ASSIGNMENT ON STANDBY LETTERS

SUBMITTED TO: SUBMITTED BY:

ALLAMA IQBAL OPEN UNIVERSITY

ABSTRACT
In today`s financial environment export-import companies have to deal with a lot of risks such as shortfall in payment, cancelation of order or default in delivery. To mitigate and eliminate these risks both parties can agree to use a Letter of Credit. A Letter of credit is an abstract, conditional payment promise of the bank of the importer in which it obligates to make a payment to the exporter on presentation of L/C compliant documents. The payment promise of the bank is legally isolated from the underlying transaction and the fulfillment of the payment promise is always attached to conditions of documentary nature. The L/C is an instrument which is often used in international transactions. The Importer has the guarantee that he only has to pay when the exporter has delivered the good and proved it by presenting the proper documents whereas the exporter has the guarantee that he gets the sales revenue after he delivered the good and presented the conforming documents. The basis is the actual contract with the condition L/C. The Importer instructs his bank to open a Letter of Credit in favor of the exporter. The condition is that the importer has an adequate credit line at his bank. The bank of the importer then opens the L/C irrevocable in favor of the exporter. The bank cooperates with a bank in the exporter`s country given by the importer or with her correspondence bank in this country. The L/C regulates all the conditions such as the type of the good, the amount or the deadlines for delivery and specifies the required documents. The most used documents are the Bill of Lading, the commercial invoice and the insurance certificate. The Bill of Lading is basically a contract and a shipper`s receipt. The Commercial invoice on the other hand lists the details of goods including INCOTERMS, the names of exporter and importer, lists charges for transport and insurance and identifies payment terms in a specific currency. The bank of the exporter then announces the exporter about the L/C after verifying that the L/C is legally and formally

conform. The exporter then checks if the L/C complies with the actual contract. After delivering the goods the exporter hands in the documents received to his bank. If the exporters bank has the payment function it will make the payment to the exporting company. Otherwise it forwards the documents to the importers bank and this bank will make the payment to the exporter and will forward the documents to the importer. With these documents the importer can finally receive his goods. But practically it is very common that the importer already received the goods when he gets the documents. The safest type of a L/C is if it is documentary, irrevocable and confirmed. So summarizing in international transactions the L/C is a safeguard for both the exporter and the importer to assure that the goods will be delivered and the payment will be made while the banks get good profits

INTORDUCATION AND HISTORY OF LOC

Understanding the nature of letters of credit as an international financial device and the reason why they have become widely used by merchants all over the world requires us to find out its historical origins. Some scholars believe that the origins of letters of credit go back to ancient Egypt and Babylon, which had an adequate system of banking. A clay promissory note of Babylon dating from 3000 B.C., is exhibited in the University Museum of Philadelphia, USA, which provided for repayment of an amount and the interest on a specific date. Another discovery is an evidence of an obligation made in 248 B.C. in Egypt for the repayment, in wheat, or upon default double its value, of a loan of money from one Zenon, which ends with and the right of execution shall rest with Zenon and the person bearing the note on behalf of Zenon". It is also verified that banks of ancient Greece prepared letters of credit on correspondents with the view to obviating the actual transport of specie in payment of accounts. The earliest devices with which merchants tried to solve these problems were with the bills of exchange and letters of credit. In their early history these payment instruments operated in a very similar way, and letters of credit were used to supplement the bills of exchange. There are scholars who believe that their development in Europe was inspired by the discoveries made by Marco Polo in the 13th century who reported the use of currency and other negotiable documents in China, concluding that such a measure was one of the reasons for the ways and means by which the Great Chan can have and indeed does have more treasures than all the kings in the world. In any case, it was impossible to conduct commerce via caravan without some sorts of documentary letters.

In the United States letters of credit emerged from the competition of factorage houses for business, which led to the issuance of promises to accept drafts against shipments. The growing number of manufacturers and their relationships with foreign traders, the specialization of banking activities and the technological development such as the more frequent use of telegraph for communicating the terms of the contracts facilitated the increasing use of letters of credit. On the other hand, letters of credit were not used exclusively by merchants. The outbreak of World War I broke the well-established and trusted trading links that had existed between the merchants worldwide. In order to keep on trading, merchants were forced to create new links with firms often unknown or not trusted. These circumstances were favourable for the extensive use of letters of credit which invited a trustworthy paymaster, a bank, into the merchants relationship. By the 1950s letters of credit had earned a predominant position in domestic commerce of the United States and were also widely used in international transactions. Since World War II the use of letters of credit in world trade remains steadfast. Although from time to time the emergence of alternative means of trade finance overshadows the use of the letter of credit, it has proven to be a flexible instrument, which can be readily attempted to the needs of changing conditions in international trade. In a world of shrinking distances and increasing trade there will be a continuing need for such a highly reliable and flexible means of payment and financing.

LETTER OF CREDIT

What is a standby letter of credit?

A Standby Letter of Credit (calledSLC or LC) are written obligations of an issuing bank to pay a sum of money to a beneficiary on behalf of their customer in the event that the customer does not pay the beneficiary. It is important to note that standby letters of credit apply only whenever the issuing bank's commitment to pay is not contingent on the existence, validity and enforceability of its customers obligation; this is called an abstract guarantee; that is, the banks obligation is to pay regardless of any disputes between its customer and the beneficiary. The issuance of letters of credit is a private transaction and does not result in the issuance of any public trading securities.

Why do we have standby letters of credit?

The standby letter of credit comes from the banking legislation of the United States, which forbids US credit institutions from assuming guarantee obligations of third parties. (Most other countries outside of the USA continue to allow bank guaruntees.) To circumvent this US banking rule, the US banks created the standby letter of credit, which is based on the uniform customs and practice for documentary credits. In 1998 the International Chamber of Commerce (ICC) added ISP98 (International Standby Practices 98) as the rules to guide standby letters of credit. These rules are slowly being adopted; however,

many of the standby letters of credit continue to rely on the ICCs older guide, Uniform Customs and Practices for Documentary Credits, 1993 revision, ICC Publication 500.

Who are the parties to the standby letter of credit?

The Applicant. This is the customer of the bank who applies to the bank for the standby letter of credit. He must provide collateral to the bank or have sufficient credit to induce the bank to issue the instrument. He also must pay the bank a fee for issuing the instrument. The Issuing Bank. This is the applicants bank that issues the standby letter of credit. The Beneficiary. This is the party in whose favor the instrument is issued. Confirming Bank. This is a bank (usually located near the beneficiary) that agrees (confirms) to pay the beneficiary rather than have the issuing bank pay the beneficiary. The beneficiary pays the Confirming Bank a fee for this convenience. The Confirming Bank then collects from the Issuing Bank the amount paid to the beneficiary. Advising Bank. This is the bank that represents the beneficiary. It may accept the letter of credit on behalf of the beneficiary and collect on it on behalf of the beneficiary. In order for the transaction to be a bank-to-bank transaction, the advising bank works for the beneficiary to keep the instrument in the banking system. Sometimes the Advising Bank also is the Confirming Bank, but not always.

What is the purpose of the standby letter of credit?

The standby basically fulfills the same purpose as a bank guarantee: it is payable upon first demand and without objections or defenses on the basis of the underlying transaction between the applicant and the beneficiary. It is up to the beneficiary to decide whether he may accept a standby.

What are the types of standby letters of credit

Performance Standby. This instrument supports an obligation to perform other than to pay money including the purpose of covering losses arising from a default of the applicant in completion of the underlying transaction. Advance Payment Standby. This instrument supports an obligation to account for an advance payment made by the beneficiary to the applicant. Bid Bond/Tender Standby. This standby supports an obligation of the applicant to execute a contract if the applicant is awarded a bid.

Counter Standby. This instrument supports the issuance of a separate standby or other undertaking by the beneficiary of the counter standby.

 Direct Pay Standby. This instrument serves to support payment when due of an underlying payment obligation typically in connection with a financial standby without regard to default. This standby is also used to directly pay an obligation where the only conditions of payment are the passage of the term and presentment of payment.

Insurance Standby. This instrument is an insurance or reinsurance obligation of the applicant.

Commercial Standby. This is the most used standby and it supports the obligations of an applicant to pay for goods or services in the event of non-payment by a business debtor.

Are standby letter of credits transferable?

Assignment of Standby letter of credit proceeds -The beneficiary can assign the proceeds of a standby letter of credit. But this assignment does not assign the rights of the beneficiary as drawer on the standby letter of credit, and only the beneficiary may exercise the drawer rights and present the demand for payment under the terms of the standby letter of credit unless the terms of the instrument provide otherwise. This means that the assignee may receive the proceeds of the standby, but in order to obtain those proceeds the beneficiary must first make the demand for payment. This also means that the beneficiary can sell by assignment, at discount, the benefits of the standby. An assignment of proceeds requires notice to the issuing bank of this action; otherwise the issuing bank would pay the beneficiary rather than the assignee. Transfer of Standby letter of credits. Standby letter of credits can be transferred to a third party ONLY with the written consent of the issuing bank AND the beneficiary.

Are standby letter of credits the subject of trading?

There is no public market for the trading of standby letters of credits. Standby letters of credits can only be transferred or the proceeds assigned in private transactions (as previously noted above). Standby letters of credit do not have CUSIP or ISIN numbering. Standby letters of credits are not trading securities, trading debt instruments, or trading investment funds, and therefore are not subject to the rules and regulations of the Security and Exchange Commission.

PRACTICAL STUDY OF THE ORGANIZATION

Raza & Co.We provide Indenting services in Pakistan. We deal in wood pulp, metal scrap, used rail and most used items. Raza & Co. has a very large number of major Consumers and Importers as Clients. We are moving a substantial volume of different goods to fulfill the growing demands of Pakistan Market.We are looking for new competitive products on a very regular terms. With mutual understanding we can work to move your quantities into Pakistan Market.Our Terms & Conditions Basic Terms1 Prices are in USD (UNITED STATES DOLLARS) and CIF2 PAYMENT TERMS : Non Transferable, Revolving Documentary Letter of Credit payable 100% upon presentation of the shipping documents to the counter of the seller??s bank, shipment by shipment.3 Supplier??s Origin : USA Europe/ Asia.4 For Used Rails, the length is from 1.5 m IPECO 2000 standard.5 Buyer must accept Sellers contract and terms6 Seller shall issue ... Phone 92-42-5008407 Address h#5 Imran St # 8, ...

The Letter of Credit Process

Participants in LC Process

Buyer Issuing Bank Advising Bank Seller (Beneficiary)

9 Steps in the Letter of Credit Process

I. Buyer and seller agree to terms including means of transport, period of credit offered (if any), and latest date of shipment acceptable.

II.

Buyer applies to bank for issue of letter of credit. Bank will evaluate buyer's credit standing, and may require cash cover and/or reduction of other lending limits.

III. IV. V. VI. VII.

Issuing bank issues LC, sending it to the Advising bank by airmail or electronic means such as telex or SWIFT. Advising bank establishes authenticity of the letter of credit using signature books or test codes, then informs seller (beneficiary). Seller should now check that LC matches commercial agreement and that all its terms and conditions can be satisfied. Seller ships the goods, then assembles the documents called for in the LC (invoice, transport document, etc.). The Advising bank checks the documents against the LC. If the documents are compliant, the bank pays the seller and forwards the documents to the Issuing bank.

VIII. IX.

The Issuing bank now checks the documents itself. If they are in order, it reimburses the seller's bank immediately. The Issuing bank debits the buyer and releases the documents (including transport document), so the buyer can claim the goods from the carrier.

Advantages Of Letter Of Credit

One of the main advantages that LC grants to business owners is the fact that they can be resold to financial institutions. Something that other documents do not allow. For the exporter, another advantage of LC is the fact that the exchange rates would remain the same as the ones shown in the original LC. Banks are more likely to have accurate information on exchange rates than the importing companies that you work with. The exporter is also in a more secure position in the availability of parallel foreign exchange payment of the sale because it is more likely that banks are more aware of the conditions and rules that change the importing company itself. When there is an LC in the midst of a import or export transaction, there is more stability in the currency regardless of the changes in the country. This is for the duration of the LC. If currencies change within a country, governments would honor the agreements established in the LC. An exporter will find that an order backed by an irrevocable LC will facilitate obtaining financing for home before export. The main disadvantages are the fees charged by the importer's bank for issuing LC and the possibility that the letter of credit reduces the credit line to borrow from your bank. Corporations working abroad are also vulnerable to the economies of the countries to which they export their goods. Corporations need to do their own research before entering a new market because LC may not protect them from negative economic dynamics. Exposure to political risk: When multinational corporations, establish subsidiaries in other countries are exposed to political risk, which represents political actions taken by the host government or the public that affect the cash flows of multinational corporations. Letters of Credit have advantages, disadvantages and risks. We will call them LC throughout this document.