What is Letter of Credit (LC)? Letter of Credit (LC) Review, Features

A letter of credit (L/C) is a document issued by a bank (i.e. the issuing bank) to an exporter (i.e. the beneficiary) in accordance with the requirements and instructions of the importer (i.e. the applicant), authorizing the importer to issue a bill of exchange with the bank or importer as the payee, guaranteeing that the bill of exchange and documents that meet the terms of the letter of credit will be accepted and paid in the future. A letter of credit is a major settlement method for international settlements. It is a written document issued by a bank that conditionally promises to pay. It is a bank credit.

About Letter of Credit

A letter of credit is a written document issued by a bank to an exporter (seller) at the request of an importer (buyer) to guarantee the liability for payment of the goods. In the letter of credit, the bank authorizes the exporter to issue a bill of exchange of no more than the specified amount with the bank or its designated bank as the payee under the conditions specified in the letter of credit, and to attach shipping documents as required, and to collect the payment at the designated place on schedule.

In international trade activities, buyers and sellers may not trust each other. Buyers are worried that after making advance payments, sellers will not ship the goods as required by the contract; sellers are also worried that buyers will not pay after shipping or submitting shipping documents. Therefore, two banks are needed as guarantors for both buyers and sellers to collect payment and deliver documents on their behalf, replacing commercial credit with bank credit. The tool used by banks in this activity is letters of credit. It can be seen that letters of credit are certificates that banks conditionally guarantee payment, and have become a common settlement method in international trade activities. According to the general provisions of this settlement method, the buyer first deposits the payment to the bank, and the bank opens a letter of credit, notifies the seller's bank in a different place to pass it on to the seller, and the seller ships the goods according to the terms of the contract and letter of credit, and the bank pays on behalf of the buyer.

origin

The name “letter of credit” comes from the French word “accréditation,” which is the power to do something, and comes from the Latin “accreditivus,” which means trust.

Classification

According to different classification bases, letters of credit can be divided into: documentary letter of credit and clean letter of credit; confirmed letter of credit and unconfirmed letter of credit; sight letter of credit and usance letter of credit; revocable letter of credit and irrevocable letter of credit, etc.

According to the different classification bases of letters of credit, letters of credit can also be divided into transferable letters of credit and non-transferable letters of credit, revolving letters of credit, open letters of credit, back-to-back letters of credit, advance letters of credit, payment letters of credit, acceptance letters of credit and negotiation letters of credit, etc.

Main content

1. Description of the letter of credit itself, such as its type, nature, validity period and expiration place.

2. Requirements for goods: Describe according to the contract.

3. Requirements for transportation.

4. Requirements for documents, namely cargo documents, transport documents, insurance documents and other relevant documents.

5. Special requirements.

6. The issuing bank’s liability clause guaranteeing payment to the beneficiary and the holder of the bill of exchange.

7. Most foreign letters of credit are annotated with: "Unless otherwise specified, this letter of credit is issued in accordance with the International Chamber of Commerce's Uniform Customs and Practice for Documentary Credits (Revised in 2007), also known as International Chamber of Commerce Publication No. 600 (UCP600)."

8. T/T Reimbursement Clause.

Parties and related persons

1. Parties to the letter of credit

(1) Issuing Bank. The issuing bank is the bank that opens a letter of credit to the beneficiary (exporter) at the request of the applicant (importer). This bank is usually the applicant's bank account.

(2) Beneficiary of the letter of credit. The beneficiary is the person who is authorized by the issuing bank in the letter of credit to use and execute the letter of credit and enjoy the rights and interests granted by the letter of credit. The beneficiary is generally the exporter.

(3) Confirming Bank: A confirming bank is a bank that guarantees payment of a letter of credit in addition to the payment guarantee of the issuing bank at the request of the issuing bank or the beneficiary of the letter of credit.

2. Person related to the letter of credit

(1) Applicant: The applicant is the person who submits an application to the bank for the issuance of a letter of credit. It is usually an importer in the import and export trade business.

(2) Advising Bank: The advising bank is the bank entrusted by the issuing bank to notify the beneficiary of the letter of credit. It is usually the issuing bank’s agent bank or branch in the exporting country.

(3) Paying Bank (Drawee Bank) of the Letter of Credit. The paying bank is the bank designated and authorized by the issuing bank in the acceptance letter of credit to bear the payment responsibility (without recourse) to the beneficiary.

(4) Accepting Bank of a Letter of Credit. The accepting bank is the bank designated by the issuing bank in the letter of credit and authorized to accept the bill of exchange under the letter of credit. Under a usance letter of credit, the accepting bank can be the issuing bank itself or another bank designated by the issuing bank.

(5) Negotiating Bank: A negotiating bank is a bank that buys the bills and documents submitted by the beneficiary based on the authorization of the issuing bank in the negotiating letter of credit.

(6) Reimbursing Bank of Letter of Credit. A reimbursing bank is a bank that, under the instruction or authorization of the issuing bank, makes payments to the paying bank, accepting bank, confirming bank or negotiating bank of the letter of credit.

(7) Transferring Bank. A transferring bank is a bank that transfers a transferable letter of credit to a second beneficiary at the request of the first beneficiary. The transferring bank is usually the notifying bank of the letter of credit.

Operation process

The operation process of documentary credit is briefly described as follows.

1. The buyer and seller stipulate in the trade contract that payment shall be made by documentary letter of credit.

2. The buyer notifies the local bank (issuing bank) to open a letter of credit with the seller as the beneficiary.

3. The issuing bank requests another bank to advise or confirm the letter of credit.

4. The notifying bank informs the seller that the letter of credit has been opened.

5. After the seller receives the letter of credit and ensures that it can fulfill the conditions stipulated in the letter of credit, it will ship the goods.

6. After the seller ships the goods, he retrieves the original bill of lading from the shipping company and prepares other documents.

7. The seller submits the documents to the designated bank, which may be the issuing bank or the paying, accepting or negotiating bank specified in the letter of credit.

8. The bank examines the documents according to the letter of credit. If the documents comply with the letter of credit, the bank will make payment, acceptance or negotiation according to the letter of credit.

9. A bank other than the issuing bank sends the documents to the issuing bank.

10. After verifying the documents and confirming that they are correct, the issuing bank will reimburse the bank that has paid, accepted or negotiated in accordance with the letter of credit in the form agreed in advance.

11. The issuing bank notifies the buyer to pay and redeem the documents, and delivers the documents after the buyer makes the payment.

12. The buyer collects the goods from the shipping company based on the documents.

effect

1. Effect on exporters

(1) To ensure that the exporter can obtain payment for goods by presenting documents that are consistent with the terms of the letter of credit.

(2) Exporters can collect payment on time.

(3) Exporters can obtain financing through package loans or documentary credits based on letters of credit.

2. Effect on importers

(1) It ensures that the importer obtains documents representing the goods.

(2) Ensure that importers receive goods on time, in good quality and in sufficient quantity.

(3) Importers can obtain financing by paying less or no deposit based on their own credit standing and the trust of the issuing bank.

3. Impact on banks

(1) The deposit or collateral paid by the importer when applying for the letter of credit can be used to facilitate the bank's use of funds.

(2) In the letter of credit business, banks can obtain various income for each service they provide, such as issuance fee, notification fee, negotiation fee, confirmation fee, amendment fee and other fees.

Features

The letter of credit has three characteristics:

1. A letter of credit is a self-sufficient instrument. A letter of credit is not attached to a sales contract. When reviewing documents, banks emphasize the written certification that the letter of credit is separate from the underlying trade.

2. The letter of credit is a pure documentary transaction. The letter of credit is paid based on the documents, not the goods. As long as the documents are consistent, the issuing bank should pay unconditionally.

3. The issuing bank bears primary liabilities for payment. A letter of credit is a bank credit, a bank guarantee document, and the issuing bank has primary liabilities for payment.

Business Process

Letter of credit fraud

The definition of "fraud" in Chinese law is reflected in Article 195 of the Criminal Law, which provides the following definition of letter of credit fraud:

Using forged or altered letters of credit or accompanying documents or papers;

Using a voided letter of credit;

Obtaining letters of credit by fraud;

Committing letter of credit fraud by other means.

In international trade activities, there are various forms of letter of credit fraud. According to the different subjects of fraud, it can be divided into fraud committed by the beneficiary, fraud committed by the applicant, and fraud committed by both the beneficiary and the applicant. According to the different means of fraud, it can be divided into counterfeit letters of credit, soft-term letters of credit, forged letter of credit documents, etc.