If you are an importer, paying your suppliers can be a challenge. You want to avoid risks, delays, and fraud, while ensuring that your goods are delivered on time and as agreed. One way to achieve this is by using letters of credit for import payments. In this article, you will learn what letters of credit are, how they work, and what benefits they offer for importers.
A letter of credit (LC) is a document issued by a bank or a financial institution that guarantees the payment to a seller on behalf of a buyer, if certain conditions are met. The buyer applies for an LC from his bank, specifying the amount, the currency, the expiry date, and the documents required to prove the shipment and delivery of the goods. The bank then sends the LC to the seller's bank, which notifies the seller that he can ship the goods and receive the payment upon presenting the documents.
Reading an LC requires foresight to avoid a discrepancy, make sure the documents requested in the LC can be fulfilled (if you are an exporter), Make sure what your LC is CLEAN LC that all the contents in it are fulfilled properly. I will give an example of one of LC " Carrier BL is required, the ship must be seaworthy, and the Ship age under 15 years, and this must be mentioned on the BL". What you should do: Before booking a space, you should check it about the seaworthy and age of the ship and whether it can be mentioned in the BL. If it turns out that the shipping line / Freight Forwarding cannot meet to be included in Carrier BL, then you must notify the buyer (Importer) to amend the LC. The amendment LC " House BL allowed "
LC issuing procedures: 1.The goods in stock and its authenticity should be showed to the buyer before signing the contract. 2.After the contract,Seller transports the product to loading port and provides the relevant?documents to the buyer. 3.Buyer provides the seller with the letter of authorization to CCIC.Then Seller issues?2%?PB?to the buyer. 4.Buyer entrusts CCIC to loading port to inspect the?product contents .The test results will come out in 3?working days. 5.L/C will be issued by buyer according to the inspection results. 6.Seller books the containers,buyer entrusts the CCIC to inspect the loading , taking samples, sealing the containers etc. 7.The detailed payment terms are based on the signed contract .
- LC is a payment method to guarantee that suppliers payment is secured. Even if the buyer doesnt pay, the issuing bank takes full responsibility to pay to seller on behalf of the buyer. - Sometimes to avoid costs and charges, buyer and seller agrees to a common term without opening LC, though it depends on some conditions; buyer seler trustworthiness, banks acceptance on this payment method etc.
LC is a payment method suitable for a low-trust environment involving the importer and the exporter. It's useful to mitigate risks. Maybe the parties are just starting a relationship, maybe the importer's country has a high risk score... it's an effective - yet expensive - way to enable these transactions.
In my experience, LC is built on payments transaction between the banks when the payment is guaranteed according to some condition that was negotiated between a client and a supplier. For example, payment will be made after the supplier will present Bill of Lading. From my opinion, the LC is a good guarantee for supplier but not such a good guarantee for a customer. For example is supplier send damaged goods the bank will still pay the money because the bank is not a commercial side of the deal and only pay when condition are met. For a client it can be used as a substitute to down payment without paying the money but the bank takes some amount as a deposit so it have costs. If you use postponed payment by the terms of LC = financing
Using an irrevocable letter of credit (LC) for import payments involves several steps. First, the buyer and seller must agree on the terms of the sale, such as the price, quantity, quality, delivery date, and payment method. The buyer then applies for an LC from their bank, providing details of the seller and the goods. The bank issues the LC and sends it to the seller's bank, either directly or through an intermediary. The seller's bank confirms the LC and notifies them to ship the goods. The seller obtains documents specified in the LC, such as an invoice or bill of lading, which they present to their bank. The bank requests payment from the buyer's bank which verifies documents and transfers funds. Finally, the seller's bank pays the seller and sends documents to the buyer's bank who releases them to claim goods from carrier.
The choice of which type of letter of credit (LC) to work with depends on your specific trade needs and circumstances. Irrevocable LC: This cannot be changed or canceled without the agreement of all parties involved. It provides a higher level of security for both the buyer and seller. Confirmed LC: In addition to the issuing bank's commitment, a second bank (usually in the seller's country) confirms the LC, adding an extra layer of payment security. This is especially useful when there are concerns about the issuing bank's financial stability.
After a comercial contract is agreed between buyer and seller, the importer applies for an LC with their bank and provide information regarding the transaction. The buyer's bank sends the LC to the seller's bank with the seller as beneficiary, then the seller's bank notifies the exporter that they can ship the goods. Once seller ships the goods and obtains carrier's B/L, seller will submit the B/L and any other document required as per terms and conditions of the LC to seller's bank, then this bank will submit such documents in exchange of payment from the buyer's bank and will transfer funds to seller. Finally, buyer's bank will deliver documents to buyer for purposes of customs clearance and reception of goods from the carrier.
3. Confirmation (optional): If the exporter is concerned about the creditworthiness of your bank, they may request a confirmation from a bank in their own country (the confirming bank). This adds an extra layer of security for the exporter. 4. LC Notification: The issuing bank will issue an LC and send it to the exporter's bank (the advising bank) in the exporter's country. The advising bank will notify the exporter about the LC's details and terms.
Actually the payment is done after the documents has been sent to buyers bank by sellers bank. And it also depends on the documents' acceptance by buyer. There are several timeframe binding for buyers bank to release payment, like 5 days from acceptance (this is standard).
Essentially, a Letter of Credit is a bank guarantee. That is to say that baking and credit rules apply. Letters of credit are also similar to contracts (changes are made through ammendments), and they are very old-school in the way that they are written (fixed and numbered fields for specific information).
Using letters of credit for import payments can offer several benefits for importers, such as reducing the risk of non-delivery or non-payment, improving the cash flow and creditworthiness, enhancing trust and reputation, and facilitating the trade and compliance. However, there are also drawbacks to consider, such as increasing the cost and complexity, limiting flexibility and control, and exposing the importer to discrepancies or disputes. With a letter of credit, the importer does not have to pay in advance or provide a deposit, but must pay fees and charges to the banks. Additionally, they must abide by the LC terms and conditions without the ability to modify or cancel it without consent from both the seller and banks. The banks will check documents for conformity with the LC but not accuracy or authenticity, potentially rejecting payment if there are errors or inconsistencies.
The main benefit that LC's bring to both importers and exporters alike, is protection for their transaction, since banks act as trustworthy intermediaries and underwriting agents as well. The benefits of LC's for importers are noticed on reducing risk of non-delivery, while the benefits for exporters is to reduce the risk of non-payment. Additionally, an LC is a very effective way to develop trust and facilitate trade among parties. The cons of LC's could be the cost and fees that banks charge for this payment method, but it might as well be worth it, given the level of protection that an LC brings to both counterparties in a transaction.
Not All L/C from all countries banks accepted due process some banks asks for irrevocable L/C payments to be granted. And as mentioned before the draft must be double checked as normally misses parts or mistakes are reported a lot.
LCs mostly secure the reception of payment from buyer to seller. A basic document for importation is the UCP 600, which clearly states the terms and conditions. These terms and conditions mostly secure seller, not buyer; to be honest. If you are a buyer, you have to be very very careful on your first time purchase from a seller. You can include any quality parameters and pre shipment tests to be on safe side.
1) Importer is guaranteed to receive timely delivery of goods. 2) It makes structuring an advantageous payment schedule easy. 3) Expediting customs clearance and ultimate delivery as the documents are received quickly. 4) It gives an assurance to the importer that the payment will only be made to the exporter upon presentation of documents evidencing the shipment of goods. 5) It reduces the risk of non-performance of the exporter.
5. Shipment and Documentation: Once the exporter ships the goods, they will prepare the required shipping and commercial documents, such as the bill of lading, commercial invoice, packing list, and any other documents specified in the LC. 6. Presentation of Documents: The exporter will present the shipping and commercial documents to their bank (the advising bank) within the specified timeframe as per the LC terms. 7. Document Examination: The advising bank will examine the documents to ensure they comply with the terms and conditions of the LC. If the documents are in order, the advising bank will forward them to the issuing bank.
I would also add the importance of drafting the LC before opening the final one. It is common to find mistakes despite having agreed on the terms of the sales beforehand. Very common mistakes are spelling, the agreed dates (e.g. last day of shipment).
Well it is indeed complex process for new importer and exporter however this have pros and cons as well. It is customizable process and helps to build new strong relationship between buyers and sellers by reducing risk. At the same time be ready for the cost of doing business in the form of bank fees and may be lots of formalities as well.
We must remember that LC is a documental process. If the shipping documents are issued perfectly according to the established terms, the payment will be on its way. But suppose the cargo itself is not as agreed, different from the terms or the documents. In this case, the bank won't know and will effect the payment anyway. The dispute will happen apart from that, after the cargo has arrived and the payment has been sent. It's also nice to remember that in some cases, there will be more banks involved, if the exporter requires the LC to be confirmed by a bank with a higher rating.
It is also important to understand that there are different types of LC, each adapted to different markets and functions or issues. Some of these known types of LC are: Revocable/irrevocable (although the revocable type is tending to become obsolete nowadays). Notified/Confirmed. Revolving. Cumulative/Non-Cumulative. At sight/deferred/usance. Transferable/Non-Transferable. Red Clause/Green Clause. Back-To-Back Stand-By.
8. Payment or Acceptance: The issuing bank will review the documents and, if they comply with the LC's terms, make the payment to the exporter or accept the exporter's draft (if a time or sight draft was issued). 9. Delivery of Documents: The issuing bank will deliver the documents to you, the importer, upon receipt of payment or acceptance. 10. Customs Clearance and Goods Receipt: With the documents in hand, you can proceed with customs clearance and take delivery of the imported goods. Using letters of credit for import payments assures both the importer and exporter that payment is made only when agreed conditions are met. It reduces the risk of non-payment or non-delivery, making it a secure payment method in global trade.