Commercial

Banking
LC
Letter of Credit
Management
Group 6B
 LETTER OF CREDIT
• A letter of credit (L/C) is a promise from a bank to make a payment after verifying that
somebody meets certain conditions.

• A letter of credit helps in ensuring that goods and services are delivered on time and
payments are made. It helps buyers and sellers  in reduction of risk. In case the buyer defaults Parties
and is not able to repay for the purchases, the bank has to pay the full or remaining balance of
the purchase.
Applicant
• Letter of credit is more predominant in international trade
Beneficiary
Parties Involved

• Applicant - Buyer in the business transaction

Issuing Bank
• Beneficiary - Seller and ultimate recipient in the business transaction Advising Bank
• Issuing Bank - Assures the seller that payment will be received duly if complied
Confirming Bank
• Advising Bank - Ensures payment will be done once issuing bank makes it

• Confirming Bank (Optional) - It confirms L/C and strictly evaluates country and issuing bank
before confirming L/C
 COMMERCIAL LETTER OF CREDIT

Commercial letter of credit are predominantly used in foreign trade. Banks act as third parties in these transactions. Commercial L/C is a
contract where issuing banks request the advising/confirming banks to make payments to the beneficiary. 

Mechanism of Commercial Letter of Credit

Let us consider a transaction to understand the flow of Commercial L/C

• Buyer - Mr. John who is a resident in New York, USA

• Issuing Bank - Bank of America, USA

• Correspondent Bank - State Bank of India, India

• Seller - Mr. Krishna who resides in India.

Seller ships the

Document
Sales Open goods and Confirmation
Issuing L/C Submission and
Agreement Commercial L/C Prepares and Payment
Verification
Documents
WORKING OF COMMERCIAL LETTER OF CREDIT
 STANDBY LETTER OF CREDIT

• A Standby Letter of Credit (SLOC) is a legal document that guarantees a bank's commitment of payment to a seller in
the event that the buyer–or the bank's client defaults on the payment under the agreement.

• It helps facilitate international trade between companies that don't know each other and have different laws and
regulations.

• Backup and secondary payment mechanism which is triggered by default.

Benefits of Standby Letter of Credit

• Payment Guarantee Types of Standby Letter of Credit

• Financing Guarantee
• Helps the applicant in getting out of the worst-case scenario Performance SLOC
• Facilitates International Trade
Financial SLOC
 WORKING OF STANDBY LETTER OF CREDIT
• XYZ Ltd. (Holding company) is established in India and expands in Indonesia as ABC Ltd. (Subsidiary company)
• ABC Ltd. approaches Indonesian Bank for financing new project

Dealing with Bank

since 40 years
Bank in India

SLOC Project Loan

ABC Ltd. Indonesia
XYZ Ltd. India

Bank in Indonesia
Indian Bank will issue SLOC electronically to Indonesian bank stating that We are guaranteeing the amount on behalf of our
customer XYZ Ltd. favoring ABC Ltd. and in the event of nonpayment of this amount by the ABC Ltd, our bank will make the
payment.
 CONFIRMED LETTER OF CREDIT
 A Confirmed letter of credit is a letter of credit in which the seller or exporter has payment guarantee from a second
bank or a confirming bank i.e. in case the first bank fails to pay then the payment will be done by the second bank.

Points of
Confirmed Letter of Credit Unconfirmed Letter of Credit
Differences

Payment
Both the Issuing & the Confirming banks are liable Only the issuing bank is liable for payment
Undertaking

More costly due to the additional charge by the

Cost Less costly as no additional charges apply
confirming bank

Risk Lower default risk due to additional assurance Comparatively riskier than confirmed LoC

Reimbursement Confirming banks demand Reimbursement

No Reimbursement Authorization
Authorization Authorization from issuing banks

Changes & The confirming bank can suggest changes and Only the beneficiary i.e. the seller can request changes
Corrections corrections directly to the issuing bank in the letter of credit via the applicant i.e. the buyer

The confirming bank checks the creditworthiness of The issuing bank checks the creditworthiness of the
Pre-Issue Checks
issuing bank buyer
 WORKING OF CONFIRMED LETTER OF CREDIT
• Buyer Ltd. is established in India and wants to buy product / service from Seller Ltd.
• Seller Ltd. is a foreign company and has no operations in India.

An Indian Bank will provide a Letter of Credit and a second bank (trusted by Seller Ltd.) will provide Confirming Letter of
Credit stating that “The above credit is confirmed by us and we hereby irrevocably undertake to honour the drafts
drawn under this credit on presentation, provided that all the terms and conditions of the credit are duly satisfied".
 REVOLVING LETTER OF CREDIT

• A Revolving Letter of Credit is an individual LC which covers multiple transactions spread across a long period of time. It is a specific LC
which is utilized for standard shipments of a similar item between a similar purchaser (importer) and the seller (exporter).

• This LC is issued only one time for a specific timeframe or a specific number of transactions.

• It avoids repetitive requirement to open separate letter of credit for each transaction.

Benefits of Revolving Letter of Credit

• Saves Time and Energy for Bank, Importer and Exporter

• Financing Guarantee
• Good payment mechanism when the transactions are long term in nature
• Saves cost of issuing a regular LC separately for every transaction

Types of Revolving Letter of Credit

• Revolving LC based on Time

• Revolving LC based on Value
 WORKING OF REVOLVING LETTER OF CREDIT
Additionally, a revolving letter of credit based on time is of two types –

Cumulative
In a cumulative LC, the previous unused limits can be used in the future months. In the previous example, if Mr. X doesn’t ship the goods in the month of May
2018, then he can ship goods worth $20,000.00 in the next month.

Non-Cumulative
In the non-cumulative LC, the previous unused LC limits cannot be used for further months. In the example mentioned above, if Mr. X does not ship any good in
May, he is only allowed to ship goods worth $10000 in June. The unused limit becomes void and cannot be utilized in the subsequent months.

Revolving Letter of credit based on Value Revolving Letter of credit based on Time
Payment through revolving Payment through
Month Transactions on the part of X
letter of credit Month Transactions on the part of Mr. X revolving letter of
Jan-18 Goods worth USD 10,000.00 manufactured and shipped Payment received USD 10,000.00 credit
Payment received USD
Jan-18 Goods worth USD 10,000.00 manufactured and shipped
10,000.00
Goods worth USD 3,000.00 manufactured, but can’t ship as the value of transaction must be
Feb-18 No payment Feb-18 Goods worth USD 3,000.00 manufactured and shipped Payment received USD 3,000.00
USD 10,000.00

Goods worth USD 4,000.00 manufactured, but can’t ship as the value of transaction must be Mar-18 Goods worth USD 4,000.00 manufactured and shipped Payment received USD 4,000.00
Mar-18 No payment
USD 10,000.00
Goods worth USD 12,000.00 manufactured but shipping of only USD
Payment received USD
Apr-18 10,000.00 allowed. So goods of USD 10,000.00 shipped and remaining
Goods worth USD 12,000.00 manufactured but shipping of only USD 10,000.00 allowed. So 10,000.00
Apr-18 Payment received USD 10,000.00 goods kept in stock
goods of USD 10,000.00 shipped and remaining goods kept in stock
Goods worth USD 8,000.00 manufactured and goods worth USD 10,000.00 Payment received USD
May-18
Goods worth USD 8,000.00 manufactured and goods worth USD 10,000.00 (USD 8000.00 of shipped (USD 8000.00 of May + USD 2000.00 of April) 10,000.00
May-18 Payment received USD 10,000.00
May + USD 2000.00 of previous months) shipped
Payment received USD
Jun-18 Goods worth USD 10,000.00 manufactured and shipped
10,000.00
Jun-18 Goods worth USD 10,000.00 manufactured and shipped Payment received USD 10,000.00 End of June
Revolving letter of credit expired
2018
 DEFERRED PAYMENT LETTER OF CREDIT

 A Deferred Payment letter of credit is a letter of credit in which Issuing bank pay to the supplier on behalf of the buyer on specified
future date after completion of transaction. Payment does not happen instantly after the confirming documents are accepted by the
issuing bank
 Deferred Payment Letter of Credit is also known Usance Letter of Credit
 The tenor of payment is generally pre-determined by the seller and buyer
 It is generally used where Buyer and Supplier has strong working relationship, or the buyer has strong credit rating
 The Deferred payment Letter of Credit can generally be classified into 2 based on the tenor which are
I. Payment within 90 days after the Bill Of Lading(B/L)- After the BL is issued, buyer has a time of 90 days from the B/L date to
make the payment
II. Payment within 30 days after sight- Date on which issuing bank receives the documents, from that date onwards buyer has 30
day to make payment of goods

Advantages of Deferred Payment of Credit

 Buyer get predetermined Credit Period
 Efficient Working Capital and Its Management by Buyer
 Buyer can import goods at relatively lower finance cost

 Advantages to the buyers is the disadvantage to the seller because they have increase working Capital Requirement
 WORKING OF Deferred Payment LETTER OF CREDIT
• Mr. XYZ residing in foreign country is an Importer who wants to buy product.
• Mr. ABC residing in India is an exporter

The Foreign Bank will provide a Deferred payment Letter of Credit in the name of beneficiary(ABC) and the advising bank
will receive the receipt of the LC through Swift . In terms and condition specified future date of payment is mentioned and
Issuing bank (Foreign bank) sends undertaking stating that the payment would be made as per terms & Condition.
 IRREVOCABLE LETTER OF CREDIT

An irrevocable letter of credit (ILOC) is an official correspondence from a bank that guarantees payment for goods or
services being purchased by the individual or entity, referred to as the applicant, that requests the letter of credit from an
issuing bank.

An irrevocable letter of credit cannot be cancelled, nor in any way modified, except with the explicit agreement of all
parties involved: the buyer, the seller, and the issuing bank. For example, the issuing bank does not have the authority by
itself to change any of the terms of an ILOC once it is issued.

Although an ILOC is irrevocable while it is in force, generally the time period during which a proposed transaction is
expected to be completed, an ILOC expires at a specified point in time, which is noted in the letter of credit.

Benefits of Irrevocable Letter of Credit

• For sellers, letters of credit are especially beneficial because the seller gets to rely on the strength of the bank, not the
strength of the buyer.
• For buyers, letters of credit help ensure that something has actually been shipped.
 RED CLAUSE LETTER OF CREDIT
The Red Clause letter of credit is a type of credit in which the buyer advances an unsecured loan to the seller to
arrange for the working capital, buying raw material, packaging of goods etc. The credit of percentage usually is
around 20-25% of the L/C value. The advanced payment is done against a documentary requirement which included
written undertaking and receipt. This loan will be arranged by a nominated bank on the assurance given by the
buyer’s bank. In case the beneficiary fails to export the goods or fails to repay the advance the nominated bank gets
the amount paid by the issuing bank.

These letter of credit are written in red ink, so they are called red clause letter of credit.

Benefits Risk Mitigation Risks

Low Interest unsecured Loan Letter of Indemnity Unauthorized use of funds

Low Cost to buyer Declaration of Intent Risk of Bad debt

Green Clause letter of Credit

It is an extended version of Red Clause LC, as it enables the advance of not only the purchase of raw materials, processing and
packaging of goods but it also takes pre-shipment warehousing at the port of origin and insurance into account.
 ASSESSMENT OF LETTER OF CREDIT

LETTER OF CREDIT APPROVAL PROCESS

 Request letter for opening a Letter of Credit

 Banks checks the credit norms
 Ability of the Applicant
 Standing of the Beneficiary
 Economic Order Quantity
 Exchange Rate Risk
 LC Documents Required
 Invoice
 Signed Letter of Credit Application
 Insurance Copy( In favour of Issuing
bank and minimum of 110% of CIF
Value)
 Import License(If commodities comes
under negative list)
 Exchange Control Copy
 Margin Money
 MANDATORY CLAUSES AND
CHECKLIST

 Documents needed to be sent by Beneficiary( bill of

lading on a later date of the LC date)
 Invoice
 Bill of Lading
 Packing List
 Insurance of Goods
 Bill of Exchange
 Inspection Certificate
 Certificate of Origin
 Duty waiver Certificate
 If Usance period is more than 180 days from the
date of shipment, relevant TC form needs to be
attached
 Usance period for commodities such as Gold, Silver
etc should not exceed 90 days.
 Bill of Lading Original copy must be produced with
sign of the Master.
 Determination of LC LIMIT

Average Price of a LC  Monthly Consumption of Goods

 EOQ(Economic Order Quantity)

 No. of LCs opened in a year(N) = (Annual

Frequency of Opening LC
Consumption/EOQ)
 Frequency of opening a LC = 12/N (in months)

LCs outstanding at a particular time  Lead Time(L)

 Transit Time(T)
 Usance Time(U)

LC LIMIT = (L+T+U/Frequency)*EOQ

Inferences:
• If sum of (L+T+U) > Frequency, then there would be multiple LCs outstanding at a particular time
• If sum of (L+T+U) < Frequency, then there would be only one LC outstanding at a particular time
Thank You
DIVISION B
GROUP 6
H005 PRAKHAR AGARWAL
H016 SAKSHI CHHABRA
H045 VAIBHAV PHALTANKAR
I002 AMAN AGARWAL
I004 SAJAL AGARWAL
I014 PRATIK DASH
I019 ARPIT GOEL
I022 KOMAL GUPTA