Goods

• Upon receipt of the Letter of

Credit, the Exporter reviews
the Letter of Credit to ensure
that it corresponds to the Exporter/
terms and conditions in the Beneficiary
purchase and sales
agreement;
• that the documents stipulated
in the Letter of Credit can be GOOD
produced; and that the terms S
and conditions of the Letter of
Credit can be fulfilled.
• Assuming the Exporter is in
agreement with the above, it
arranges for goods shipment.
Importer/
Applicant
 3. Flow of Documents & Payment
• After the goods are 3
shipped, the Exporter
presents the
Documen
documents specified Exporter/ 2 Advising/
ts
Beneficia Confirming
in the Letter of Credit ry Bank
to the Advising/ 4

Documen
Confirming Bank. 5
• Once the documents GOODS

ts
are checked and 1
found to comply with
the Letter of Credit
(i.e. without
discrepancies), the Importe
Issuing
r/
Advising/ Confirming Applican
Bank
Bank forwards these t
 Cont..
Flow of Documents & Payment
3
• In turn, the Issuing
Bank examines the
Documen
documents to ensure Exporter/ 2 ts
Advising/
Beneficia Confirming
they comply with the ry Bank
Letter of Credit. 4

Documen
• If the documents are 5
in order, the Issuing GOODS

ts
Bank will obtain 1
payment from the 7
Documen
Importer for payment ts
already made to the
Confirming Bank. Importe
6 Issuing
• Documents are r/
Bank
Applican
delivered to the t
 Risk Analysis: Letters of
Credit
Importer Exporter

Advantages: Advantages:
•Importer is assured that, for •An undertaking from the Issuing
the Exporter to be paid, all Bank that you will receive
terms and conditions of the payment under the Letter of
Letter of Credit must be met. Credit provided that you meet all
terms and conditions of the Letter
•Ability to negotiate more of Credit.
favourable trade terms with •Shifts credit risk from the
the Exporter when payment by Importer to the Issuing bank.
Letter of Credit is offered. •Not obligated to ship against a
Disadvantages: Letter of Credit that is not issued
as agreed.
•A Letter of Credit assures
Disadvantages:
correct documents but not •Documents must be prepared in
necessarily correct goods.
strict compliance with the
Documents Required By The L/C

•All Documents Must Conform To The Letter Of

Credit And Be Consistent With Each Other

Three Forms Of Documents:

The Financial Claim

1
The Transport Document
2
Other Documents
3
 1. THE FINANCIAL CLAIM: THE
“DRAFT”
•A NEGOTIABLE INSTRUMENT SIMILAR TO A CHECK)
Generally The Draft Is:
1) Drawn On The Bank That Issued The L/C
2) Payable At A Certain Time (Or Tenor)
3) In The Currency Specified In The L/C

Examples Of “Tenor”: At Sight, At 120 Days Bill Of

Lading Date, On August 31, 20xx, 30 Days Date, Or
Any Determinable Date.
“at sight” is for immediate payment. For any tenor beyond s
ank “accepts” The draft to mature/be payable at a future dat
is called a banker’s acceptance, and can be discounted)
2. Transport Document: The
Bill Of Lading

1) A “Contract Of Carriage” To Ship Goods

2) A “Title Document” To Ownership Of The
Goods (Except Truck, Rail, Air B/L’s)
3) Consignment “To Order”=negotiable
4) Notify Party (For Arrival Of Goods)
5) Freight Charges (Prepaid Or Collect)
6) Shipping Ports (“From” & “To”)

Note: All Aspects Must Conform To The L/C, And

Be Consistent With Other Documents
 • Other Documents

• Commercial invoice – description of goods critical

—must be verbatim
• Packing list – amount of goods in each package
or container
• Insurance certificate – usually 110% of value of
goods, covering risks specified in the L/C
• Certificate of origin – attests to the country of
origin
• Inspection certificate – independent verification
of quality/quantity
• Other documents – any required for certain
products
COMMON DOCUMENTS
TO A LETTER OF CREDIT
• Draft
• Commercial Invoice
• Transport Document
• Packing List
• Weight List
• Insurance Policy or Certificate
• Certificate of Origin
• Beneficiary’s Certificates
• Other Certificates
• Copy of Fax detailing shipping information
• Other documents as needed for the individual
transaction
AMENDMENTS TO THE L/C
• Are costly
• Are time consuming
• The seller instructs the buyer of the necessary
amendment
• The buyer must then request their bank to issue
the amendment
• The seller’s bank cannot request the issuing
bank to make an amendment
• Amendments have to be advised through the
same bank which advised the original L/C
• The beneficiary should notify the advising bank
of the approval or rejection of the amendment
Thank You !