Basics of Letters of Credit

Basics ofLetters of Credit

Agenda • Topics to be covered • Basic terms of Trade • Letters of Credit • INCOTERMS • Applications

Terms of Trade • Cash in Advance • Letter of Credit • Collection • Open Account

? Buyer Takes All the Risk Seller Takes All the Risk ? ? Pre-Pay Letter of Credit Documents Against Payment Documents Against Acceptance Open Account Who Should Take the Risk?

Policy Issues 1) Choose Method of Payment a. Establish country risk criteria b. Standards for particular buyers • Payment history • Size of transactions/credit limit • Credit History

Policy Issues 2) Set Policies for Each Method a. Cash in advance – wire transfers Vs. check b. Open account – discount policy, controls etc. c. Documentary Collections – payment at sight d. Letters of Credit – “Policy Letter” – L/C Checklist 3)Enforce the Policies That You Set

A Foreign Check Does Not Represent Immediate Payment • Foreign Checks Must Be Sent Back for Collection

Documentary Collections Buyer/Importer Seller/Exporter Buyer’s Bank Seller’s Bank

Seller/Exporter UPS Buyer/Importer Bank Seller/Exporter Buyer/Importer

A Letter of Credit is: • A substitution of the bank’s credit for the buyer’s • A bank’s promise to pay upon the satisfactory compliance with the L/C’s terms and conditions by the L/C’s Beneficiary • Note – Banks Deal in Documents ONLY

Letters of Credit • Parties to a letter of credit • Letter of Credit Types • Import • Export • Standby • L/C cycle

Parties to a Letter of Credit PARTY LETTER OF CREDIT TERM

Parties to a Letter of Credit (Cont’d) PARTY LETTER OF CREDIT TERM

Back up in case of non-payment or non-performance Generally not expected to be drawn Used for services/goods “After the fact” Primary source of payment Used for actual goods Somewhat simultaneous Standby Commercial

Standby L/C • Financial • Performance • Bid Bond • Performance Bond

TransactionCycle Buyer/ Importer Applicant - 1 Seller/ Exporter Beneficiary - 4 L/C L/C Application L/C Advising Bank Confirming Bank Negotiating Bank -3 Issuing Bank 2

DOCs DOCs $ DOCs Merchandise Buyer/ Importer - 8,9b Seller/ Exporter - 5,11 $ $ Advising Bank Confirming Bank Negotiating Bank - 6,10 Issuing Bank - 7,9a

Endorse the back! DRAFT January 5 • Sight 20 • Pay to the order of $ • Dollars • To At 00 ABC Exporter 8,020.00 Eight Thousand Twenty Dollars and 00/100 Drawn under Documentary Credit No. M0491110NS00616, of the Standard Chartered Bank, Seoul, Korea, dated September 17, 1999 Standard Chartered Bank New York, NY ABC Exporter

Common Documents • Draft • Transport Document (b/l) • Commercial invoice • Insurance policy or certificate • Packing list • Certificate of origin, weight • Beneficiary statements

When you receive an L/C • CHECK IT CAREFULLY!!! • Review it ASAP • L/C mirror sales contract • Can you perform • Can you provide ALL the documents

Critical Things to Look For • Latest shipment date • Expiry date • Partial shipments • Merchandise description • Can you provide documents required

Known bank Known country risk Known customs and language Unknown bank (??) Country stability Currency stability Foreign laws and usages Domestic International

Confirmation Out of Business Issuing Bank Confirming Bank

Credit Issues • As Applicant • your Credit Worthiness • your Collateral • As Beneficiary • probably none

Cost Issues • As Beneficiary • minimal cost usually • if confirmed, expect to pay • As Applicant • based on your credit and/or collateral • use of other bank services

Where to get more information • ICC Uniform Customs and Practice for Documentary Credits (UCP 500) • ICC Guide to Documentary Credit Operations for the UCP 500 • INCOTERMS 1990 • International Standby Practices 1998  (http://www.iccwbo.org)

Basics of Letters of Credit