Pranesh007
Accountant
Tigerkiller
Management Trainee
+1 Other

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Hi Friends Can any one explain me in details what is letter of credit and how and when it is used. You can also send me links or attachments Regards Pranesh
Dear Paresh
L/c is an payment method used in the Import & Export transactions, there are L/c's which are also used in domestic transactions like dealing with deemed export companies, companies located in SEZ & EOU etc. Importer issues the L/c in favor of Exporter for the transaction value agreed though the respective bankers. There is standard format for the application depending upon the banks style. You need to have the sufficient balance with bank to issue for the L/c on your account or you need to have the L/c limit sanctions from the banks. L/c is subject to time limit of 3mths to 6mths as agreed terms of contract of import/ export.
This basic information is sufficient for you I hope so
Vikrant Waghmare
Siddhivinayak Consultancy, Thane
Cell:9702303900

A. LC discounting (i.e. LC negotiation) Vs Bill Discounting Limit

In Bill Discounting, the Bank buys the bill (i.e. Bill of Exchange or Promissory Note)

before it is due and credits the value of the bill after a discount charge to the

customer's account. The transaction is practically an advance against the security of

the bill and the discount represents the interest on the advance from the date of

purchase of the bill until it is due for payment.

What is the role of LC now? The LC facilitate the transaction and confirms that the

exporter/manufacturer do not have risk of being default. LC is as good as the cash.

Even the exporter can discount the LC subject to acceptance by the importer. Hence if

there is no bill discounting facility, the beneficiary gets the payment subject to

deduction of margin and bank charges and approval by both banks along with the

buyer.

In case of bill discounting facility the seller gets the bill discounted immediately it

shows and submit the required documents to its bank. But intimation needs to send to

the buyer through its (buyers) bank as the transaction is backed with Letter of Credit.

B. LC Vs Buyers Credit

Buyer opens the letter of credit (usance) in favour of seller. Now the seller on

submission of required documents’ can discount the LC or stays away i.e. hold the LC

as it is. The seller will send the documents along with goods to the destination. The

buyer will release the goods by accepting the documents at the bank. But the due date

of payment has not come yet i.e. LC is not expired yet.

Suppose the buyer, due to any reason say to leverage its books, wants to postpone

the payment. But extension is not possible in the same form. What is the solution now?

The buyer will take the following course of action and if accepted by all the parties, it

might get the extension for some period as approved:

1. The buyer will identify overseas bank/financial institution (or a bank having its

branch overseas) (say X) which give the services of buyer’s credit. The buyer

will request for availing the facility with all the details about transaction. On

satisfaction, the bank (X bank) will generate the Offer in favour of the LC

issuing bank (i.e. buyer bank or say Y bank)

2. On the basis of the Offer, the buyer approach to its bank (Y bank) for issuance

a Letter of Comfort in favour of X bank against this LC. The Y bank will charge

some fees for the services. Here Y bank works as a broker. But the bank will

continue to hold the LC by marking the facts on its face and also continuously

blocked the LC limit.

3. Now the buyer takes this Letter of Comfort and approach the X bank which will

give payment to Y against this Letter of Comfort against some charges.

It is totally a secured transaction where Y bank guarantees to X bank.

The buyer gets the extension of payment period and also benefitted by getting the

funds at LIBOR rate.

C. If additional credit needs of exporters arises due to firm orders/ confirmed letter of

credit (and which are not taken into account while fixing regular credit limits of

borrower) are to be met in full even if sanction of such additional credit limits exceeds

Maximum Permissible Bank Finance (MPBF).

D. Receivables arising in domestic/inland sales by drawing bills of exchange under

usance Letter of Credit and negotiated with the terms & conditions of LC are excluded

while calculating minimum net working capital under MPBF (second method of

lending).

In other words domestic receivables covered by bills of exchange under usance LC

shall be accorded the same treatment as export receivables and no margin on such

receivables will have to be brought.

E. Advising and confirming the export Letter of Credit (LC)

Advising bank does not undertake any commitment except to verify the authenticity of

the message received by it at the time of advising the LC to the exporter. Advising of

LC does not, therefore, involve any credit risk for the bank.

Confirmation of LC implies a definite undertaking being given by the confirming bank to

the opening bank and the confirming bank is placed in the same position as that of

opening bank in relation to beneficiary. But even in these cases the confirmation to the

LC is added by the bank on behalf of the opening bank only and not on account of

beneficiary (exporters)). This would also, therefore, not constitute a credit facility to the

exporters. These services facilitate banking operations and the beneficiary of the LC

need not necessarily the customers of the confirming bank.

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