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What is letter of credit ? A letter of credit (L/C) is a signed instrument embodying an undertaking by the banker of a buyer to pay a certain sum of money to his seller on presentation of documents evidencing shipment of specified goods subject to compliance with the stipulated terms and conditions.

Parties involved in letter of credit  Seller or a beneficiary who is to receive money  Buyer  Issuing Bank, whom the buyer is a client, and  Advising bank, whom the seller is a client.

How letter of credit works?

Types of Letter of credit  Irrevocable versus Revocable L/C  Confirmed Irrevocable versus Unconfirmed Irrevocable L/C  Transferable L/C  Revolving L/C  Back to back L/C  Standby L/C

Irrevocable versus Revocable L/C  Revocable L/C may be cancelled or modified without prior notice by the issuing bank to the beneficiary.  An Irrevocable L/C does not suffer from such disadvantage and it is,therefore, widely accepted.

Confirmed Irrevocable versus Unconfirmed Irrevocable L/C  An irrevocable letter of credit (L/C) opened by an issuing bank whose authenticity has been confirmed by the advising bank and where the advising bank has added its confirmation to the credit is known as confirmed irrevocable letter of credit.  An irrevocable letter of credit (L/C) opened by an issuing bank in which the advising bank does not add its confirmation to the credit is known as an unconfirmed irrevocable letter of credit.

Transferable Letters of Credit  Credit specifically states it is ‘transferable’. ‘Transferable’, ‘transmissible’ and ‘assignable’ convey the same meaning  Used generally when the business is transacted through middleman  Original credit is in favour of middleman, who asks for the transfer of credit to the manufacturer or the actual supplier  It may be available in whole or in part to another beneficiary  The letter of credit that was transferred to second beneficiary is called TRANSFERRED CREDIT

Back-to-back L/C  Back-to-back L/C is a type of L/C issued in case of intermediary trade. Intermediate companies such as trading houses are sometimes required to open L/Cs by supplier and receive Export L/Cs from buyer.

Back-to-back L/C  Back-to-back credits are usually requested by middle persons who do not have sufficient credit available at their banks to open their own L/Cs to the ultimate suppliers. Under a back-to-back L/C the middle person will ask a bank to issue a second L/C in favor of the ultimate supplier, while using the L/C issued by the buyer as collateral.  When one L/C is used as security to obtain the issuance of a second L/C covering the same transaction, and when all terms and conditions of both credits are identical, except for amounts and dates in the second L/C which must be smaller and earlier, the arrangement is defined as a back-to- back L/C.

Revolving Letter of Credit  When a letter of credit (L/C) is specifically designated " revolving letter of credit ", the amount involved when utilized is reinstated, that is, the amount becomes available again without issuing another L/C and usually under the same terms and conditions.  The revolving L/C may be used in shipments of a wide range of goods to a buyer within a period of time (several months to one year usually).

Standby L/C  Standby L/Cs differ from commercial L/Cs; they do not usually cover shipments of goods, but more often services or performance. The standby L/C is not secured by underlying merchandise as is usually the case with conventional L/Cs. In this respect, the standby L/C is much like an unsecured loan and requires careful advance scrutiny by the issuing bank.  If the seller performs his or her obligation, there will be no need for the buyer to draw against the standby letter of credit which supports the obligation.

Cont..  Standby letters of credit are commonly used to-- * assure the refund of advance payments; * support the obligation of a successful- bidder to accept a contract and to perform under the terms of the contract * back up bonds issued by insurance companies; and * stand behind a monetary obligation under a promissory note or another like commitment (rental payments, etc.).

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