NON FUND BASED CREDIT.

LETTERs OF CREDIT & BANK GUARNTEES

BM Session 25
 METHODS OF PAYMENT IN INTERNATIONAL
TRADE
• ADVANCE PAYMENT
• OPEN ACCOUNT
• COLLECTION BASIS
• PURCHASE OF EXPORT BILL BY BANK
• DISCOUNT OF EXPORT BILL BY BANK
• NEGOTIATION OF BILL UNDER L.C
 ADVANCE PAYMENT

The seller may demand an advance payment. when

✓the buyer’s credit is doubtful or
✓ the political or economic environment of the
buyer’s country is unstable
 OPEN ACCOUNT
✓The goods are delivered directly by the
Exporter to the importer
✓A clean bill is drawn by exporter on Importer.
✓Payment is made by importer at the end of
the agreed period, through banking channels
✓ A High degree of trust is required between
the buyer and the seller.
✓It is more advantageous to the buyer.
 COLLECTION BASIS

• The Exporter ships the goods to the country of the importer.

• The documents of title to goods are submitted by the Exporter to his
banker .
• Exporter’s bank sends the documents to his Correspondent bank abroad
for collection basis
• No Finance is made by the Exporter’s Bank to the Exporter( Seller)
• On payment of the Bill amount by Importer, the correspondent bank
delivers the documents of title to goods to the Importer , and remits the
amount to Exporter’s Bank
 PURCHASE / DISCOUNT
OF EXPORT BILL BY BANKS
• When the goods are supplied by the Exporter to
the Importer against collection basis, the Exporter
will be out of funds, until the bill is paid by the
Importer.
• Hence the Exporter requests his bank to finance
against the Bill
• Banks Purchase the Demand Bills ( Bills payable
immediately.
• Banks Discount the Usance Bills ( Bills payable after
some time .
 PURCHASE / DISCOUNT OF EXFPORT BILL BY BANKS (contd…..)

• If the bill is paid on presentation ( Demand Bill), or on the

due date ( Usance Bill), it is well and good.
• If the Bill is dishonoured by the importer / Buyer, on the
due date the banker can recover the amount of made by
them
• Recourse Is Available To The Exporer’s Bank ,in the event of
dishonour of the bill.
• Having paid the amount of advance against the export bill
to the banker, now exporter takes up the matter with the
importer for recovery.
 NEGOTIATION

ACCEPTING THE DOCUMENTS AGAINST THE

L.C AND
MAKING PAYMENT TO THE EXPORTER,
WITHOUT RECOURSE TO THE EXPORTER,
IS CALLED NEGOTIATION.
 Documentary letter of credit
✓An undertaking issued by a bank,
✓on behalf of the importer/buyer,
✓in favour of the exporter/seller, that
✓if the specified documents, showing that a shipment
has taken place, or a service has been provided,
✓ are presented to that bank, within the stipulated
time,
✓exporter/seller will be paid.
 PARTIES TO LETTER OF CREDIT
➢ Applicant ( Importer)
➢ Issuing bank
➢ Beneficiary ( Exporter)
➢ Advising bank
➢ Confirming bank
➢ Negotiating bank
➢ Reimbursing bank

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 PRE-REQUISITES FOR ESTABLISHING AN LC

• The trade control is regulated by DGFT through the

customs Department.
• Exchange control is regulated by RBI through Authorized
Dealers in Foreign Exchange.(Banks)
• First locate the market and find your customers.
• Obtain Importer Exporter Code Number (IE Code) from
Regional Director General of Foreign trade (DGFT).
• Know about the Current EXIM Policy, as to whether the
goods which he wants to export or import are permitted
to be exported/ imported as per the rules in force.
 LC MECHANISM

3 LC transmitted to correspondent Bank

L p
C a
R y D
E m O
4 2 Q e C
U n S
E t D
S
1 Sale/Purchase agreement T 12 11 o
c
13 u
5 goods B/L
m
6 B/L e
Goods n
D
p
14 t
o
c a s
u y
m m 8
e e
n 10
n
t
7 s t
10B

Documents 10A

Reimbursement of LC amount
9
 NEGOTIATION OF BILLs UNDER L.C
1) Importer’s Bank opens a letter of letter of credit, in the
name of exporter, and sends it to its correspondent bank
in the country of exporter.
2) The correspondent bank , verifies the authenticity of the
L.C and advises the same to Exporter. Hence it is called
advising bank.
3) Now Exporter ships the required goods and submits the
documents to the nominated bank (The bank named in
the L.C to whom the exporter is required to submit the
documents for the purpose of negotiation )
 NEGOTIATION OF BILLs UNDER L.C ( continued……)
4) Some times the advising bank may also be nominated as
negotiating bank.
5) The negotiating bank scrutinizes the documents
submitted by the Exporter, as to whether they are in
strict compliance with the stipulations in the letter of
credit opened by the importer’s bank.
6) The Negotiating Bank has to follow THE DOCTRINE OF
STRICT COMPLIANCE
 NEGOTIATION OF BILLs UNDER L.C ( Continued….)
7) If the documents submitted by the Exporter are in strict
compliance with the terms of L.C, Negotiating Bank pays the
amount of the bill to the Exporter.
8) Negotiating Bank having paid the amount to the Exporter, is
now out of funds. Hence it seeks reimbursement from the
reimbursing bank(The bank named in the L.C),i.e. the bank
with whom the L.C opening bank maintains the Nostro
account.
9) Some times the functions of Advising Bank , Negotiating
Bank and Reimbursing Bank are discharged by one and the
same Bank.
 NEGOTIATION OF BILLs UNDER L.C ( Continued….)

10) Now the Negotiating Bank sends the documents to the

L.C. Opening Bank.
11) L.C opening Bank verifies the documents received
from the negotiating bank as to whether they are in
strict conformity with the terms of L.C.
12) If any discrepancy is found the L.C opening bank has
to notify the same to the Negotiating bank with in
Five working days subsequent to the date of receipt of
documents. Other wise the documents are deemed as
accepted by the L.C opening Bank.
 NEGOTIATION OF BILLs UNDER L.C ( Continued…..)

13) Once the documents are refused by the L.C opening

bank, the negotiating bank has to pay back the amount
received by it from the reimbursing bank.
14) Now Negotiating Bank is out of funds.
15) The Negotiating bank cannot recover the amount from
the Exporter.
16) Now the negotiating bank has to persuade on the
Exporter for the settling the matter with the Importer for
acceptance of the documents by his banker.
17) It is for this reason that, some banks negotiate LCs
under reserve, ( By highlighting small little insignificant
discrepancies), and try to have recourse to the Exporter.
 Types of letters of credit

REVOCABLE L.C
REVOCABILITY
L IRREVOCABLE L.C
E
T SIGHT L.C
T TENOR USANCE L.C
E
R B FIXED L.C
S A USAGE OF LC REVOLVING L.C
S
E CONFIRMED L.C
O D
F CONFIRMATION
UNCONFIRMED L.C
O
N SINGLE L.C
C TYPE OF
R EXPORTER BACK TO BACK L.C
E
NEGOTIATION L.C
D PAYMENT
I TERMS ACCEPTANCE L.C
T
RED CLAUSE L.C
ANTICIPATORY
CREDITS GREEN CLAUSE L.C
 BILL OF EXCHANGE
FINANCIAL DOCUMENTS
PACKING LIST

E
INVOICE
X
INSPECTION CERTIFICATE
P
COMMERCIAL DOCUMENTS MANUFATURER’S ANALYSIS
O CERTIFICATE
R
WEIGHT NOTE
T

BILL OF LADING

D AIRWAY BILL

O LORRY RECIEPT
TRANSPORT DOCUMENTS
C
POSTAL RECIEPT
U
MULTIMODAL TRANSPORT
M DOCUMENT

E
INSURANCE / RISK COVERING
MARINE INSURANCE POLICY
N DOCUMENTS

T
COVER NOTE
S

CONSULAR INVOICE
REGULATORY/ OFFICIAL
CERTIIFICATE
LEGALISED INVOICE

CERTIFICATE OF ORIGIN
 UCPDC 600
• UCPDC is the common reference for the Uniform Customs and Practice for
Documentary Credits.
• The objective of the UCP is to create a set of contractual rules that would
establish uniformity to conflicting national regulations.
• The Uniform Customs and Practices (UCP) for Documentary Credits were
first issued in 1933 by the International Chamber of Commerce.
• The purpose was to overcome conflicting national laws on letters of credit as
well as to bring about uniformity in banking practices.
• The UCP 600 has come into effect from July 1, 2007.
• It contains 39 articles. Some of the new articles in UCP 600 have been adopted
from the practices in International Standard Banking Practices (ISBP) and
principles of International Standby Practices.
 UCPDC 600: SOME IMPORTANT ARTICLES
✓If a L.C is silent it is deemed as Irrevocable.
✓In Letters of credit transactions banks deal in
Documents and not in Goods.
✓Banks get maximum five clear working days for
verification of documents submitted against the
L.C
✓Banks assumes no liability or responsibility for the
form, sufficiency, accuracy, genuineness,
falsification or legal effect of any document, or for
the general or particular conditions stipulated in a
document or superimposed thereon.
 CASE: 1 [UCPDC : ART- 5]
• The negotiating bank sends the documents to L.C
opening bank .
• The documents are strictly in conformity with the
terms of L.C.
• When the L.C opening bank is about to make the
payment, the importer informed the Bank that the
goods are reported to have been lost in the sea and
advised the L.C opening bank not to make the
payment.

❖What should the L.C opening bank do?

 CASE-2, [UCPDC-Art-34]

✓Documents received against the L.C are strictly

as per the terms of L.C.
✓However, the Importer reports that the Bill of
lading is a fake one
✓Importer advises the L.C opening bank not to
make the payment.

❖What should the L.C opening bank do?

 WHAT IS BANK GUARANTEE?
SANJAY BULANKI BOARD: Founder & CEO of e Finance Management.
 TYPES OF BANK GUARANTEES
• FINANCIAL GUARANTEE : Here, the bank guarantees that the applicant will meet the financial
obligation. And in case he fails, the bank as a guarantor has to pay.
• PERFORMANCE GUARANTEE : Here the guarantee issued is for honouring a particular task and
completion of the same in the prescribed/agreed upon manner as stated in the guarantee document.
• ADVANCE PAYMENT GUARANTEE : This guarantee assures that they would return the advance
amount in case of no fulfilment of the terms.
• PAYMENT GUARANTEE / LOAN GUARANTEE : The guarantee is for assuring the payment/loan
repayment. In case, the party fails to do so, a guarantor has to pay on behalf of the defaulting borrower.
• BID BOND GUARANTEE : As a part of the bidding process, this guarantee assures that the bidder
would undertake the contract he has bid for, on the terms the bidding is done.
• FOREIGN BANK GUARANTEE : Foreign BG is a guarantee which is issued for a foreign beneficiary.
• DEFERRED PAYMENT GUARANTEE :P When the bank guarantees some deferred payment, the
guarantee is termed as Deferred Payment Guarantee. For example, A company purchases a machine on
credit basis with terms of payment being 6 equal instalments. In this case, since the payment is deferred
to a later period, creditor seeks deferred payment guarantee for an assurance that the payment would
reach him in the given time period.
• SHIPPING GUARANTEE : This guarantee protects the shipping company from all kinds of loss, in
case the customer does not pay. This document helps the customer to take possession of goods.
• GUARANTEE FOR WARRANTY OBLIGATION OR WARRANTY BOND : This is an assurance that
there will be a proper delivery of the ordered goods as per the agreement.
 WHY IS BANK GUARANTEE IMPORTANT?
• ADDS TO CREDIT WORTHINESS :BGs reflect the confidence of
the bank in your business and indirectly certify the soundness of your
business.
• ASSESSMENT OF BUSINESS : In the case of foreign transactions or
transactions with Government organizations, the foreign party or a
Government Undertaking is constrained and cannot assess the
soundness of each and every applicant to a project. In such cases, BGs
act as a trusted instrument to assess stability and creditworthiness of
companies applying for projects.
• THE CONFIDENCE OF PERFORMANCE : When new parties
associate in the business and are skeptics about the performance of the
company undertaking the project, performance guarantees help in
reducing the risk of the beneficiary.
• RISK REDUCTION :Advance payment guarantees act as a protection
cover wherein the buyer can recover the advance amount paid to the
seller if a seller fails to deliver the goods or services. This protects
against any probable loss that a party can suffer from a new seller.
 BASIS FOR
COMPARISON
LETTER OF CREDIT BANK GUARANTEE

Meaning Letter of credit is an financial document A bank guarantee is a guarantee given

for assured payments, i.e. an
undertaking of the buyer's bank to make
payment to seller, against the
documents stated.
Liability Primary
by the bank to the beneficiary on
behalf of the applicant, to effect
payment, if the applicant defaults in
payment.
Secondary

Risk Less for merchant and more for bank. More for merchant and less for bank.

Parties 5 or more 3

Default Doesn't wait for applicant's default and Becomes active only when the
beneficiary to invoke undertaking. applicant defaults in making payment.

Payment Payment is made only when the Payment is made on the non-
condition specified is fulfilled. fulfillment of obligation.

Suitable for Import and Export business Government contracts