Letters of Credit

CIPS has formulated positions on letters of credit as this method of payment

is increasingly common due to the increase in global sourcing. Letters of
credit are part of the procurement process in international trade and should
be familiar to purchasing and supply management professionals along with
other aspects of international trade such as INCOterms.

Introduction the purchasing and supply management professional should

be aware of the ‘conditional’ nature of the letter of credit; if
CIPS’ position is that although all purchasing and supply the conditions have clearly not been met by the supplier, the
management professionals should be aware of letters of bank will probably refuse to make the payment. Hence
credit, and may regularly use them, they should always seek effective communication with the supplier is of paramount
assistance and advice from colleagues who specialise in importance.
Finance and International Logistics. If such assistance is not
available, CIPS encourages purchasing and supply Creating the Letter of Credit
management professionals to seek help from their
organisation's bank. The buying organisation opens a letter of credit through their
own bank. CIPS recommends that all letters of credit are
CIPS Positions on Practice signed off by the buying organisation's Finance Director. The
supplier's ‘Shipping Manager/Director’ should be requested
CIPS views are stated through-out this document but the key to provide the signature at the other end as it is he or she
statements are summarised below: who will have to comply with the conditions that the letter of
credit contains.
• CIPS recommends that before using letters of credit, There is a charge made by the bank for the service which
purchasing and supply management professionals should buyers usually try to have the supplier bear; these charges are
seek advice/assistance from colleagues with appropriate often high and the supplier will therefore usually try to
expertise in other departments (e.g. Finance/Accounts) negotiate the responsibility for these charges.
within the organisation.
• CIPS advises that all letter of credit should be signed off Normally, suppliers wish to have a bank in their own country
by a senior member of the organisation's Finance/ confirm the letter of credit if, for example, the supplier is
Accounts Department. unfamiliar with the issuing bank. Purchasing and supply
• CIPS considers that it is one of the responsibilities of the management professionals should be aware that a confirmed
purchasing and supply management professional to letter of credit requires the payment to come from a bank in
negotiate and optimise the precise terms of a letter of the supplier's country - usually the same city. If the letter of
credit. credit is ‘unconfirmed’ the payment is made from a distant
• CIPS would advise purchasing and supply management place in the buying organisation's country.
professionals to be aware that letters of credit do not
imply the quality or fitness for purpose of any goods being Confirmation also governs the place where the documents
purchased on this basis. are checked; if there is a confirming bank and it finds an
error, the supplier should be able to take the amended
• CIPS endorses the recommendations of the International paperwork to the bank to enable payment to be processed.
Chamber of Commerce (ICC) concerning the procedures The confirming bank commits to pay in the event that the
relating to the use of 'documentary credits' for the issuing bank fails to pay on those letters of credit which have
purposes of international trade. ‘without recourse’ terms i.e. the buyer has no recourse
• CIPS recommends that, in the event of changes being whatsoever upon the seller should the documents not be
made to the terms of a letter of credit once it has been honoured when they are due.
issued, the bank honouring the letter of credit should be
informed without delay. Usually letters of credit are irrevocable and are categorised as
• Whilst acknowledging their usefulness, CIPS would advise such in that they cannot be cancelled or changed unless both
caution before deciding to employ letters of credit in view parties agree to such an amendment. If the purchasing and
of the costs, administration and possible risks involved. supply management professional requires the letter of credit
to be changed, they must provide the issuing bank with
What is a Letter of Credit? instructions relating to the proposed change.

A letter of credit is a legal document that entitles the supplier
to payment under the terms and conditions stipulated in the
letter of credit when it is presented to the bank along with
documentation that guarantees that the shipment has been
made.
Many letters of credit are not for goods but for services and
in such cases ‘shipping documents’ are not applicable and so
some other evidence of service provision is required.
Irrespective of whether the payment is for goods or services,
The bank then advises the supplier of the proposed changes
by means of an amendment that is communicated via the
advising bank. If the supplier agrees to the changes then they
will be implemented.
Benefits of Using Letters of Credit
The supplier would normally request a letter of credit from
the buyer as it provides reassurances for them that they will
be paid once the goods have been shipped as requested.

Tel +44(0)1780 756777 • Fax +44(0)1780 751610 • Email ckw@cips.org • Web www.cips.org
Letters of Credit

However, many governments insist that the letter of credit is CIPS emphasises the critical importance of ensuring the
the only payment mechanism available; this is so that right wording is employed in respect of letters of credit.
governments can closely control access to foreign exchange. This is important in two respects:

Buyers benefit because letters of credit assist in the security
of supply in that the supplier must guarantee that the goods
have in fact been shipped to the buyer when he presents the
letter of credit for payment. If however, the wording is
inadequate in the letter of credit e.g. the conditions are weak
or unclear there could be a problem in ensuring security of
supply.
Purchasing and Supply Management
Professionals and Letters of Credit
• the wording states precisely and clearly what is intended
• the correct form of words are used (as the words have
specific meaning within the finance profession and in the
legal profession).
CIPS strongly recommends that purchasing and supply
management professionals seek advice and guidance from
their professional colleagues in Finance when issuing letters
of credit.

CIPS believes that it is one of the functions of purchasing Purchasing and supply management professionals must also
and supply management professionals to negotiate and agree be aware of the practical difficulties in changing the terms of
all aspects of the procurement process. For instance the a letter of credit once it has been issued. This can be
terms of the letter of credit e.g. letters of credit need not problematic even if both parties agree to the change.
necessarily be payable on sight i.e. the time they are
presented to the bank. CIPS suggests that one way of minimising such problems is
to ensure that the bank responsible for paying the letter of
Purchasing and supply management professionals can credit is immediately informed of any changes and
negotiate payment periods such as 80 days after shipment, confirmation of acceptance of such a change is formally
which allows the buying organisation to accrue interest on received.
the funds and helps cash flow, whilst the supplier is satisfied
that they will be paid in due course. Conclusion
In addition to negotiating the terms of the letter of credit This document is not intended to provide extensive
related to the payment, purchasing and supply management information about letters of credit e.g. it does not explain the
professionals should negotiate the relevant conditions. different types of letters of credit such as ‘back to back’,
Although this is usually the responsibility of international ‘rolling’, ‘standby’ etc. each which have their own advantages
logistics professionals, CIPS encourages purchasing and and disadvantages and which should be used in different
supply management professionals to take a more significant circumstances.
role in the negotiation and arrangement of airway bills,
consignment notes, packing lists, INCOterms, etc. Rather, it is intended to encourage purchasing and supply
management professionals to take a more active role in this
Letters of credit are also used as negotiation instruments; for aspect of international trade. CIPS position is that letters of
instance, the supplier can take a letter of credit to the bank credit are a useful payment tool, but they should only be
and negotiate a loan based on the future income a letter of used where necessary as they involve a great deal of
credit represents. Similarly, the letter of credit can contain administration, risk and cost to be a suitable payment
terms which allow the supplier to be paid immediately even mechanism for day to day trading situations.
though the terms state 80 days; this is called discounting’ and
involves the confirming bank taking a percentage for
enabling this payment.

CIPS emphasises that letters of credit in no way guarantee

the quality or fitness for purpose of the goods and therefore
the usual principles regarding ‘acceptance’ should be applied
to the purchase contract.

CIPS supports the approach taken by The ICC which is

detailed in Croner's guide on international trade. The ICC
has produced:

• A set of rules governing ‘documentary credit’ operations

called the Uniform Customs and Practice for
Documentary Credits (UCP) publication 500 (1993
revision). Nearly all banks through-out the world use
these rules but the UCP must be expressly incorporated
by all parties into the contract and so into the
documentary credit itself.
• A new and comprehensive credit application form,
publication 516, for use with the 1993 revision of the
above rules. This not only contains the form, but also
comprehensive guidance notes on completion and the
significance of the information required. As matters
included on the credit application should be covered in
the purchase contract, this form will provide a useful
checklist.

Tel +44(0)1780 756777 • Fax +44(0)1780 751610 • Email ckw@cips.org • Web www.cips.org