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LETTER OF CREDIT

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Title: LETTER OF CREDIT


1
  • LETTER OF CREDIT

2
LETTER OF CREDIT /DOCUMENTARY CREDIT
  • Letter of Credit is an undertaking issued by a
    Bank (Issuing Bank), on behalf of the buyer (the
    importer), to the seller (exporter) to pay for
    goods and services provided that the seller
    presents documents which comply with the terms
    and conditions of the Letter of Credit

3
LETTER OF CREDIT
  • UCPDC 600 Edition effective from 1st July
    2007
  • Documentary Credit means any arrangement that is
    irrevocable and thereby constitutes a definite
    undertaking of the issuing bank to honour a
    complying presentation.

4
  • Complying presentation
  • a presentation that is in accordance with
  • the terms and conditions of the credit,
  • the applicable provisions of these rules (UCP
    600) and
  • international standard banking practice.

Honour a. to pay at sight if the credit is
available by sight payment. b. to incur a
deferred payment undertaking and pay at maturity
if the credit is available by deferred
payment. c. to accept a bill of exchange
("draft") drawn by the beneficiary and pay at
maturity if the credit is available by
acceptance.
4
5
LETTER OF CREDIT
  • Three main contracts underlying LC
  • - Sale Contract between Buyer Seller
  • - Application-cum-Guarantee between
    Applicant(Buyer) and Issuing Bank
  • - LC itself (contract between Issuing
    Bank and Beneficiary/Seller)
  • ( LC independent of other two contracts)

6
Mechanics of Documentary Credit
CONTRACT
GOODS
DOCS
DOCS
Advising bank
Negotiating Bank/ Confirming Bank
Reimbursing Bank
6
7
Parties to Letter of Credit
  • Opener/Buyer
  • Issuing Bank
  • Advising Bank
  • Beneficiary/Seller
  • Nominated Bank/Negotiating Bank
  • Confirming Bank
  • Reimbursing Bank

8
Documents under Credit
  • Financial documents Drafts
    (ISBP Para 43 to 56)
  • Transport documents BL, AWB etc
  • (UCP Articles 19 to 27, ISBP Para 68 to 169)
  • Insurance documents Certificate/ policy
  • (UCP Article 28, ISBP Para 170 to 180)
  • Commercial documents Invoices
  • (UCP Article 18, ISBP Para 57 to 67)
  • Miscellaneous documents All other documents
  • Certificate of origin, Packing list, Quality
    certificate etc.
  • Documents other than invoices, transport and
    insurance documents are not defined by UCPDC
  • Only Certificate of Origin dealt with under ISBP
    Para 181 to 185

9
Types of credit
  • Security to beneficiary
  • Confirmed
  • Mode of settlement
  • Payment/ deferred payment
  • Acceptance
  • Negotiation
  • Involving middlemen
  • Transferable
  • Back to back
  • Involving advances
  • Red Clause Credit
  • Green Clause Credit
  • Involving repeated transactions
  • Revolving
  • Stand by

9
10
Transferable Credits
  • Credit has to be opened as transferable
  • The beneficiary is normally a trader or agent
  • He transfers credit to his supplier - second
    beneficiary.
  • Transferred by a bank at the request of first
    beneficiary
  • Second beneficiary can supply goods and negotiate
    documents as if he had received the credit.
  • He may pay commission to first beneficiary for
    the order
  • There can be more than one second beneficiary.
  • No third beneficiary is permitted.

10
11
Transferable Credits
  • The following parameters may be changed while
    transferring a credit
  • Amount of credit, unit price and quantity of
    goods
  • Date of expiry, last date of shipment and last
    date of negotiation can be brought forward
  • of insurance cover may be increased.
  • First beneficiary has the right to substitute
    documents negotiated by second beneficiary.

11
12
Back to Back Credits
  • Exporter receives a credit from his buyer (
    Selling credit)
  • He has to procure goods from other suppliers
  • He opens a credit for purchase of the goods (
    buying credit)
  • Second credit is said to be back to back to the
    first one.
  • Bill proceeds of the export LC (Selling LC) will
    be used to meet liabilities under the second
    (Buying LC)
  • Amount of back to back credit will be lower.
  • Usance period of the back to back credit should
    be equal to or more than that of the export
    credit.
  • Bank still at risk if the customer fails to
    export
  • No concession in margin and security norms.

12
13
Revolving Credits
  • Credit is opened to cover a series of regular
    transactions over a longer period
  • Beneficiary will submit a series of documents
  • Maximum value of each document will be fixed and
    is the revolving limit
  • LC amount is the maximum value of documents that
    can be handled under the credit.
  • The credit may be reinstated automatically or
    after payment of earlier bill.
  • It can be opened as cumulative or non cumulative.

13
14
Standby Letters of Credit
  • Credit is issued for a particular amount and for
    a particular period
  • Trade takes place on running account basis.
  • Beneficiary does not submit documents to bank.
  • If there is a default, he can claim funds from
    opening bank giving a certificate of default
  • No quibbling over discrepancies and documents
  • Opening bank will pay on demand
  • Works like a bank guarantee
  • UCPDC is applicable if so declared in the credit

15
LC Regulations
  • Foreign Trade Policy requirements.
  • FEMA requirements.
  • Credit norms of Central Bank.
  • UCPDC 600 Provisions.
  • Banks Internal Credit Policies/ procedures.
  • Public notices issued by DGFT
  • Uniform Rules for bank-to-bank reimbursements 525
  • Incoterms 2010

16
Banks Obligation Responsibilities
  • Issuing Bank (opening bank)
  • ( UCP Article 7)
  • -the prime obligator
  • -to ensure credit-worthiness and
    trust-worthiness of the applicant
  • - Once credit is opened, the bank is placing
    itself as a substitute for the buyer.

17
Banks Obligation Responsibilities
  • Advising Bank has the obligation to authenticate
    the credit once it is received and passing it
    promptly on to the beneficiary ( Art.9).
  • Confirming Bank takes over the responsibilities
    of the issuing bank as far as the beneficiary is
    concerned though it has got recourse to the
    Issuing Bank (Art 8).

18
Banks Obligation Responsibilities
  • Negotiating Bank
  • to examine docs. Within 5 banking days after
    receipt of the documents at their counters(Art
    14b).
  • to ensure compliance of credit terms ( on the
    basis of documents alone) as well as consistency
    of docs with each other.

19
Protection to Banks
  • Banks are not responsible
  • for the genuineness or contents of any documents
    submitted (Art. 34)
  • For losses etc. arising from transmission
    problems (Art. 35)
  • Force Majeure ( Art. 36)
  • For the failings of their correspondent Banks
    (Art. 37)

20
Protection to Banks
  • Issuing Bank is responsible for all Bank charges
    and other costs at home or abroad even if they
    are supposed to be paid by other party (Art. 37
    c).
  • Applicant is responsible for any adverse
    consequences of foreign laws (Art. 37d).

21
LETTER OF CREDITAppraisal / Assessment
  • satisfactory track record.
  • dealings with only one bank.
  • Liabilities of the applicant to the Bank and
    third parties.
  • Means by which the applicant is expected to meet
    his commitment once the bills arrive.
  • Margin he should deposit.

22
Appraisal Issues..
  • Limit to be commensurate with turnover and CC
    limits.
  • Should be for genuine trade/ manufacturing
    activity.
  • Usance period of the LC should ordinarily have
    relation to the working capital cycle.
  • Level of inventory carried should be commensurate
    with industry norms / past trends.

23
Appraisal Issues.
  • LCs for purchase of machinery / capital goods
    should be backed by borrowers own funds or a
    term loan sanctioned for the purpose.
  • Wherever warranted, in addition to margin, where
    prescribed, we may also retain a lien on the
    undrawn portion of the CC limit for the value of
    bills to be received under the LC.

24
Appraisal Issues
  • Sister concerns
  • Where the opener and beneficiary are sister
    concerns, LCs should not normally be necessary.
  • Take care of kite-flying operations.
  • Standing of the beneficiary.
  • D/A facilities to applicants of undoubted
    standing and where security available is much
    more than the value of LC.

25
Appraisal Issues
  • While computing purchase of imported material on
    LC basis take net of import duty.
  • Assess limits for usance and sight LC separately.
  • Usance period should not exceed the production
    cycle excepting in the case of bulk imports.
  • Keep in mind the accepted projections regarding
    Sundry Creditor levels.
  • Margins security depending on track record.
  • Cash budget monitoring to track availability of
    funds.

26
Appraisal Issues.
  • Revolving LCs
  • To be valid for not more than 1 year
  • The limit should be a sub-limit.
  • The LC value should be restored for further
    negotiation only after the advice of retirement
    of the previous bill has been received from the
    issuing bank by the beneficiary bank.

27
ASSESSMENT OF LC LIMIT
  • While assessing Letter of Credit Limit, the
    following points need to be noted
  • Purchases of RM on LC basis should be net of
    Import Duty LC amount should cover FOB, CIF or
    CF value of goods- should not include customs
    duty and other charges payable in India. Payment
    of these charges should be taken care of by the
    main working capital(CC) A/C of Applicant.
  • Transit time should be treated as Nil if usance
    period starts from shipment date.

28
Other issues
  • Arriving at D.P
  • Ensure that the stocks covered by bills which
    have been received under LCs opened by us, and
    not yet retired, are not included for computing
    the D.P. in CC account.
  • Devolvement of LCs
  • In case of irregularity in CC account do not open
    further LCs.
  • Take adequate margins and step up in case of it
    becoming a habit in worse cases stop further
    issues.
  • Mark lien on DP so that usance bills are properly
    retired on due date.

29
Treatment of stocks covered by Usance LC
  • Lien should be earmarked against advance value of
    stocks for the outstanding usance LC bills.
  • This ensures provision of margins on the stocks
    covered by usance LCs right from the time the
    stocks are bought on credit backed by the Banks
    commitment.
  • Thus, it ensures that the margin is available
    well before the CC a/c is debited for the matured
    LC bill.

30
Treatment of stocks covered by Usance LC
  • In some cases it is quite possible that the units
    may not be in a position to provide margins right
    from the time of purchases against LCs. In such
    cases, based on merits, earmarking of lien for
    the value of usance LC bills outstanding may be
    permitted against the aggregate market value of
    stocks (including the LC stocks) instead of
    against the advance value of securities.

31
Precautions
  • The limits for demand LCs and usance LCs should
    be assessed separately with ample justifications.
  • The usance period should not, generally, exceed
    the production cycle.
  • In case of bulk imports, establishment of LCs for
    longer usance period may be considered
    selectively.
  • When liability under LC is met by creating an
    irregularity in the Cash Credit account, the
    relative LC limit should not be released for
    opening further LCs till the account is adjusted.
  • Frequent Devolvement's Warning signal!

32
Assessment of LC Limit
  • We assume that
  • - Annual consumption of material to be
    purchased under LC C (Rs..)
  • Lead time from opening LC to
  • shipment
    L (months)
  • - Transit time
    T (months)
  • - Credit (usance) period available U (months)

33
Assessment of LC Limit
  • L T U Purchase Cycle P (months)
  • LC Limit P x C/12
  • Say, lead time, i.e. time from order
    placement to shipment
    10 days
  • Transit period
    20 days
  • Usance period from arrival of goods 3m
  • Total Purchase Cycle
    4m
  • Monthly consumption of material Rs 100
    lacs
  • LC Limit(4 x 100) Rs 400 lacs

34
ASSESSMENT OF LC LIMIT
  • M/s XYZ COMPANY LIMITED
  • LETTER OF CREDIT LIMIT OF Rs. 20 CRORES

  • (Rs. in crores)

Total purchase of Raw Materials (RM) 172.64
Purchase of RM under LC 69.41
Average monthly purchase of RM A 5.78
Average usance period B 3 months
Lead time transit period C 1 month
Total of B C D 4 months
Requirement of LC Limit A x D 23.12
LC Limit recommended 20.00
35
Assessment of LC Limit
  • Let us assume as follows (Rs in lacs)
  • i) Annual purchase of RM 3200
  • ii) RM purchase under LC(50) 1600
  • iii) Purchase under demand LC 800
  • iv) Purchase under usance LC 800

36
Assessment of Demand LC Limit
  • Time gap from opening till shipment 1 m
  • Transit period from date of shipment
  • till date of retirement
    0.5 m
  • Demand LC Limit 800 x 1.5/12 Rs 100 lacs


37
Assessment of Usance LC Limit
  • Lead Time, i.e from opening
    LC till shipment
    1 month
  • Transit Period, i.e. from date
  • of shipment till date of receipt of documents
    by importer
    0.5 months
  • Average usance period 2 months
  • Usance LC Limit 800x3.5/12 Rs 233 lacs

38
THANK YOU
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