Presentation on theme: "CHAPTER EIGHT THE BASIC LETTER OF CREDIT. With a letter of credit banks become directly involved by committing themselves to pay the seller, which enables."— Presentation transcript:
With a letter of credit banks become directly involved by committing themselves to pay the seller, which enables trade to take place. In collection the bank’s role is basically only to transfer funds. A letter of credit is an instrument issued by a bank by which the bank furnishes its credit, in place of the buyer’s credit. The letter of credit is widely used and is regarded as a key bank product that enables an important amount of international trade to take place. Letters of credit can be either revocable (cayılabilir) or irrevocable (cayılamaz). Irrevocable L/C means it cannot be canceled or changed without the consent of all parties. Beneficiary (exporter, seller) The account party (importer, buyer) The exporter has to fulfill all the conditions of the L/C before payment to him can be made (CY 1- C41 forms).
MERCHANDISE CONTRACT A letter of credit transaction usually begins after a merchandise contract, between the buyer and seller has been made. The bank is not a party of the contract. It only deals with the documents and not the merchandise. However the L/C should be drawn in strict compliance with the provisions of that contract. The amount of credit, the expiration date, the shipping date, the documents to be presented etc. must be included. See figure 8.1 Certain protections for both buyer and seller are inherent in all letters of credit. The seller knows that it will be paid as soon as it complies with the terms of the L/C; the buyer knows that no payment will be made until documents are presented, showing that the shipment has been made as specified.
APPLICATION FOR AN IMPORTER LETTER OF CREDIT A request for a commercial L/C is similar to an application for a loan. The bank usually insists that the documents be in negotiable form so that it obtains title to the documents between the time it makes payments and the time it is reimbursed. A letter of credit is considered a self-liquidating loan. Although the bank have control over the title of documents, after making payment, the banker should not consider this to be sufficient security since merchandise may have limited market. The price may change, etc. The banker usually asks for the evidence that the merchandise is insured as an added protection. See figure 8.2 Part shipments and transshipments must be clarified.
THE EXPORTER’S RESPONSIBILITIES A L/C is sent either directly to the beneficiary or indirectly through a correspondent bank. The beneficiary examines the terms and the conditions of the L/C and if an amendment is needed the beneficiary contact the buyer and asks for an amendment covering the changes. “To order of shipper, blank endorsed” Expiration Date Documents must be presented to the bank as soon as they are prepared and not later than 21 days after issuance of bills of lading. If the bill of lading reaches the importer after the ship has arrived, the merchandise can only be released with a bank guarantee.
NEGOTIATION The bank examines the documents to see whether they comply with the conditions of the L/C. This is known as negotiation. If there is a discrepancy, the bank does not pay and contacts the seller -who requested the opening of the L/C. The customer however can accept to receive the goods in spite of the discrepancy. But if the customer refuses to accept any deviation from the original requirements, the bank will refuse to pay the draft. In this circumstance the seller has to correct the discrepancy before payment can be made to him. Each party in the L/C process examines the documents. If banks have been careless and overlooked discrepancies, the buyer may refuse to pay. In letters of credit, the bank remains responsible even if the buyer is no longer able to repay the bank. The bank carries the risk.
If the importer is unable to pay the bank, the bank has the bill of lading in negotiable form. The bank can take possession of the merchandise. This is why the bank requires that bills of lading be in negotiable form and goods should not be consigned directly to the buyer. The banks collect fees for the opening letters of credit, for advising and confirming it and for negotiating the documents when presented.
FRAUD All parties concerned deal in documents and not in goods (the Uniform Customs and Practice for Documentary Credits). The problem arises when the bank knows or strongly suspects that the documents, when presented, do not describe the merchandise or fraudulently misrepresents the facts. The bank has to act with caution. But some people argue that the best way to get out of this situation is that, the “account party-the buyer” should apply for a court order rather than putting pressure on the bank not to pay.
COLLECTIONS VERSUS LETTERS OF CREDIT An irrevocable letter of credit is an obligation of the bank to pay if all conditions are met. In collection the bank has no obligation and the buyer (importer) is responsible for the payment. An importer might not pay an exporter for many reasons (importers may change their minds or go out of business or price of goods go down etc). In letters of credit, drafts are drawn on banks that mean the payment is certain, and therefore allows exporters to easily discount the document for cash (transferability of drafts). But in collection, a draft payable at a future date is drawn on the buyer, not on a bank and there is always the chance that the buyer can go into bankruptcy etc. before maturity. The cost of letters of credit is much more than the cost of collections. ACCOUNT The amount of the letter of credit appears as a contingent account as soon as it is issued. Usually 20% risk is calculated for letters of credit. When the letter of credit is paid this amount is taken out of contingent account.