Subject: BANKING OPERATIONS II

Course no. : 412FIN

College: Sadhu Vaswani Institute of Management Studies for Girls
Class: MBA Part II
Submitted to: Prof. Soumyakant Das
Assignment No: 3 (THREE)
Topic: Letter of Credit
Objective: To understand what is letter of credit and how it safeguards the

interest of the exporters.

Methodology: Secondary data
Submitted by: Ms. Anjali Thakur
Roll No: 13153
Submission Date: Monday 22th March, 2015

Introduction
Importing and exporting involves risks. Exporters run the risk of buyers failing to pay for goods,
while importers may risk paying but never receiving anything. Because of the distances
involved, it may be difficult to resolve any disputes.
One way of reducing the risks is to use a letter of credit - sometime known as documentary
credit. This can offer a guarantee to the seller that they will be paid, and the buyer can be sure
that no payment will be made until they receive the goods.
There are several different types of letters of credit available to use, depending on the
circumstances.
This guide explains what letters of credit are, how they work, and when you might consider
using one. It looks at some of the drawbacks of using a letter of credit and explores some
possible alternatives. It also explains the international rules that govern most letters of credit.
What is a letter of credit?
A letter of credit is basically a guarantee from a bank that a particular seller will receive a
payment due from a particular buyer. The bank guarantees that the seller will receive a specified
amount of money within a specified time. In return for guaranteeing the payment, the bank will
require that strict terms are met. It will want to receive certain documents - for example shipping
confirmation - as proof.
Why use a letter of credit?
Letters of credit are most commonly used when a buyer in one country purchases goods from a
seller in another country. The seller may ask the buyer to provide a letter of credit to guarantee
payment for the goods.
The main advantage of using a letter of credit is that it can give security to both the seller
and the buyer.
Advantages for sellers
By asking for an appropriate letter of credit a seller is reassured that they will receive their
money in full and on time. A letter of credit is one of the most secure methods of payment for
exporters as long as they meet all the terms and conditions. The risk of non-payment is
transferred from the seller to the bank (or banks).
Advantages for buyers
When a buyer uses a letter of credit they get a guarantee that the seller will honour their
side of the deal and provide documentary proof of this.

 Letter of Credit

1. An Importer (Buyer) and Exporter (Seller) agree on a purchase and sale of goods where
payment is made by Letter of Credit.
2. The Importer completes an application requesting its bank (Issuing Bank) to issue a Letter of
Credit in favour of the Exporter. Note that the Importer must have a line of credit with the
Issuing Bank in order to request that a Letter of Credit be issued.
3. The Issuing Bank issues the Letter of Credit and sends it to the Advising Bank by
telecommunication or registered mail in accordance with the Importers instructions.
4. The Advising Bank will verify the Letter of Credit for authenticity and send a copy to the
Exporter. The Exporter examines the Letter of Credit to ensure: a) it corresponds to the terms
and conditions in the purchase and sale agreement; b) documents stipulated in the Letter of
Credit can be produced; and c) the terms and conditions of the Letter of Credit may be
fulfilled.
5. The Exporter arranges for shipment of the goods, prepares and/or obtains the documents
specified in the Letter of Credit
6. The Exporter submits all the relevant docs required to the Advising Bank.
7. That bank checks the documents against the Letter of Credit and forwards them to the Issuing
Bank.
8. The Issuing Bank examines the documents to ensure they comply with the Letter of Credit
terms and conditions. The Issuing Bank obtains payment from the Importer for payment
already made to the available with or the Confirming Bank.
9. The Advising bank makes payment to the exporter and Documents are delivered to the
Importer to allow them to take possession of the goods from the transport company.

HOW LETTER OF CREDIT SAFEGUARDS THE INTEREST OF THE

EXPORTERS?

In a letter of credit terms of business transactions, rejection of export payment by raising

complaint on quality of goods cannot be effected.

Buyer cannot deny payment by raising dispute on quality of goods, as letter of credit
terms and conditions are based on documentation. Some of the fraudulent buyers

deliberately delays or hold payments by complaining on quality of goods.

Letter of credit minimizes the credit risk of exporter. In an import and export trade, the
geographical distance between importer and exporter is very far; hence ascertaining
credit worthiness of buyer is a major threat. In a mode of Letter of credit, such risk can be
avoided.

Letter of Credit provides a security to exporter which is another advantage of a letter of

credit. Based on such security, the exporter can preplan his further business activities to
strengthen his business world.

In a letter of credit, any dispute in transaction can be settled easily, as Letter of Credit
terms and conditions are under the guidelines of uniform customs and practice of
documentary credit.

In a letter of credit, all required documents have been mentioned well in advance of
shipment and there is no confusion or misunderstanding to the importer (buyer) to
inform supplier to act in between. This helps exporter to preplan efficiently which saves
time.

Against a Letter of Credit, an exporter can avail per shipment finance from banks or other
financial institutions. Many banks extend financial assistance with minimum bank
interest, as letter of credit is a safe export order.

Assurance to receive money in full is another advantage of letter of credit. In a letter of

credit, an exporter can ensure that he receives full amount as per LC which helps seller to
plan future business ideas.

The exporter receives money on time. Finance at right time is a prime factor for any
business transaction. So if a business man receives his anticipated amount on time, he can
plan his business activities smoothly without wasting time.

Normally and widely, a confirmed irrevocable LC is opened by buyer and seller which
are suitable for both. A confirmed irrevocable letter of credit is a confirmed order for
any exporter is concerned. So the exporter need not worry on cancellation of his export
order or changes in said order. This helps a lot for an exporter for his business plans in
various levels including financial plans, minimizing production risk, saving time etc.

Meeting delivery schedule by proper production plan is one of the major advantages
under a letter of credit terms of business. Normally, under a non LC business terms, the
buyer may keeps on changing delivery schedule as per their requirements time to time.
So this change of delivery schedule at importers interest leads exporter to rearrange his
overall daily business activities.

WEBLIOGRAPHY

1. http://www.scacli.ca/letters-of-credit-an-introduction

2. http://info.maybank2u.com.sg/business/financing/tradefinancing/export.aspx

3. http://www.hrbcb.com.cn/eng/international3-6.jsp

4. http://www.investopedia.com/terms/d/documentarycollection.asp