Letter of Credit

 Understanding the Letter of Credit & Parties Involved

 Types of Letter of Credit
 How does a Letter of Credit Work?
 OES & Jenbacher LC Establishment Procedure
 Advantages of the LC
 Letter of Credit Vs Bank Guarantee
 What are Incoterms?
 What is the Letter of Credit?
Letter of Credit – accreditation, i.e, to be empowered to perform a particular activity/ task.

A commitment / written undertaking issued by a bank upon the request of the buyer and is given
to the seller.

Guarantees that the seller will receive payment in full as long as the agreed conditions are met
and in the event that the buyer is unable to make payment , the bank will cover up the
outstanding.

ICC, International Chamber of Commerce, publishes letter of credit rules, called UCPDC (Uniform
Customs and Practice for Documentary Credits)

Latest set of UCPDC is UCP 600.

 Parties to the Letter of Credit
Terms Definition Activity
COMMERCIAL PARTIES

Makes the LC application after finalizing the T&Cs of purchase transaction; The Buys /
Applicant Buyer. Importer

Beneficiar Seller of the goods /services, in whose favor credit has been approved, takes the
y benefit; The Seller. Sells/ Exporter
BANKS
Issuing/ One which upon the receipt of request of its customer (applicant) opens the LC in Issues the LC/
Opening favor of beneficiary. It issues the LC doc to the seller’s/ beneficiary’s bank. It is the Importer’s
Bank Applicant’s or the Buyer's Bank. Bank
Advises the
Advising Advises the issuing bank on the LC and also sends the credit to the beneficiary. It LC/ Exporter’s
Bank is the Seller’s Bank. bank
It is the 3rd party bank (usually in the country of the Beneficiary) which undertakes
the responsibility of payment by adding its guarantee to the credit opened by the
Confirmin Advising bank. It is though an extra cost but reduces the risks further to the Confirms the
g Bank beneficiary. LC

Reimbursi It is a bank with which the Issuing Bank has an account from which payment has Pays to the
 Types of Letter of Credit
Revocable : Gives issuer the amendment or cancellation right of the credit any time without prior notice to the beneficiary.
Since, this does not provide any protection to the beneficiary, therefore is not frequently used, rather has been obsolete..

Irrevocable: cannot be cancelled/ modified without the written consent of both the issuing bank and the beneficiary.
Confirmed Irrevocable LC requires confirming bank's written consent in order any modification or cancellation has to be
effective. All LCs are Irrevocable

At Sight: The commercial LC is payable when the beneficiary presents the complying documents, i.e upon seeing the
carriage documents the bank has to make the payment.

Confirmed An LC is said to be confirmed when a second bank adds its confirmation (or guarantee) to honor a complying
presentation at the request or authorization of the issuing bank. This goes with the elimination of country risk which may
come. The confirming bank takes the responsibility that ever such a situation comes when the Issuing Bank fails to make
the payment, confirming bank will make it any case.

Unconfirmed does not acquire the other bank's confirmation.

 Types of Letter of Credit
Revolving: Single LC that covers multiple shipments over a long period of time.
Instead of arranging a new L/C for each separate shipment, the buyer
establishes an L/C that revolves either in value (a fixed amount is available
which is replenished when exhausted) or in time (an amount is available in fixed
installments over a period such as week, month, or year).

Deferred: The commercial LC is payable on a specified future date allowing the

buyer some extra time before payment is claimed from the importer’s bank, i.e,
the payment to the seller is not made when the documents are submitted, but
instead at a later time defined in the letter of credit. This is also called “Usance
LC”. LC is deferred at a Discount Rate.

KIBOR/ LIBOR + Bank’s spread+ Discount Rate

10.86% + ~3% + Disc Rate

(Today’s KIBOR for 6 months tenor)
How does the Letter of Credit Work?
 How does the Letter of Credit Work?

1. The Buyer completes a contract with the seller and fills in a letter of credit application form

2. The buyer sends LC application to his bank for approval (supplemented by the PI, and any specific LC draft if

required).

3. The issuing bank approves the application and sends the L/C details to the Seller’s bank (Advising or

Beneficiary bank)
 How does the Letter of Credit Work?

5. Once the seller is satisfied with L/C conditions, he ships the goods at agreed time.

6. The seller present the docs (BL) to his banker

7. The Advising bank examines them against the agreed terms as per L/C. and the ICC rules. If they are in

order, docs are sent to the issuing bank. If not, are sent back to the seller and corrected ones are
 How does the Letter of Credit Work?

8. If the docs are proved correct, the Issuing bank pays the money promised or agreed to in the future. If

incorrect the issuing bank contacts the buyer for authorization to pay or accept the documents

9. The Issuing bank sends Advice acceptance and payment to the Advising Bank.

10. The seller is notified by advising/ confirming bank that payment has been made.
 Jenbacher

OES DXB
 OES Order Placement in Jenbacher
OES has majorly 2 types of order placement in Jenbacher

(i) Stock order (ii) Customer order

OES Places order in Jenbacher

for multiple units altogether OES Dxb Opens LC in
Customer opens LC OES
Dxb Bank Jenbacher’s Bank

OES Dxb Jenbacher


Customer Customer OES Dxb Jenbacher

 
Good to be preferably shipped in customer’s name else to
OES Dxb (in the worst case) to stock in its warehouse Goods are shipped in the name of customer.
 OES to Jenbacher L/C Establishment Procedure

Performa invoice is received to OES from Jenbacher

OES makes LC application in its DXB bank ; Applicant Bank/ Issuing Bank (IB)

OES Applicant Banks are

 Emirates NBD
 HBL Dubai
 MCB Dubai

IB shares it with Jenbacher’s Advising Bank (AB)

If any amendment in the LC is required by AB or by the Beneficiary (Jenbacher) then Jenbacher advises us
and we write back to our IB who sends this LC amendment to the AB and share its copy with us.

Once Jenbacher is satisfied with the LC, it declares “Clean LC” and that it will ship the goods in due time
 OES to Jenbacher L/C Establishment Procedure
After the goods board the vessel, Jenbacher shares the shipping docs with its AB. The Shipping docs include
 Bill of Lading  Certificate of Origin
 Commercial Invoice  Performance Guarantee
 Packing List  Vessel Certificate

Docs from AB  IB  Buyer (OES)  OES sends to Customer  Customer uses them for Custom Clearance

The Negotiation Period starts from the date of shipment. It is 15, 21, 30 or whatever no. of days the parties
agree within which the documents must be presented for payment, acceptance or negotiation. After which the
LC becomes discrepant.

Note: The LC doc has a clause of “Non Negotiable Docs” which means ,only the original docs submission by the
customer to the Port Authority could release the goods, no copy docs may work.

For stock orders, 3 months prior to shipment, OES has to specify the customer’s name to Jenbacher else OES
Dxb is assigned as customer.
 Advantages of LC
• The beneficiary is assured of payment as long as it complies with the terms and conditions of the letter
of credit.

• The credit risk is transferred from the applicant to the issuing bank.

• The beneficiary minimizes collection time as the letter of credit accelerates payment of the
receivables.

• The beneficiary’s foreign exchange risk is eliminated with a letter of credit issued in the currency of the
beneficiary’s country.

• An LC often negates the need (by the buyer) to pay a deposit before the delivery is made
 LC Discrepancies
L/C that
 does not comply with the terms and conditions under which it was established,
 is without a required item of information, or
 the information provided is inconsistent with the associated documents.

 Examples of Discrepancies include

 Letter of credit has expired*  Ocean Bill of Lading issued by forwarding agent
 Late presentation of documents unacceptable
 Late shipment of goods  Insurance does not cover risks stipulated in L/C
 Bill of Lading not clean  Insurance issued after shipment date
 Inconsistent spelling of parties’ names in documents  Bills of Lading and Drafts not properly endorsed
 Drafts not completed properly.

*LC expiry means the last date to submit the exported documents with bank for negotiation, i.e, LC is void if even the goods
have been shipped before the date (mentioned in LC for shipment), but docs not submitted for negotiation within the
validity period of Letter of Credit.
 Letter of Credit Vs Bank Guarantee

Letter of Credit (LC) Bank Guarantee (BG)

LC is an obligation taken on by the banks ensuring Bank guarantee is a safety measure taken to reduce
that the transactions between the two parties shall the risk of the loss if the transaction doesn't go as
proceed as planned. planned.

The bank will transfer the funds once the criteria set The sum is only paid if the opposing party does not
out in the LC doc are met. fulfill the stipulated obligations under the contract.

Ensures the payment will be made as long as the Ensures from any loss or damage due to
services are performed. nonperformance by either party in the contract
 What are Incoterms?
• International Commercial Terms set the International rules for commonly used terms in
foreign trade.

• They define obligation on both the parties involved in the trade, i.e, The Buyer & the
Seller.
• Determine the distribution & transfer of risk regarding the goods
delivered from seller to consumer.

• State the clear sharing of expenses between the parties during

transport

• Incoterms are published by the International Chamber of

Commerce (ICC)
Why are the Incoterms Important?

•Where the goods need to be

delivered?
•Who bears risk & up to what point?
•Who pays for the transportation?
•Who pays for insurance?
•Who pays for handling charges?
Incoterms
 Incoterms
EX WORKS Seller’s Premises, buyer incurs the risks for bringing the goods to their final destination

FCA Free CArrier, seller delivers the goods, cleared for export, at a named place
Free Alongside Ship, goods are placed alongside the buyer's vessel, buyer has to bear all costs and risks of
FAS loss of or damage to the goods from that moment.

FOB Free On Board, seller pays for transportation up to the port of shipment + loading on the vessel cost
Carriage Paid To, Risk transfers to buyer upon handing goods over to the first carrier at the place of
CPT shipment in the country of Export

CFR (CNF) Cost & Freight, Seller pay the costs and freight to bring the goods to the destination port.

CIF Cost, Insurance and Freight, Same as CFR with insurance also to be paid by the seller

CIP Carriage & Insurance Paid, Same as CPT but Insurance also in seller’s scope

DAT Delivered At Terminal, seller is responsible for all costs and risks until destination port

DAP Delivered At Place, seller is responsible for all costs and risks until destination place

DDP Delivered At Terminal, same as DAP with taxes &custom duties also to be seller’s scope