Export Letter of Credit Cycle
Buyer/seller discuss preliminary details of the contract
Applicant and beneficiary sign the contract which indicates the payment for the sale
Will be settled by presentation of documents under a letter of credit.
Applicant prepares application, delivers application to the issuing bank, requesting
Issuing bank to open letter of credit in favor of the beneficiary.
ISSUING BANK
Issuing bank checks credit line of customer, determines pricing and reviews the language
of the application for workability. May recommend changes to the application.
Role of the Issuing Bank
Determine method of advising Choose reimbursing bank (if any) and provide payment
authorization Determine refinancing method, if required Name negotiating bank
Issuing bank forwards the letter of credit to the advising bank.
Role of the Advising Bank
Verify authenticity, Review for workability, Clarify terms & conditions,
Collect advising fees, if necessary Advising bank forwards letter of credit to the beneficiary.The beneficiary should also review the letter of credit.
BENEFICIARY
Beneficiary reviews letter of credit for their needs and consistency with contract.
BENEFICIARY REVIEW
Letter of credit amount, Expiration date, Shipment date,
Bank’s engagement, Negotiating bank, Bank charges,
Shipping terms,Documents,Currency,Tenor,UCP 500
Role of the Reimbursing BankDoes not receive a copy of the original letter of credit.
Does not receive nor check the documents against the letter of credit
Holds authorization from the issuing bank to effect payment against claims received
Beneficiary forwards the letter of credit & the goods to the freight forwarder.
Freight forwarder arranges for shipment and prepares documents for drawing under the letter of credit.
NEGOTIATING BANK
=================
Negotiating bank reviews documents for compliance with the l/c terms, and if in order,
follows letter of credit instructions.
Negotiating Bank claims funds from the reimbursing bank and forwards the documents to
the issuing bank
Reimbursing bank remits to the negotiating bank, who transfers the funds to
the beneficiary through the beneficiary’s bank.
Issuing bank receives documents and reviews documents for compliance with the
terms of the letter of credit.
If issuing bank finds documents in order, the documents are released and payment or
acceptance is obtained from the applicant.
Applicant utilizes the documents to clear customs and pick up the goods.
Introduction to Trade Finance
=====================
International Trade
=============
International trade is trade beyond the borders of the country. The buyer and seller
reside in different countries.
International trade
Visible trade is the export and import of physical goods.
Invisible trade is the export and import of services.
Why International Trade?
==================
Countries and their governments encourage exports because:
they may require a strategic product(oil,coal etc.,)
they have a surplus(coffee,oil etc.,)
they need foreign exchange(to pay for the import of key goods or
capital development projects)
they have a competitive advantage in a product or a services
They want to increase economic growth and/or their influence in the
world through greater trade
Risks in International Trade
====================
Risk for Exporters
Distance between buyer and seller
Exporters have to assess both, the honesty and the financial standing of the
overseas buyer Efficient resolution of disputes Restrictions imposed by overseas governments
Risks
====
Risk for Importers
- The goods ordered may arrive late or damaged
The good may not be as per the specifications ordered
Political risk associated with the government in the buyer's country
Transfer risk involving the economy of the buyer's country
Commercial risk, also found in domestic sales, of whether the buyer can
and will pay the seller when payment is due
Mitigation of Risks
===================
Banks can apply international codes of practice particularly Collections:
Uniform Rules for Collection No.522; Letters of Credit :
Uniform Customs and Practices No.500
Banks can maintain control over the goods on behalf the exporter
Banks can give their financial backing to the transactions
Banks can act as a channel of communication for payments
Importance of trade terms
==================
Trade terms are key elements of international contracts of sale, since they tell
the parties what to do with respect to carriage of the goods from seller to buyer
and export and import clearance They also explain the divisions of costs and
risks between the parties
Incoterms
=======
To simplify communications between traders about matters relating to transport,
insurance etc, the International Chamber of Commerce has created a set of thirteen
standard packages of terms and conditions, designed to suit typical trading conditions.
These are called Incoterms –International commercial terms.
First published in 1936
Official title is “International Rules for the Interpretation of Trade Terms”
Incoterms tell the parties what to do with respect to the carriage of goods from
Seller to Buyer and export and import clearance.
The terms also explain the division of costs and risks between the parties.
Trade Finance Terms
===============
Collection
refers to the handling of documents by banks in accordance with instructions received
Commercial Documents Invoices, transport documents, documents of title etc..
Financial Documents Bills of Exchange (Drafts), Promissory notes, Cheques or
similar instruments used for obtaining the payment.
Bill of Exchange (Draft)
An unconditional order in writing by the Drawer / Exporter to the Drawee / Importer,
requiring the person to whom it is addressed to pay on demand or at a fixed or
determinable future time, a sum certain in money to or to the order of the Payee Bearer.
Drawee
The person on whom a Bill of Exchange or Draft is drawn and from whom
payment is due.
Drawer
The person who draws the BOE on another person (Drawee) and to whom
payment is due.
Sight Draft
A Bill of Exchange or Draft which requires immediate payment, “At Sight”.
Tenor Draft
A Bill of Exchange (Draft) which is payable at a future date. Also referred to as a
Usance / Term Draft.
Acceptance
A Bill of Exchange or Draft, which has been signed as "accepted"
by the party upon whom it is drawn, assuming the obligation of repayment.
Avalisation
To add an “Aval” means a specific endorsement on a Bill of Exchange or Draft by
the Collecting bank, which guarantees payment should the Drawee (the Importer)
default on payment of the bill at maturity.
Documents against Payment (D/P)
Also known as Cash against Documents in which documents are sent to the
Collecting Bank with instructions that they are to be handed over to the
Importer only in exchange for payment.
Documents against Acceptance (D/A)
Importer's bank, normally the Collecting Bank, will release Documents
against the Acceptance of the Bill of Exchange or Draft by the Importer.
Commercial Invoice
It is the accounting document by which the Exporter claims payment from
the Importer for the value of the goods / services being supplied / rendered.
Bill of Lading
A document that acts as a receipt for the goods from the shipping company to
the Exporter.
Air Waybill
Also known as an "Air Consignment Note", it is an air transport document issued by
airlines when goods are sent by air freight.
Shipping Guarantee / Delivery Order
Document issued by the Presenting / Collecting to the Importer to clear goods in the event
of loss or delay of documents.
Presenting Bank
The Bank who presents documents to the Importer.
Collecting Bank
The Bank involved in the process of collecting funds / payment. The Collecting Bank
may also be known as the Presenting Bank.
Remitting Bank
The Bank to which the Exporter has entrusted the collection documents.
Reimbursing Bank
The Bank instructed or authorised to provide reimbursement (funds).
Documentary Credit
===============
What is trade
Trade consists of three (03) components : G.A.P
Goods movement
whereby the goods will be transported from one point of origin to another point of origin.
Agreement
is a business transacdtion entered into by two (2) parties whereby one party agrees to
perform/sell [i.e. the Seller] and the other party agrees to pay/buy [i.e. the Buyer]
at an ‘agreed price’
Payment mechanism
the price is effected based upon the ‘agreed and pre-determined’ mode set up by the
Seller and the Buyer
What is domestic or local trade
The goods will be transported from one point of origin to
another point of origin inside the same country.
What is international trade
The goods will be transported from one point of origin in one country to another point
of origin in another country
The ideal situation
For the Buyer : wants to pay only when the goods arrives
For the Seller : wants to be paid before sending the goods
Characteristics of Trade
It must comprise of either a combination or any one of the followings :
An agreed product or services
an agreement [Proforma invoice, sales contract,etc]
shipping and delivery details
payment terms
documentation requirement
insurance coverage
Cash in advance
Definition
Cash in advance is an arrangement between the exporter and the importer as follow :
[a] Importer pays cash in advance to the exporter
[b] Exporter ships the goods to the importer
[c] Exporter sends the shipping documents to the importer.
Commercial Letters of Credit
=====================
A letter of credit is a banking mechanism which allows importers to offer secure
terms to exporters.
Letters of credit contain the following elements:
a payment undertaking given by a bank (Issuing bank) on behalf of a buyer (applicant)
to pay a seller (beneficiary) a given amount of money on presentation of specified
documents representing the supply of goods within specific time limits
These documents conforming to terms and conditions set out in the letter of credit
Documents to be presented at a specified place
Parties to Letters of Credit
===================
Applicant - The importer who applies for the LC
Issuing Bank - The importer's bank who issues the LC
Beneficiary - The exporter who gets paid under the LC
Advising Bank - The LC is communicated to the exporter to the bank via the exporters bank.
This bank advises the exporter of the LC and so is called the Advising Bank.
Confirming Bank - The advising bank may agree to confirm the LC, thereby becoming a
Confirming Bank.
Negotiating Bank - It may agree to take part in the settlement process
by becoming a Paying, Negotiating or accepting bank
Why are Letters of Credits used?
=======================
To protect the seller from fraudulent buyers
To protect sellers against importers country risk
Having the advising bank check the documents protects the buyer
in receiving a proper shipment
Establishing credibility of buyer and seller
About Letters of Credit
=================
Letter of credit is neither an unconditional guarantee of payment to the seller nor a
means of assuring the buyer that goods paid for will be satisfactory
It says that payment will be rendered if and only if the documents required by the LC
comply with the terms and conditions of the credit
But the LC protects a seller from an unscrupulous buyer
Revocable LC – Once established, can be modified or cancelled at any time without
notice to or consent of the seller.
Irrevocable LC – is a binding commitment, and any change or amendment
to the credit desired by the buyer or seller must be agreed to, by all
parties concerned.
Confirmed LC – A LC wherein a particular bank takes the responsibility
to make payment.
Unconfirmed LC – No obligation of payment, treated like a normal LC.
No confirmation clause found.
Elements to Letters of Credit
=====================
Whether the credit is revocable or irrevocable
Expiry date
Name of the seller
Name of the buyer
Amount of the credit
Tenor of the draft
General description of the merchandise
Shipping terms (FOB, CIF, etc)
Documents required (Invoices, packing lists, insurance certificates
Contracts to Letters of Credit
=====================
Three contracts to LC
The purchase order or sale contract between the buyer and the seller
The Letter of Credit application/agreement between the buyer and the issuing bank
The Letter of credit itself between the issuing bank and the seller
Import Letters of Credit
=================
Between an importer and a foreign seller
Importer applies for LC with his bank
LC terms should be consistent with the terms of sale contract
Seller presents all the documents referred to in the LC to his
bank and it reaches the Issuing Bank
Payment on satisfactory compliance of the documents with LC
Export Letters of Credit
=================
Between an exporter and a foreign buyer
Foreign buyer applies for LC with his bank
LC terms should be consistent with the terms of sale contract
Seller presents all the documents referred to in the LC to his
bank and it reaches the Issuing Bank
Payment on satisfactory compliance of the documents with LC
Special Letters of Credit
==================
Transferable LC
The value of a single LC is divided between the 1st beneficiary(trader)
and the 2nd beneficiary (supplier of goods). 1st and 2nd beneficiaries make
their own presentations of documents to the advising bank. The 1st beneficiary
substitutes the 2nd beneficiary’s invoice and Bill of Exchange with his own
documents before presenting the documents to the Advising Bank.
Back to Back LC
The master LC is offered as a security for another LC – the slave LC.
Red Clause Documentary Credit
A Documentary Credit with a special condition incorporated into it that authorizes
the Confirming Bank or any other Nominated Bank to make advances to the Beneficiary before
presentation of the documents. The clause is incorporated at the specific request of the
Applicant, and the wording is dependent upon his requirements.
Revolving LC
It covers a series of transactions over a period. It can be cumulative and non-cumulative.
Reinstatement can be automatic or on advice of the Issuing Bank Banks’ exposure is
for the total amount and for the entire period
Instalment LC
Similar to a revolving, non-cumulative LC Except is that once the exporter misses a
shipment, the credit ceases to be in effect
Standby LC
LC which represents an obligation to the Beneficiary on the part of an Issuing Bank
to repay money borrowed by the Applicant, or advanced to or for the account of the
Applicant, to make payment on account of any indebtedness undertaken by the Applicant,
or to make payment on account of any default by the Applicant in the performance of
an obligation.
Evergreen LC
A standby LC with an initial expiration date is issued Contains a clause that it will
be automatically extended for additional periods unless the issuing bank provides
notice to the beneficiary stating otherwise
Clean LC
Beneficiary request for a LC wherein the only document is a draft drawn on the
Issuing Bank Issuing Bank pays and the applicant is required to reimburse once the
draft is presented
Common Discrepancies
=================
Documents are inconsistent Documents were presented more than 21 days after date
of shipment Draft is drawn incorrectly or for the wrong amount Invoice includes
charges inconsistent with shipping terms in the LC Insurance coverage is insufficient
Bill of Lading is not consigned correctly/not endorsed Transhipment included whereas
in LC it is not Documents are not signed in accordance with LC terms
Terms - Letters of Credit
=========================
Confirmed Irrevocable Documentary Credit – A definite undertaking by the Confirming
Bank to the Beneficiary (Exporter), provided the stipulated documents are presented to
the Confirming Bank or to any other Nominated Bank on or before the expiry date and
the terms and conditions of the Documentary Credit are complied with, to pay, to accept
Bills of Exchange (Drafts) or to negotiate .
Irrevocable/Revocable – All Documentary Credits should state whether they are
Revocable or Irrevocable, in the absence of which, they will be considered
as Irrevocable
Issuing Bank/Opening Bank – The bank that acts at the request of and on the
instructions of the Applicant (the Importer/Buyer) by opening a Documentary
Credit in favour of the Beneficiary (Exporter)
Claiming Bank - The bank that pays, incurs a deferred payment undertaking,
accepts Bills of Exchange or Draft(s), or negotiates under a
Documentary Credit and presents a Reimbursement Claim to the Reimbursing Bank.
Confirming Bank - The bank which, at the request of, or with the permission of,
the Issuing Bank, adds its own irrevocable undertaking to honor the Documentary
Credit if the Issuing Bank should default, provided that the underlying documents
are in order and are presented within the validity period of the Documentary Credit
Advising Bank - A bank, normally domiciled in the Beneficiary's (Seller's/Exporter's)
country, which is chosen by the Issuing Bank to forward the Documentary Credit
under advice to the Beneficiary.
Negotiating Bank – The bank that is requested to give value for Bills of Exchange Drafts)
and/or documents under a Documentary Credit
Negotiation – means the giving of value for Bills of Exchange (Drafts) and/or
Documents by the bank authorized to negotiate (the Negotiating Bank). With recourse
Without recourse
Nominated Bank - All Documentary Credits are required to indicate a bank
(the Nominated Bank) which is authorized to pay, to incur a deferred payment
undertaking, to accept Bills of Exchange (Drafts) or to negotiate. The bank that is
nominated to do the above is the nominated bank
Presenting Bank – The Collecting Bank in a Documentary Collection who is making
presentation of the documents to the Drawee (Buyer/Importer).
See also Collecting Bank.
Principal - The Exporter/Seller under a Documentary Collection who entrusts the
handling of a Collection to its bank
Reimbursement Authorization - Issued by an Issuing Bank to a Reimbursing Bank to
reimburse a Claiming Bank, or, if so requested by the Issuing Bank, to accept and pay a
Time Draft(s) drawn on the Reimbursing Bank.
Reimbursement Amendment - This is an advice from the Issuing Bank to a Reimbursing
Bank stating changes to a Reimbursement Authorization.
Reimbursement Claim - It is a request for payment of funds due by the Claiming Bank to the
Reimbursing Bank
Reimbursement Undertaking - A separate irrevocable advice of the Reimbursing Bank,
issued upon the authorization or request of the Issuing Bank, to the Claiming Bank
named in the Reimbursement Authorization, to honor that bank's Reimbursement Claim
provided the terms and conditions of the Reimbursement Undertaking have been
complied with.
Documentary Collections
==================
Collection
=======
Collection means the handling of documents in accordance with instructions
received in order to:
Obtain payment and / or acceptance
Deliver documents against payment / acceptance
Deliver documents on other terms / conditions
Clean Collection and Documentary Collection
=================================
Clean collection means collection of financial documents not
accompanied by commercial documents
Documentary collection means collection of
Financial documents accompanied by commercial documents
Commercial documents not accompanied by commercial documents
Parties to Collection
===============
Principal
The party entrusting the handling of a collection to a bank
Remitting bank
The bank to which the principal has entrusted the handling of a collection
Collecting Bank
Bank other than the remitting bank, involved in the process of collection
Presenting Bank
The collecting bank making presentation to the drawee.
Documentary Draft Collections
=======================
Documents are entrusted to a bank for delivery only after the sellers’ collection
instructions are met
Banks act only as a collection agent
Banks do not assume liability for payments
Bill of exchange or “Bill”
Documentary Sight Drafts
===================
Exporter entrusts his invoice, B/L and other documentation
Accompanied by a draft “At Sight” drawn by him on the importer
To remitting bank for collection of payment
Remitting bank forwards to its overseas correspondent bank with “D/P’ or “C.A.D”
Documentary Time Drafts
===================
Exporter entrusts his invoice, B/L and other documentation
Accompanied by a draft payable certain number of days after sight or after the
date of invoice.
The “tenor” is originally agreed upon between the parties
To remitting bank for collection of payment
Remitting Bank forwards to its overseas correspondent bank with instructions
“deliver documents against acceptance”
Avalized Drafts
===========
Combines features of a time draft with banks’ guarantee
The collecting bank is asked to add its guarantee, or “Aval” to the time draft
After obtaining the importers’ acceptance but before release of the documents
Collecting Bank is responsible for payment of the draft if buyer fails
Fee higher than a normal time draft or sight draft
Direct Collections
=============
Enables exporter to forward the collection instructions and documents directly
to the buyers’ bank
Airmailing the documents speeds up the collection process
Exporter sends in the forms provided by his Bank
The overseas bank treats it as if received from the remitting bank and makes payment
Errors in Direct Collections
====================
Bills of lading and insurance certificates are not endorsed
Drafts are incorrectly drawn or not signed by drawer
Instructions for payment of charges are absent
Amount of commercial invoice are different
Methods of Payment
===============
Types of Payment Risk Borne by
==============================================
Open Account Trading Seller
Advance Payment Buyer
Collections Cushion provided by banks
Documentary Credit Issuing Bank
COLLECTIONS
===========
Collection - Meaning
===============
Simplest and common method in international trade.
No engagement for banks.
Banks shall act only as agents.
Parties trust each other
Economical
Parties Involved
===========
Seller-Drawer
Buyer-Drawee
Remitting Bank - Seller’s Bank
Collecting Bank -Intermediary
Presenting Bank - Buyer’s Bank
Types of Collections
===============
Documentary Collections
Clean Collections
Direct Collections
Documentary Collection
==================
Collection of financial documents accompanied by any commercial documents
Clean Collection
================
Collection of financial documents not accompanied by any commercial documents
Direct Collection
=================
Documents are sent directly to drawee’s bank by drawer
What is Tenor ?
===============
It is the time agreed between the parties either to effect payment immediately
or at a future date or on other specified terms Tenor should be unambiguous,
easily understandable & definable
Terms of Payment
=============
Documents Against Payment/Cash Against Documents/Sight
Document Against Payment after term days
Documents Against Acceptance after terms days.
Other Terms and Conditions
Guarantees
========
What is a Guarantee?
==============
A Guarantee is issued by a bank on behalf of its customer, the Exporter, as
financial assurance to the Importer to be collected in the event that the Exporter
defaults on certain
specified contractual obligations.
The bank that issues a Guarantee will pay the named beneficiary the amount
specified on presentation of a written demand as outlined in the Guarantee.
While there are standard Guarantee formats, Guarantees can be tailored to
meet your specific contractual needs.
Often Standby Letters of Credit are used instead of Guarantees. Standby
Letters of Credit work in much the same way as Guarantees, offering
financial assurance to the Importer if the Exporter defaults on agreed-upon
contractual obligations. However, there
are at least two important ways in which Standby Letters of Credit
differ from Guarantees :
Standby Letters of Credit are governed by the International Chamber of
Commerce’s UCP while Guarantees are subject to the laws of the country of the
Issuing Bank.
Banks in several countries, including the United States, are not empowered
to issue Guarantees, and therefore use Standby Letters of Credit instead.
Basic Facts: Types of Guarantees
========================
These types of Guarantees are commonly requested in foreign contracts:
Bid Guarantee:
==========
An Importer will often ask foreign contract bidders to post a Bid Guarantee
as evidence of serious intent to supply the goods or services if selected.
In the event that the selected supplier is unwilling or unable to carry out
the contract, the Importer can collect the amount of the Bid Guarantee.
Advance Payment Guarantee:
=====================
An Advance Payment Guarantee covers the amount of the down-payment the
Exporter requests from the Importer and provides the Importer with some security that,
if the Exporter does not deliver under the terms of the contract, the amount of the
down-payment would be retrievable.
Performance Guarantee:
=================
A Performance Guarantee permits the Importer to draw on the Guarantee if
the Exporter fails to perform according to the terms of the contract. For example,
in the event that the Exporter is unable to complete the contract as agreed halfway
through a project, the Importer is compensated with the amount of the Performance Guarantee.
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