What is Letter of Credit?
1. The letter of credit is a written instrument issued by the buyer’s bank authorizing the seller to draw in accordance with certain terms and conditions. (Frank Henious)
2. The letter of credit is a commitment on the part of the buyer’s bank to pay or accept draft drawn upon provided such drafts do not exceed a specified amount. (Pritchard)
OPENING OF LETTER OF CREDIT
Following are the stages to get commercial L.C.
- Preparation of Documents
- Contact with Bank
- Import License
- Application Form
- Scrutiny of Application
- Margin Requirement
- Issuance of L.C.
- Delivery of Goods
(1) Agreement: First of all, the Importer and Exporter make an agreement for the purchase and sale of commodities or goods.
(2) Preparation of Documents: After the agreement, the importer provides the following information in a form.
- Kind or type of commodities or goods.
- Price of commodities or goods.
- Quantity of commodities or goods.
- The mode of payment.
(3) Contact with the Bank: After finalizing the agreement, the importer makes contact with the bank to open L.C.
(4) Import License: The issuing bank or importer’s bank while issuing LC requires the import license and the Proforma invoice from the importer.
(5) Application Form: If the bank is satisfied with the information provided by the importer then it provides him an application form in which all the essential points of the agreement are written.
(6) Scrutiny of the Application: The bank scrutinizes the application, examines the customer’s credit standing, the type of goods to be imported’ the market demand of the goods, the collateral offered to cover the credit.
(7) Under taking from Importer: After accepting the application, the bank obtains an undertaking from the importer that he will buy all the documents from bank at the prescribed markup fixed by the central bank.
(8) Margin Requirement: The bank asks the importer to deposit a certain proportion of the total Value of goods to be imported. Normally, the margin requirement may be up to 10 % to 40 %.
(9) Issuance of L.C.: After getting satisfaction from all the information and documents provided by the importer, the bank issues a L.C. to Exporter’s bank. Now both the traders can deal confidently because the banks have accepted the responsibility for the payment and receipt.
(10) Confirmation: Firstly, the LC. is confirmed by fax or other telecommunications and then actual letter of credit is sent in writing to the beneficiary.
(11) Delivery of Goods and Documents: The exporter delivers the goods after the confirmation of Letter of Credit and his bank sends the concerned documents to the importer’s bank.
(12) Payment: The importer’s bank clears the payment after examining document’s in the light of agreement and then hands over all the documents to the after receiving the remaining amount in form of draft or cash.