1. Lecture 8 Letter of Credit

2. I. IntroductionIntroduction II. Parties in a Letter of CreditParties in a Letter of Credit III. Contents of a Letter of CreditContents of a Letter of Credit IV. Categories of Letters of CreditCategories of Letters of Credit V. Basic Documentary Procedure of L/CBasic Documentary Procedure of L/C VI. Characteristics of Settlement by L/C VII. Specimen Letters Concerning L/C

3. I. Introduction –Background informationBackground information –Definition of L/CDefinition of L/C –Advantages of L/CAdvantages of L/C –The Functions of L/CThe Functions of L/C –Limitations of L/CLimitations of L/C

4. 1Background information 1) With the development of international trade, by the end of the 19th century, documentary letter of credit came into existence so as to facilitate international payment by making use of the financial expertise and the reputation of the banks.

5. 2) The intervention of banks helps solve the problem of mutual distrust between buyers and sellers, because letter of credit provides a high level of protection and security to both buyers and sellers. It belongs to bank credit and banks serve as the intermediaries between buyers and sellers.

6. 3) Technological advance in banking, transportation and telecommunications have made it possible for the worldwide acceptance of L/C operations.Technological advance

7. 2. Definition of L/C According to UCP500, a letter of credit/ a documentary credit is the written promise of a bank that acts at the request and on the instructions of the applicant and undertakes to pay the beneficiary the amount specified in the credit, provided that the terms and conditions of the credit are observed by the beneficiary.

8. 3.Advantages of L/C 1) For sellersFor sellers 2) For buyersFor buyers 3) For banksFor banks

9. 1) For sellersFor sellers The seller is assured that payment will be made by a bank provided that the terms and conditions of the L/C are complied with. The seller can apply to the negotiating bank for packing loan before shipment against the L/C, while under remittance and documentary collection, exporter can not get any accommodation from the bank.

10. 2) For buyers A. The buyer is assured that payment will be released to the seller only after the bank receives the title documents called for in the credit.

11. B. It reduces tying up the buyer ’ s capital. When the buyer applies to the bank for the opening of the L/C, the buyer only pays a certain percentage of deposit for security. If the buyer ’ s integrity is sound, he does not need to pay any deposit for security. Most part of the proceeds can be paid when the documents arrive at the issuing bank ’ s counter.It reduces

12. 3) For banks For issuing bank: For negotiating bank:

13. For issuing bank: Though it undertakes to pay the proceeds, yet he has the buyer ’ s deposit for security in hand. When the negotiating bank sends the documents to it and asks for reimbursement, this bank has the title documents in hand. Therefore, it is not very risky for the issuing bank.

14. For negotiating bank: If the documents presented by the beneficiary conform to the L/C stipulations, it can pay the proceeds to the beneficiary before receiving them from the issuing bank by deducting the interest incurred between the date of payment and the date of receiving the proceeds from the issuing bank. In this way, the negotiating bank can earn interests and commission charges.

15. 4. The Functions of L/C 1) Assurance and security Bank credit is superior to commercial credit. By using an L/C, the mutual distrust between the buyer and the seller is relieved to a great extent.

16. 2)Financial accommodation In L/C operations, banks not only offer credit and service, but also provide financial accommodation by means of packing loan, buying the bill of exchange.

17. 5.Limitations of L/C It should be noted that L/C is not perfect. Banks deal in documents only, but not goods. Banks are responsible for issues relating to documents under L/C, not the issues relating to the goods themselves.

18. For buyers For sellers

19. For buyers 1)The buyer is not assured of receiving the goods as stipulated in the contract.

20. 2)The seller may counterfeit documents that appear on their face to be in conformity with the L/C stipulations and get payment, which makes the buyer a victim of the fraud.2)The seller 3)The procedure for the buyer is more complicated than that under remittance and collection.

21. For sellers The buyer may delay in opening the L/C so that the shipment schedule is too tight for the seller. The buyer may trap the seller by including some clauses in the L/C to make it difficult for the exporter to perform the contract and the L/C.

22. The seller has to follow the instructions of the L/C exactly in making documents required. It is very demanding and time consuming. The exporter must exercise great care to conform to the L/C stipulations. Otherwise, there might be some discrepancies between the L/C and the documents or inconsistency among the documents. The seller has to take the risk of being refused to pay by the issuing bank or the buyer.The seller

23. II. Parties in a Letter of CreditParties in a Letter of Credit There are several parties to an L/C. Each party has multiple names. The name used for each party depends upon who is speaking. But the main parties involved are as follows:

24. 1. applicantapplicant (buyer, importer, accountee, account party, opener ) 2. issuing bankissuing bank (buyer ’ s bank, opening bank ) 3. advising bankadvising bank (seller ’ s bank, notifying bank ) 4. beneficiary (seller,exporter )beneficiary (seller,exporter ) 5. negotiating banknegotiating bank 6.confirming bank

25. 1. applicant applicant (buyer, importer, accountee, account party, opener ) It is the buyer who applies to his bank for opening a letter of credit naming the seller as beneficiary.

26. 2. issuing bank (buyer ’ s bank, opening bank )

27. The bank that issues the credit upon instructions of the buyer, and is responsible for payment of the L/C provided that the terms and conditions of the credit are complied with by the beneficiary. It is usually the bank at the place where the buyer is located.The bank that issues

28. 3. advising bank (seller ’ s bank, notifying bank )

29. The advising bank is the bank at the seller ’ s country and may be the branch of the issuing bank or its correspondent bank. Upon instructions and entrustment of the issuing bank, the advising bank advises the L/C to the beneficiary.

30. The advising bank should check the apparent authenticity of the credit. If it does not check the authenticity by comparing the signature and test keys, it should be liable for the losses of the beneficiary. The advising bank

31. 4. beneficiary (seller, exporter ) It is the seller, the exporter who receives advice of the credit from the advising bank, has the right to use the L/C, complies with the terms and conditions of the credit, and gets paid.

32. If the issuing bank goes bankrupt or refuses to pay without good reasons, the exporter has the right to ask for payment from the importer, and the importer should be responsible for payment.the issuing bank

33. 5. negotiating bank It is the bank where the exporter sends/ presents and negotiates the documents. It may be the advising bank or another bank authorized to negotiate the documents. If there is no specific stipulation in the L/C, the exporter may present the documentary draft to any bank that is ready to do the negotiation.

34. In L/C operations, the negotiating bank serves as the bona fid holders of the drafts and the nominator of the beneficiary, the drawer of the drafts. Negotiation means giving value to drafts and/ or documents by the bank authorized to negotiate.Negotiation

35. 6.confirming bank Sometimes, upon the authorization of the issuing bank, another bank should add its own confirmation to the L/C. It is then called a confirming bank.

36. III. Contents of a Letter of CreditContents of a Letter of Credit Although there is no uniform form covering L/C, their contents are almost the same.

37. 1. to be generalto be general 2. to be concreteto be concrete

38. 1. to be generalto be general to be general, there are three main parts all the important terms and conditions of the sales contract signed by two parties. Documents required if they are not included or stipulated in the contract. Banker ’ s undertaking clauses

39. 2. to be concrete to be concrete, the common contents of a credit are as follows:

40. 1) General statement: credit number, date of issue, date and place of expiry, date and place of negotiation. 2) Types of L/C: whether it is irrevocable, transferable, or confirmed, etc. 3) Parties to an L/C: applicant, issuing bank, beneficiary, advising bank, paying bank, negotiating bank, etc.

41. 4) Draft clauses: if drafts are needed, then it should have the drawee, tenor, drawn clause, etc. 5)Type of payment availability: sight payment, deferred payment, acceptance or negotiation, for example: “ this credit is available with any bank by negotiation ”

42. 6)Description of commodities ： name, specification, quantity, quality, packing, price, etc., of the goods. The price includes unit price, total value, price terms, port or place of destination, etc.

43. 7) Currency code and amount of the L/C. The amount of the L/C: is the maximum amount that the issuing bank undertakes to pay. 8) terms of shipment and insurance

44. 9) Documents required 10) Special or additional conditions 11) Issuing bank ’ s undertaking clauses 12)Sender/receiver information, test keys or authentication code, etc.

45. IV. Categories of Letters of Credit Documentary Credit vs. Clean Credit Revocable vs. Irrevocable Documentary CreditsRevocable vs. Irrevocable Documentary Credits Confirmed vs. Unconfirmed L/C Payment Credit （ Sight Payment Credit, Deferred Payment Credit ）, Acceptance Credit and Negotiation CreditPayment Credit （ Sight Payment Credit, Deferred Payment Credit ）, Acceptance Credit and Negotiation Credit Sight Credit, time/ Usance Credit

46. 1.documentary credit vs. clean credit According to whether shipping documents are required or not, credit can be classified into documentary credit and clean credit.

47. documentary credit It means that payment, negotiation or acceptance are effected against documentary drafts and shipping documents or only against shipping documents including transport document, commercial invoice, insurance policy, etc.. Documentary credit is most frequently used in international trade.

48. Clean credit It means the opening bank effects payment only against the draft drawn on it by the beneficiary without any shipping documents attached. It is seldom used.

49. 2.revocable vs. irrevocable documentary credits Documentary credit can be issued by the issuing bank as revocable or irrevocable.

50. revocable credit It means that the credit may be amended or cancelled by the issuing bank at any moment and without prior notice to the beneficiary.

51. However, the issuing bank must reimburse another bank if this bank has effected payment, acceptance or negotiation against documents that appear on their face to be in compliance with the terms and conditions of the credit before the bank receives any notice of amendment or cancellation.

52. irrevocable credit It means that once the L/C is opened, it cannot be cancelled or amended within its validity without the agreement of the issuing bank, the confirming bank, if any, and the beneficiary.

53. 3.confirmed vs. unconfirmed L/C Under irrevocable documentary credits, according to whether there is another bank undertaking to pay, in addition to that of the issuing bank, it can be divided into confirmed and unconfirmed L/C.

54. unconfirmed L/C It is also called advised L/C. if a credit is not confirmed by another bank, it is an unconfirmed L/C. under an unconfirmed L/C, only the issuing bank assumes the undertaking to pay, thus payment is the sole responsibility of the issuing bank.

55. Such an L/C may be advised to the seller through a bank in the seller ’ s country called advising bank, and the documents may be presented to that bank or another nominated bank for payment, negotiation or acceptance. However, the final responsibility for payment rests with the issuing bank alone.

56. confirmed L/C If the sellers have any doubt about the issuing bank and its credit standing and the stability of the economy and politics of the importing country, the beneficiary may require that another bank in the seller ’ s country should add its confirmation to a credit.

57. According to the different means of payment availability, irrevocable documentary credit can be divided into the following four types.means of payment availability 1) payment credit (sight payment credit, deferred payment credit),1) payment credit (sight payment credit, deferred payment credit), 2) acceptance creditacceptance credit 3) negotiation creditnegotiation credit

58. 1) Payment creditPayment credit sight payment L/C Deferred payment L/C

59. sight payment L/C It means that the paying bank, upon presentation of all the documents that conform to the L/C stipulations, pays at sight.

60. Deferred payment L/C It means that the beneficiary does not need to submit drafts and may ask for payment from the issuing bank or the nominated bank on the maturity dates determinable in accordance with the L/C stipulations, provided that the stipulated documents are presented to the issuing bank or to the nominated bank and that the terms and conditions of the credit are complied with.

61. 2) Acceptance L/CAcceptance L/C It is a kind of time L/C. unlike the deferred payment credit, the beneficiary needs to draw a time draft. The drawee of an acceptance credit should accept the drafts across its face first and pay on maturity dates.

62. 3)Negotiation L/C Negotiation L/C means that the issuing bank invites other banks to buy the drafts and/ or other documents, i.e. it allows the beneficiary to present the documents to any bank or nominated bank.

63. If the terms and conditions of the L/C are met, the negotiation bank pays the seller after deducting the interest and formality fees. Afterwards, the negotiation bank sends the documents to the issuing bank for reimbursement. In case the issuing bank refuses to reimburse, then the negotiation bank has the recourse( 追索权 ) to the beneficiary.

64. It can be subdivided into two kindsIt can be subdivided into two kinds: open negotiation credit or free negotiation credit restricted/ restrictive negotiation L/C

65. open negotiation credit or free negotiation credit That means the beneficiary may present and negotiate the documents in any bank he chooses. But the bank must be its regular business bank and has good reputation. The L/C clause goes like this: “ credit available with any bank for negotiation. ”

66. restricted/ restrictive negotiation L/C It means the beneficiary is only allowed to take the documents to the nominated bank for negotiation. Its clause goes like this: “ credit available with bank of china by negotiation only. ” Or “ negotiation is restricted to bank of china only. ”

67. 5.sight credit, time/ usance credit This group is classified according to the time of payment.

68. 1)Sight credit It means that the issuing bank or its nominated bank effects payment, or negotiation immediately upon receipt of the drafts and/ or other documents that are in conformity with the L/C stipulations, such as the above-mentioned sight payment credit and sight negotiation credit.

69. 2) Usance L/C It includes seller ’ s time L/C (deferred payment credit, acceptance credit) and the buyer ’ s time L/C

70. Seller ’ s time L/C It means that issuing bank or its nominated banks, after receiving the drafts and/ or documents that are in conformity with the L/C stipulations, undertakes to pay within the stipulated time.

71. Buyer ’ s time L/C The contract stipulates that payment is to be effected at sight. But the importer asks his bank to issue a time L/C, in which it stipulates that the beneficiary draws time drafts and the discount charges and interest are for the account of the applicant, while the exporter can get payment once the documents are duly presented to the issuing bank or its nominated banks, and are found to appear on their face to be in conformity with the L/C stipulations. So, for the seller, it is a sight L/C, for the buyer, it is a time L/C.

72. In fact, by using a buyer ’ s time L/C, the importer makes use of the issuing bank ’ s capital. By bearing the discount charges and interest, the importer gets the accommodation of the issuing bank, i.e. he pays at maturity.

73. V. Basic Documentary Procedure of L/C Broadly speaking, there are four basic groupings of steps in the procedure of L/C:

74. 1. Issuance of L/C 2. Amendment of L/C 3. Utilization of L/C 4. Settlement of L/C However, the documentary procedure varies with the types of L/C. therefore, this lesson we will take “ irrevocable, documentary, and negotiation L/C available at sight ” as an example to illustrate the procedure.

75. Step 1: contract Step 2: application for opening an L/C Step 3. opening an L/C Step 4. L/C verification and notification Step 5 L/C Amendment Step 6 L/C Utilization and Settlement

76. Step 1: contract Through a series of face-to-face negotiation or exchange of business correspondence, the buyer and the seller decide to sign the sales contract. In the contract, they agree that payment shall be made on an L/C basis.

77. Step 2: application for opening an L/C After the contract is signed, the buyer should instruct his bank to open a letter of credit within the stipulated time limit. He should first fill up an application from and present it to the opening bank.

78. Step 3. opening an L/C Since a documentary credit is a promise of the bank to pay the seller, the bank, upon receiving the buyer ’ s instructions, will check the credit standing of the applicant and the contents of the application to see whether they are consistent with national and international banking and legal requirements.

79. If the application is satisfactory to the bank, the opening bank will open a documentary credit in either of the following ways: 1)L/C opened by mail 2)L/C opened by tele — transmission

80. 1)L/C opened by mail It is often issued in one original and several copies and sent by airmail to the advising bank, the issuing bank ’ s correspondent bank.

81. 2)L/C opened by tele — transmission Full Cable Brief Cable

82. Full Cable If the credit is opened with detailed information, the issuing bank will add a test key to it and send it to the advising bank by cable, telex or by SWIFT entrusting the advising bank with the task to notify the seller of the credit. It is customarily called “ Full Cable ”. These credits often have the wording “ This is an operative instrument ” or similar expressions.

83. Brief Cable Sometimes, the issuing bank will only inform the seller of part of the L/C contents, such as credit number, amount, shipment date and validity by a brief cable, which is called a pre-advised credit. This kind of L/C is not an operative instrument and it cannot be used for shipment, negotiation, payment or acceptance. Often there is the wording: “ Mail confirmation to follow. ”

84. Step 4. L/C verification and notification Upon receipt of the credit from the issuing bank, both the advising bank and the beneficiary should check the L/C carefully.

85. –What should the advising bank check? –L/C notification –What should the beneficiary check?

86. What should the advising bank check? whether the credit standing of the issuing bank is sound or not whether the test key of a tele- transmitted credit conforms to that kept at the advising bank and whether the signature of an L/C opened by mail is in conformity with the specimen signature at the advising bank for the purpose of testing the authenticity of the L/C

87. Whether there is the undertaking clause or whether it is clear and definite Whether the credit has become effective or not. Whether the credit is revocable or irrevocable. Whether it bears the date and place of expiry and date or period of presenting the documents to the relevant bank. Check some special clause.

88. L/C notification After checking the L/C, the advising bank should underline the parts of the L/C that the beneficiary should pay close attention to, or give some suggestions to the beneficiary. For example: “ this is a pre-advised L/C, please wait until the original L/C arrives ”.

89. What should the beneficiary check? When the beneficiary receives the L/C from the advising bank, it should also check the terms and conditions of the L/C carefully.

90. pay close attention to the notation by the advising bank examine whether the names and addresses are legally correct check whether the L/C stipulations conform to the contract terms and conditions examine those terms that are not listed in the contract to see if they are acceptable and if they contradict the contract terms

91. check the documents required to see if the beneficiary has difficulties in obtaining some of the documents examine the place of expiry to see whether it is in the exporter ’ s country check whether the period for document presentation is sufficiently long enough for the seller to get all the documents ready before this period.

92. Step 5 L/C Amendment After checking the L/C stipulations, if the beneficiary finds some discrepancies between the contract and the L/C or between the L/C and the UCP500, the beneficiary should then advise the applicant of these discrepancies asking for amendment to the L/C. if the applicant agrees with the beneficiary, it should apply to the issuing bank for amendment.

93. Step 6 L/C Utilization and Settlement Utilization is the process of the seller ’ s shipping the goods, presenting the documents to the negotiating bank and getting paid.

94. VI. Characteristics of Settlement by L/C –the issuing bank has the primary liabilities for payment –L/C is a self-sufficient instrument –It is simply a document transaction