Letter of Credit+Procedure

CRIDIT MANAGMENT MBA Banking & Finance 3rd Term

Letter of Credit There are numbers of factor involved in oversees trade. 1.

The exp The expor orte ters rs ar are e unc uncer erta tain in ab abou outt imp impor orte terr cap capac acit ity y of payment.

2.

The imp The impor orte ters rs ar are e unw unwil illi ling ng to pa pay y amo amoun untt un unle less ss th the e goods are actually received.

3.

In ca case se of no non n pay payme ment nt th the e sel selle lers rs sh shou ould ld ha have ve le lega gall rights in foreign country.

4.

There Ther e sh shou ould ld be an ag agen ency cy wh whic ich h sho shoul uld d me meet et th the e seller need of finance when goods are shipped to importer.

The commercial banks here come for the help of  exporter and importer. The importer bank can undertake the obligation to pay to the exporter, this is usually done through letter of credit.

What

is letter of Credit? Credit?

 A letter of credit is commitment on the part of buyers bank to pay or accept draft drawn upon it provided do not exceed a specified amount.

Features of L/ L/C C Issued by the importer bank Guarantees of payment to the exporter Up to specified amount 

Parties

in letter of Credit

There are four parties

unt Party:  Account  Acco Buyer or importer on whose account and request the L/C is opened.

Issuing Bank: The bank which issue or open L/C on o n the request of  Importer

rter or Sell er. Exporter Expo ller. The seller in whose favor L/C is drawn Paying

ego or Neg otiating bank:

The paying bank in the exporter country.

Types of Letter of Credit 1.

rrevoc e L/ L/C Irrev ocabl ble C one in which the issuing bank gives a lasting undertaking to accept in due course to pay bills drawn upon it. It can not be altered or cancelled with out  the consent of the parties.

2.

evoc e L/ L/C Rev ocabl ble C it can be cancelled with out the consent of the beneficiary bank. Issuing bank has also right of amendment.

nfirmed L/ L/C 3. Co Con C That which has the protection of the credit standing of the importers as well as the exporter bank. The exporter expor ter bank when confirm the letter of credit take the liability of paying agent in case the issuing bank fails to make payment to exporter.

nfirmed L/ L/C 4. Unco con C the bank through which The credit is negotiated does not give any guarantee to the exporter that  the bill drawn will be honored

5.

L/C Documentary L/ Document C One

which provides for bill to be accompanied by documents of title to goods such as the bill of o f loading, invoice, insurance etc.

L/C 6. Open L/ C When there is no conditions attached in the letter of  credit is called open or clean L/C. L/ C.

Fix L/C 7. Fi xed L/ C When L/C is issued for fixed amount.

evol ving L/ L/C  Rev olving C where both amount and time is fixed. It is automatic. It does not need renewal during the period of validity.

nsfferabl e L/ L/C  Trans ble C That under which the beneficiary has right to request the paying bank to make the credit available in whole or in part  to one or more other parties

nsfferabl e L/ L/C  Non Non -T -Trrans ble C Ordinary

L/C in which beneficiary does not enjoy any rights r ights of transfer credit to any other person.



With

urse L/ L/C Reco course C

L/C where issuing bank is under under obligation to make the the payment of the bill drawn on the opener of the credit, if he refuses to make payment of the bill.

L/C  Back-to-Back L/ C The original buyer first request to his bank to issue the first  documentary credit to the seller. The seller request to his bank to issue a separate documentary credit in favor of the actual supplier.

Procedure

of Opening Letter of Credit

1. Application for the letter of Credit. 2. Line of the Credit. 3.

Opening

the Letter of Credit.

4. Handling of the Documents. 5. Payment by the importer to the banker. 6. Liability of the issuing bank.

1. Appl tio Appliicati on fo forr the letter of Credit. Credit.  An importer prepares an application on the prescribed Form available form the bank. the information which are supplied in the application application are based on the contract contract such as the value of  merchandise ,port of shipment, port of unloading, expiry date of the papers and brief description of the goods. If the bank is satisfied with the application , it will signed and and acceptance acceptance agreement with the importer.

2. Line of the Credit. Before issuing the letter of the credit ,precautions for securing its credit . The bank first examines the customers credit  standing, the type of goods, the collateral offered to cover the credit , then then it establish the the amount i.e. i.e. the line of credit. credit.

3. Opening the Letter of Credit. The letter of credit can be opened by mail or by cable, when it  is opened by the mail, the issuing bank send letter of credit  and to carbon copies to the importer. The importer then dispatch the letter of credit to the exporter in foreign country by mail, one carbon copy is kept for the record. The second carbon copy after signing is sent to the bank by the importer, if any importer directs the banks to open letter of credit by cables the importers bank send a cable to the corresponding bank bank in the foreign country with a request  to notify the exporter.

4. Handling of the Documents. When the exporter receives a letter of credit , he presents the required documents and the draft to the bank in his own country after shipping of documents if the bank is satisfied with the documents in the importing country and pay the exporter at official rate in the country of his own country.

5. Payment

impo rter to the banker. by the im porter

When the bank approves the application of the customer for opening letter of credit ,it does not lend money to the importer ,the bank lends the importer to use the credit standing the foreign country. the banks makes the contract with the importer bank that when the draft is send by the negotiating bank for payment of the importer will make the payments to the bank not latter latter then the day only the bank bank is to honors honors the obligations. In case case of sight letter of credit the payment  to the corresponding bank is to be made on the day the draft  and documents are received ,when the time of lletter of credit  is used the importer is to arranged the payment not to later

6. Liability of the issuing bank. The liability of the issuing bank is to examine the documents I order to confirm their validity. If the documents on face appear to be in order the the payment should be released .If the the any defect in found in the documents and the issuing bank honors the draft, The importer can claim damages. The banker is not  responsible to see wither the merchandise confirm the sale of  contract or they physically exist. the issuing bank is only responsible for the completeness and regulatory of documents relating to the letter of credit.

Documents in foreign Trade. 1.

Financial documents

2.

Transport documents

3.

Commercial do documents

4.

Insurance documents

Financial documents are: Bill of exchange Promissory note Trust receipt  Delivery order and ware house receipt.

Import Financing Facilities One

of the most important functions performed by the banks engaged in international banking is to finance exports and imports of the country trade with foreign fo reign countries. Just as domestic trade requires various financing methods, there are several ways of financing international trade

They are cash in advance, open o pen account, documentary collection and letter of credit. Of all of these methods the most important is letter of credit. cr edit. Cash in advance involve little risk and are highly advantageous to exporter. They are not very popular as a means of financing foreign trade, because of many disadvantageous for foreign buyers(importer). The buyer is forced to have a considerable amount of  working capital.

The buyer will also at the mercy of the exporters because of the possibility of the shipment of inferior merchandise, delayed shipments, and even bankruptcy of the exporter. Political unstable economic conditions can effect the shipment. Cash in advance present some disadvantageous to the foreign purchasers while open account presents similarly disadvantageous to the exporter. If the foreign for eign purchaser is slow in payment will experience drain in working capital. The exporter does not have any negotiable instrument  evidencing the obligation, which would become very important in case of dispute.

There is 3 Types of Import Financing 1.

Impor ortt fi financing ag against do docume men nt.

2.

Impo Im port rt fi fina nanc ncin ing g ag agai ains nstt mer merch cha and ndis ise. e.

3.

Finance against tru russt receipts.

Payment against

import documents

The supplier after effecting shipment of goods, present  shipping and other documents as required under terms of  credit with the buyers. Documents are forwarded with a covering letter in two sets original and duplicate in separate covers) When these documents are received by the bank, the examiner checks them against against the bank copy of the letter of  credit point by point. In case of any discrepancies,the discrepancies,the examiner may reject or negotiate under an indemnity from the supplier before payment is made to the advising/negotiating advising/negotiating bank in terms of the credit. 

Bank Ba nk wi will ll ma main inta tain in NIP NIPAD AD le ledg dger er..



Entry will be made



NIPAD Deb ebtt (Dr) and HO a/c will be credit (Cr). NIPAD mean Non interest interest payment payment against document 

Refund of margin In order to secure the the finance finance as prescribed by the State Bank of Pakistan reasonable margin is recovered from the importer on landed cost of consignment and all other expenses incurred in connection to the import of goods as under. 1.

NIPAD with up to date mark up

2.

Custom duty

3.

Sales tax

4.

Extra surcharge

5.

Import surcharge

6.

Warehouse, clearing agent charges income tax etc.etc In case of financing against documents bank will pass entry for refund of margin debiting sundry deposits margin a/c on

Reversal of liability Bankers liability on L/C is debited while customer liability on L/C is credited. Then the memo of cost co st is prepared on form-1 mean the form showing complete details of  Import goods to state bank of Pakistan i.e. NTR, income tax circle, Id card No, place and date of  issue, Name and address of authorized dealer, name and address of beneficiary goods, quantity, port of shipment, date of shipment, License NO., Invoices value in foreign currency, registration no. with state bank, importer name etc.  After the completion of procedure pro cedure the documents are kept in separate envelope mentioning following f ollowing particulars. NIPAD, LC number, Amount, and Importer name. description of goods, quantity, quantity, port of shipment, date of 

License NO., Invoices value in foreign currency, registration no. with state bank, importer name etc.  After the completion of procedure pro cedure the documents are kept in separate envelope mentioning following f ollowing particulars. NIPAD, LC number, Amount, and Importer name.

Retirement of NIP AD  At the time of retirement r etirement of documents following vouchers are passed.  Amount of NIPAD, including mark up on NIPAD, postage charges, commission on NIPAD, service charges, etc.  After the amount is debited to party account draft/bill of  exchange are endorsed in favor of the importer, where certificate regarding foreign exchange is given on the copy of invoice.

Finance against merchandise  Any ban bank k who who estab establis lishes hes a docume documenta ntary ry let letter ter of of credit  credit  is bound to honor its commitments com mitments for the importer bills at the time of payment if otherwise in order.  A. retirement by importer. B. by authoring finance at the request of the importer against the security of imported merchandise. C. Forced (FIM) finance against imported merchandise.  When When docu documen ments ts are not ret retire ired d by the imp importe orter, r, the bank in order to save its interest, clearing the goods by debiting FIM A/C which is known as a forced FIM. Force FIM: In case the importer does not come forward to retire the goods so in order to save the interest of the bank all the charges are debited to FIM A/C. The goods after clearance stored with bank godowns, the importer should be pressed to take delivery of the goods..

 In case case of refus refusal al goods goods sho should uld be auct auction ioned ed to adju adjust  st  outstanding FIM A/C.

uments through FIM A /  /C Retirement of doc ocuments C Under this loan the importer impor ter applies for a regular sanction limit from the bank and following documents are executed by the importer  IB-6A IB-6A . Agree Agreemen mentt of fina finance nce for work working ing cap capita itall on marked up basis  Form IB 12 12-DP Note  Fo Form rm IB IB-2 -26 6 let lettter of of pled pledge ge  Res Resolu olutio tion n by the the board board of dire director ctors, s, if app applic licabl able e  Insurance policy Other

relevant documents for collateral security if any

 Letter Letter of reque request st from from the imp importe orterr if if desir desires es to to avoid avoid loan facility under this agreement. The bill of lading is to be indorsed by the importers fever to get relies of the consignment from the shipping co. Bill of exchange is marked with paid stamp duly signed by the bank official and delivered to the importer.  The The bank bank is is to secu secure re more more by by obtai obtaini ning ng col colla late teral ral securities in the shape of equitable mortgage of property proper ty with personnel guarantee.

Financed against Trust Recei eip pts. This type of facility is provided to most valuable clients of the bank though it is very risky because the bank has no control over the goods. In this case the approval of the competent  authority is obtained and following documents are executed.  Application TR financing financing is allowed on on documentary documentary bill draw under letter of credit (Foreign or inland). The facility is allowed only to those parties who have been allowed by competent 

 Do Docu cume ment ntss re requ quir ired ed in ca case se of TR TR  Bi Billll of exc excha hang nge e dul duly y sign signed ed by the the par party ty..  D.P.Note  Letter of trust   Collateral if an any  Mark up ag agreement.  Invoice.  After obtaining the documents, the shipping documents are delivered to importer on trust 

 And understanding that the bill amount along with the mark up will be deposited by importer with in the approved period after selling the goods whichever is earlier. Mark up is charged 50 paisa per 1000 on daily product basis and paid when importer pays the entire finance.  Transportation Bond: These bonds are issued where the customer has undertaken to transport capital equipment (imported by the employer for the project) from the harbor to the worksite.  Retention money bond(RMBs) These are issued to avoid retention of money (usually)ten percent )by the employer from each progress progr ess payment due to the customer

In order to cover hither to untraceable mistakes or faults in the completed construction work, until usually one following final completion o\f the project. 

Working

capital replenishment bond: (WCRG)

These are issued by the bank in favor the employer who advance funds to the contractor to bridge financial payment  delays on receivable due by himself.  Maintenance bond: These are issued at the end of  construction period remain outstanding un till the end of  maintenance period. This is usually one year. The purpose of this bond is to prevent pr event the contractor from leaving the construction site after the construction is completed and the last progress payment received.  Completion Bond: in many cases construction companies and turn-key contractors are committed not only to

Construct but also to operate more mor e importantly, to operate successfully during a previously agreed period of  time.  Custom bond These are often requested to be issued in connection with imported equipment which are subsequently re-exported upon completion of the project. By giving such a bond, exemption is obtained from paying import duties and sale tax to the custom authorities of the country involved. Deferred payment guarantee: Issued on behalf of  an importer customer to cover deferred payment terms agreed upon between him and the supplier of plant and machinery.

Risks for the Bank 1.

The ban The bank k un unde derr tak takes es gr grea eatt ris risk k by by adv advan anci cing ng lo loan anss on sureties. The guarantor may lose his property during the period of loan contract. If the debtor fails to pay the debt, the bank can not recover the amount  from the two parties.

2.

In ca case se th the e deb debto torr fai fails ls to re repa pay y th the e loa loan, n, th the e ban bank k may not be able to get back the money even by suing the debtor and the guarantor. The case may fail on technical grounds.

3.

If at any time the bank has to change the constitution or it has to amalgamate with other banks, the guarantee is terminated unless otherwise stated.

Precautions: Greater

need for analysis of financial standing and for ascertaining the performance ability of  the customer.