Parties Involved, Types and Essential Documents
A Letter of Credit (LC) acts as a critical independent undertaking from an issuing bank. Specifically, it guarantees that the beneficiary receives their payment once they fulfil all specified terms. Even if the buyer refuses to pay, the bank maintains its promise to honor the transaction. Therefore, importers typically request these credits to provide sellers with financial security upon meeting the agreed requirements.
The letter of credit can be used for both inland and cross-border trade. It is normally issued by the buyer’s bank as an undertaking to the seller.
Parties Involved in a Letter of Credit
Successful trade finance depends on several key participants. Each role ensures security and transparency throughout the transaction:
- Applicant: This is the buyer or importer. They request the bank to open the LC on their behalf.
- Beneficiary: This is the seller or exporter. They receive payment after presenting documents that match the LC terms.
- Issuing Bank: This bank opens the credit and takes responsibility for paying the beneficiary.
- Advising Bank: Operating in the exporter’s country, this bank verifies the LC’s authenticity for the seller.
- Confirming Bank: This bank adds its own guarantee to the LC. This provides the seller with an extra layer of security, especially in high-risk international trade.
- Nominated Bank: The issuing bank authorises this institution to receive documents and pay the exporter.
- Reimbursing Bank: This bank settles claims from the negotiating bank, usually through the issuing bank’s Nostro account.
Type of Letter of Credit
Trading parties choose different LC structures based on their specific needs for credit and security.
- Sight and Usance LC- Sight LC requires immediate payment once the seller presents complying documents. Conversely, a Usance LC allows payment at a fixed future date, which offers the buyer a period of credit.
- Confirmed LC- In a Confirmed LC, a second bank adds its own payment guarantee. Sellers often request this when they want more security than the issuing bank alone provides.
- Revolving and Transferable LC- Revolving LC restores the credit value after the buyer uses a portion, making it perfect for repeat shipments. A Transferable LC allows the primary seller to pass the credit to secondary suppliers.
- Back-to-Back LC: Back-to-back letters of credit involve two distinct LCs for one transaction. Intermediaries often use these to protect both the original manufacturer and the middleman in international deals.
Essential Documents for LC Transactions
Exporters must provide specific paperwork to trigger the payment process. Most LC transactions require the following documents:
- LC Draft: The initial version of the credit instrument.
- Commercial Invoice: The primary bill for the goods or services.
- Bill of Lading or Air Waybill: Proof that the carrier received the goods for sea or air transport.
- Packing List: A detailed list showing the contents of the shipment.
- Certificate of Origin: A document verifying the country where the goods were made.
- Certificate of Inspection: Proof that the goods meet the necessary quality standards.
