Letter of credit (L/c) is the most preferred payment option for
exporters. Compared to other payment options, L/c has many safeguards
for sellers and at the same time assurance for buyers. It is usually
issued by larger banks and contain a promise to pay a seller (beneficiary)
upon receipt of goods by a buyer if certain conditions outlined
in the letter have been met.
What is Letter of Credit ?
Letter of Credit or (L/c) is a legal document to arrange payment
between a buyer(importer) and seller (exporter). The bank, as intermediary,
ensures security for both parties, giving the exporter confidence
that the importer is capable of paying for the goods while assuring
the importer that payment will be made to the exporter only after
the terms outlined in the letter of credit have been met.
Analysis of typical L/c Transaction
Though a L/c can have great many variations (please see later part
of this article) - for simplicity and ease of understanding, I have
made a simple step-by-step description of a typical L/c transaction.
Step 1 After successful negotiation
on price, specification, quality etc, Buyer selects a seller
and places order for specified goods
Step 2 Seller accepts the order
Step 3 Buyer and Seller agrees
on terms and conditions of the sale. Buyer instructs its bank
to open a L/c incorporating previously agreed terms of sale
Step 4 The buyer's bank prepares
a Letter of Credit (L/c), including all instructions to the
seller's bank concerning the shipment and sends the L/c to the
seller's bank, requesting confirmation. The seller may request
confirmation from a confirming bank for added security.
Note: There are often delays
at above two steps for various reasons like buyer does not have
sufficient funds or seller requests change in L/c terms. Amendments
are issued to incorporate changes in L/c terms.
Step 5 The Seller's bank prepares
a letter of confirmation to forward to the seller along with
the L/c. The seller reviews carefully all conditions in the
L/c specially shipment schedule in consultation with his freight
Step 6 The seller arranges the
goods and hand over to freight forwarder for delivery at appropriate
port or airport.
Step 7 Once goods are loaded/shipped,
the forwarder completes necessary documentation and hand them
over to the seller. The seller then presents the documents to
his bank, informing full compliance with terms and conditions
Step 8 The seller's bank reviews
the documents. If they are in order, the documents are airmailed
to the buyer's bank for review and passing necessary documents
to buyer. The buyer gets the documents needed to claim the goods.
Step 9 The buyer's bank returns
accepted draft and informs buyer. Buyer pays bank.
Step 10 The seller's bank gets
payment and pays seller.
The letter of Credit Ensures that:
Payment to the seller will only be made after the terms of the L/c
have been met. The documents, which have been reviewed by the bank's
experienced staff, are in order. The seller is assured of the buyer's
ability to pay and, as a result, a better price and more advantageous
terms of payment may be offered.
Is Letter of Credit 100% Safe for Exporters
The answer is - yes and no. Yes, if you follow all L/c instructions.
No, if you overlook certain pitfalls.
For detail discussion on potential pitfalls in L/c payment and how
to secure your position as seller - please read following article
published in past issue of FAIDA
Letter of Credit - How to secure your payment
Be aware of potential traps in L/c payment
FAIDA Vol II, Issue 7; July 11' 2001
(please see Related Links below)
Various Kinds of L/c and its Lingo
For information on various kinds of L/c and meaning/implication
of technical terms - please read following article published in
past issue of FAIDA
More on Letter of Credit - Closer look at some key terminology
FAIDA Vol II, Issue 8; July 18' 2001
(please see Related Links below)
Happy and Safe Surfing
Dr. Amit K Chatterjee
- Newsletter on Business Opportunties from India and Abroad
Vol: 4, Issue 21
; Jan 23' 2004
Dr. Amit K. Chatterjee
(Amit worked in blue-chip Indian and MNCs for 15 years in various
capacities like Research and Information Analysis, Market Development,
MIS, R&D Information Systems etc. before starting his e-commerce
venture in 1997. The views expressed in this columns are of
his own. He may be reached at firstname.lastname@example.org