letter of credit project

7/28/2019 Letter of Credit Project

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HAILEY COLLEGE OF

BANKING & FINANCE

MARKETING OF BANKING PRODUCTS & SERVICES

TOPIC:

Documentary Credit

Submitted to:

RIAZ AHMAD MIAN

Submitted by:

Mahmood Aslam (M11MBA003)Shabbir Ahmed Sethi (M11MBA038)

Bilal Ahmad (M11MBA015)

Muhammad Ahsan Alahi (M11MBA053)

Afzaal Ahmed (M11MBA034)


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Documentary Credit Page 1

Contents

Dedication .................................................................................................................................. 3Acknowledgment ....................................................................................................................... 4Introduction ................................................................................................................................ 5What is a Letter of Credit? ......................................................................................................... 6Definition of letter of Credit ...................................................................................................... 7Parties Involved in a Letter of Credit ......................................................................................... 71. Accepting Bank .................................................................................................................. 72. Advising Bank .................................................................................................................... 73. Confirming Bank ................................................................................................................ 84. Exporter/Beneficiary/Seller ................................................................................................ 85. Importer/Applicant/Buyer .................................................................................................. 86. Issuing Bank ....................................................................................................................... 87. Reimbursing Bank .............................................................................................................. 88. Transferring Bank ............................................................................................................... 8Working of Letter of Credit ....................................................................................................... 9Types of Letter of Credit.......................................................................................................... 111. Documentary Letter of Credit. .......................................................................................... 112. Open or Clean letter of credit. .......................................................................................... 113. Revocable Letter of Credit ............................................................................................... 114. Irrevocable LC .................................................................................................................. 115. Confirmed LC ................................................................................................................... 116. Unconfirmed LC ............................................................................................................... 127. Transferrable LC ............................................................................................................... 128. Un-transferable LC ........................................................................................................... 129. Usance LC ........................................................................................................................ 1210. At Sight LC ................................................................................................................... 1211. Red Clause LC .............................................................................................................. 1212. Green Clause LC ........................................................................................................... 1313. Back to Back LC ........................................................................................................... 1314. Fixed LC ....................................................................................................................... 1315. Revolving LC ................................................................................................................ 1416. With recourse LC .......................................................................................................... 1417. Without recourse LC ..................................................................................................... 14


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18. Standby LC ................................................................................................................... 14Documents involved in Letter of Credit .................................................................................. 151. Transport Documents: ...................................................................................................... 152. Insurance Documents: ...................................................................................................... 173. Financial Documents: ....................................................................................................... 194. Commercial Documents: .................................................................................................. 205. Official Documents: ......................................................................................................... 21Incoterms.................................................................................................................................. 22Types of INCOTERMS ........................................................................................................... 23Limitations of INCOTERMS ................................................................................................... 26Advantages and Disadvantages of Letter of Credit ................................................................ 27Advantages to the Importer ...................................................................................................... 27Disadvantages to the Importer ................................................................................................. 27Advantages to the Exporter ...................................................................................................... 28Disadvantages to the Exporter ................................................................................................. 28Risks in Letter of Credit ........................................................................................................... 29General Risks in Letters of Credit: .......................................................................................... 291. Country Risk: (Political Risk) .......................................................................................... 292. Fraud Risk: ....................................................................................................................... 30 Risks to the Applicant: ..................................................................................................... 30 Risks to the Beneficiary:................................................................................................... 30 Risks to the Banks: ........................................................................................................... 31Conclusion ............................................................................................................................... 32Glossary ................................................................................................................................... 33


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Dedication

First of all I would like to thanks to Almighty ALLAH who give us

strength to complete this project and make it finalize.

Then we would like to dedicate this project to our parents,

whose blessings and support has been always kept us motivated,

sincere and dedicated to our objectives in life.


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Acknowledgment

Education without guidance is aimless. We would like to

acknowledge the inspirational instruction and guidance ofMr. RIAZ

AHMED MIAN whose vision and guidance has really put us on alimit to test. Our teacher has given us a deep appreciation and courage

to complete this project.

We would also like to thank our Principle of Hailey college of

Banking & Finance, Mr. Khawaja Amjad Saeed for giving and

creating new opportunity of learning and education in this faculty.

We would also like to acknowledge the support and assistance given

me by other fellows. We are very thankful to all that has been very

generous in their support of my academic pursuits and many of my

co-workers have contributed ideas, feedback and advice.


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Introduction

Letters of Credit have been a cornerstone of international trade dating back to the

early 1900s. They continue to play a critical role in world trade today. For any

company entering the international market, Letters of Credit are an important payment

mechanism which helps eliminate certain risks.

Our purpose in publishing this guide is to provide a basic understanding of Letters of

Credit from both the Importers and Exporters points of view. In addition, we hope

that it will serve as a handy reference tool as you use Letters of Credit in your

international trade transactions.

A documentary credit (D/C or DC) is a document issued by a financial institution

which provides an irrevocable payment undertaking to a beneficiary against

complying documents as stated in the credit. It is often referred to as a Letter of

Credit, abbreviated as LC or L/C, documentary letter of credit, or simply as credit.

Once the beneficiary or a presenting bank acting on its behalf, makes a presentation to

the issuing bank or confirming bank, if any, within the expiry date of the LC,

comprising documents complying with the terms and conditions of the LC, the

applicable UCP and international standard banking practice, the issuing bank or

confirming bank, if any, is obliged to honour irrespective of any instructions from the

applicant to the contrary. In other words, the obligation to honour (payment) is shifted

from the applicant to the issuing bank or confirming bank. Non-banks can also issue

letters of credit however parties must balance potential risks.


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What is a Letter of Credit?

A Letter of Credit, simply defined, is a written instrument issued by a bank at the

request of its customer, the Importer (Buyer), whereby the bank promises to pay the

Exporter (Beneficiary) for goods or services, provided that the Exporter presents all

documents called for, exactly as stipulated in the Letter of Credit and meet all other

terms and conditions set out in the Letter of Credit.

A Letter of Credit is also commonly referred to as a Documentary Credit. There are

two types of Letters of Credit: revocable and irrevocable. A revocable Letter of Credit

can be revoked without the consent of the Exporter, meaning that it may be cancelled

or changed up to the time the documents are presented. A revocable Letter of Credit

affords the Exporter little protection; therefore, it is rarely used. An irrevocable Letter

of Credit cannot be cancelled or changed without the consent of all parties, including

the Exporter. Unless otherwise stipulated, all Letters of Credit are irrevocable.

A further differentiation is made between Letters of Credit, depending on the payment

terms. If payment is to be made at the time documents are presented, this is referred to

as a sight Letter of Credit. Alternatively, if payment is to be made at a future fixed

time from presentation of documents (e.g. 60 days after sight), this is referred to as a

term, usance or deferred payment Letter of Credit.


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Definition of letter of Credit

A written undertaking given by a Bank on behalf of the Buyer, to pay the Seller

an amount of money within a specified time, providing the Seller presents

Documents strictly in accordance with the terms laid down in the Letter of

Credit.

Parties Involved in a Letter of Credit

The following definitions will assist in understanding a Letter of Credit (L/C)

transaction.

1.Accepting BankThe bank named in a term (usance) Letter of Credit on which drafts are drawn that has

agreed to accept the draft. By accepting the draft, the Drawee Bank signifies its

commitment to pay the face amount at maturity to anyone who presents it at maturity.

After accepting the draft, the Drawee Bank becomes the Accepting Bank.

2.Advising BankThe bank to which the Issuing Bank forwards the Letter of Credit with instructions to

notify the Exporter (Beneficiary).

available with Bank The bank authorized in the Letter of Credit to effect payment

under, accept or negotiate the Letter of Credit.


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3. Confirming BankThe bank which, at the request of the Issuing Bank, adds its confirmation to the Letterof Credit. In doing so, the Confirming Bank undertakes to make payment to the

Exporter upon presentation of documents under the Letter of Credit.

Drawee Bank The bank named in the Letter of Credit on which the drafts are to be

drawn.

4. Exporter/Beneficiary/SellerThe party that has contracted to sell goods.

5. Importer/Applicant/BuyerThe party that has contracted to buy goods.

6. Issuing BankThe bank issuing the Letter of Credit on behalf of the Importer (Buyer).

7. Reimbursing BankThe bank designated in the Letter of Credit to reimburse the available with Bank

which submits payment claims under the Letter of Credit.

8. Transferring BankThe bank authorized by the Issuing Bank to transfer all or part of the Letter of Credit

to another party at the Beneficiarys request.


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Working of Letter of Credit

The following is a step-by-step description of a typical Letter of Credittransaction:

1. An Importer (Buyer) and Exporter (Seller) agree on a purchase and sale of goods

where payment is made by Letter of Credit.

2. The Importer completes an application requesting its bank (Issuing Bank) to issue a

Letter of Credit in favour of the Exporter. Note that the Importer must have a line of

credit with the Issuing Bank in order to request that a Letter of Credit be issued.

3. The Issuing Bank issues the Letter of Credit and sends it to the Advising Bank by

telecommunication or registered mail in accordance with the Importers instructions.

A request may be included for the Advising Bank to add its confirmation (See page

24 for more information on Letter of Credit confirmation). The Advising Bank is

typically located in the country where the Exporter carries on business and may be the

Exporters bank but it does not have be.

4. The Advising Bank will verify the Letter of Credit for authenticity and send a copy to

the Exporter.

5. The Exporter examines the Letter of Credit to ensure:

a) it corresponds to the terms and conditions in the purchase and sale agreement;

b) documents stipulated in the Letter of Credit can be produced; and

c) the terms and conditions of the Letter of Credit may be fulfilled.

6. If the Exporter is unable to comply with any term or condition of the Letter of Credit

or if the Letter of Credit differs from the purchase and sale agreement, the Exporter

should immediately notify the Importer and request an amendment to the Letter of

Credit.


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7. When all parties agree to the amendments, they are incorporated into the terms of the

Letter of Credit and advised to the Exporter through the Advising Bank. It is

recommended that the Exporter does not make any shipments against the Letter of

Credit until the required amendments have been received.

8. The Exporter arranges for shipment of the goods, prepares and/or obtains the

documents specified in the Letter of Credit and makes demand under the Letter of

Credit by presenting the documents within the stated period and before the expiry date

to the available withBank. This may be the Advising/Confirming Bank. That bank

checks the documents against the Letter of Credit and forwards them to the Issuing

Bank. The drawing is negotiated, paid or accepted as the case may be.

9. The Issuing Bank examines the documents to ensure they comply with the Letter of

Credit terms and conditions. The Issuing Bank obtains payment from the Importer forpayment already made to the available withor the Confirming Bank.

10. Documents are delivered to the Importer to allow them to take possession of the

goods from the transport company. The trade cycle is complete as the Importer has

received its goods and the Exporter has obtained payment.


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Types of Letter of Credit

1. Documentary Letter of Credit.A documentary letter of credit is one which provides for bills to be accompanied by

documents of title to goods such as the bill of loading invoice the policy of insurance,

etc.

2. Open or Clean letter of credit.If there are no conditions attached in the letter of credit for keeping the documents of

title to the goods as security the letter is called open or clean letter of credit. Such

letters of credit are issued by the issuing bank only to those parties which are highly

credit worthy. Here the seller sends the goods directly to the buyer together with the

relative shipping documents of title.

3. Revocable Letter of CreditIn this type of credit buyer and the bank which has established the LC, are able to

manipulate the letter of credits or make any kinds of corrections without informing

the seller and getting permissions from him. According to UCP 600, all LCs are

Irrevocable, hence this type of LC used no more.

4. Irrevocable LCIn this type of LC, Any change (amendment) or cancellation of the LC (except it is

expired) done by the Applicant through the issuing Bank must be authenticated by theBeneficiary of the LC. Whether to accept or reject the changes depends on the

beneficiary.

5. Confirmed LCAn LC is said to be confirmed when another bank adds its additional confirmation (or

guarantee) to honor a complying presentation at the request or authorization of the

issuing bank.


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6. Unconfirmed LCThis type of letter of credit, does not acquire the other bank's confirmation.

7. Transferrable LCA Transferable Credit is the one under which the exporter has the right to make the

credit available to one or more subsequent beneficiaries. Credits are made transferable

when the original beneficiary is a middleman and does not supply the merchandise

himself but procures goods from the suppliers and arrange them to be sent to the

buyer and does not want the buyer and supplier know each other. The middleman is

entitled to substitute its own invoice for the one of the supplier and acquire the

difference as his profit in transferable letter of credit mechanism

8. Un-transferable LCIt is said to the credit that seller cannot give a part or completely right of assigned

credit to somebody or to the persons he wants. In international commerce, it is

required that the credit will be un-transferable.

9. Usance LCIt is kind of credit that won't be paid and assigned immediately after checking the

valid documents but paying and assigning it requires an indicated duration which is

accepted by both of the buyer and seller. In reality, seller will give an opportunity to

the buyerto pay the required money after taking the related goods and selling them.

10.At Sight LCIt is a kind of credit that the announcer bank after observing the carriage documents

from the seller and checking all the documents immediately pays the required money.

11.Red Clause LCIn this kind of credit assignment seller before sending the products can take the pre-

paid and parts of the money from the bank. The first part of the credit is to attract the

attention acceptor bank. The reason why it named so, is that the first time this credit is


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established by the assigner bank, to take the attention of the offered bank, the terms

and conditions were written by red ink, from that time it became famous with that

name.

12.Green Clause LCIn the case of a green clause letter of credit (documentary credit with advance

payment) the beneficiary can request that the correspondent bank pay an agreed

amount in advance (defined in the terms and conditions of the letter of credit). The

advance is basically intended to finance the production or purchase of the goods to be

delivered under the documentary credit. Unlike the red clause letter of credit, the

advance is paid only against receipt of an additional document providing proof that

the goods to be shipped have been warehoused, as well as against receipt and written

commitment from the beneficiary to subsequently deliver the transportation

documents by an agreed date.

13.Back to Back LCThis type of LC consists of two separated and different types of LC. First one is

established in the benefit of the seller that is not able to provide the corresponding

goods for any reasons. Because of that reason according to the credit which is opened

for him, neither credit will be opened for another seller to provide the desired goods

and sends it.

Back-to-back L/C is a type of L/C issued in case of intermediary trade. Intermediate

companies such as trading houses are sometimes required to open L/Cs by supplier

and receive Export L/Cs from buyer. SMBC will issue a L/C for the intermediary

company which is secured by the Export L/C (Master L/C). This L/C is called "Back-

to-back L/C".

14.Fixed LCWhen a letter of credit is issued for a fixed amount up to which the issuing bank is

liable for either acceptance or payment, the L/C is called fixed. The beneficiary can

draw one or more bills to utilize the specified amount within the specified period.


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15.Revolving LCSingle L/C that covers multiple-shipments over a long period. Instead of arranging a

new L/C for each separate shipment, the buyer establishes a L/C that revolves either

in value (a fixed amount is available which is replenished when exhausted) or in time

(an amount is available in fixed installments over a period such as week, month, or

year). L/Cs revolving in time are of two types: in the cumulative type, the sum

unutilized in a period is carried over to be utilized in the next period; whereas in the

non-cumulative type, it is not carried over.

16.With recourse LCThis too is an ordinary letter of credit. Here the issuing bank is under obligation to

make the payment of the bill drawn on the opener of the credit if he (customer)

refuses to accept or pay the amount of the bill.

17.Without recourse LCHere the issuing bank is not under obligation to make the payment and so it is said to

be a letter without any liability.

18.Standby LCStandby letters of credit may apply in general to transactions which are based on the

concept of default by the applicant in performance of a contract or obligation. In the

event of default, the beneficiary is permitted to draw under the letter of credit.

Standby letters of credit may be used as a substitute for performance guarantees, or

issued to guarantee loans granted by one firm to another, thereby securing payment to

the creditor in the event the other party fails to repay its obligation on the due date.

Even if the applicant claims to have performed, the bank issuing the letter of credit is

obliged to make payment provided the beneficiary produces complying documents,

usually a sight draft, and a written demand for payment.


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Documents involved in Letter of Credit

There are many important points in a letter of credit transaction that need to be taken care of

professionally. However, documentation is much more important than any other part of the

letter of credit transactions. This importance stems its power from the letter of credit

structure. Letters of credit transactions are related to the documents only. Let us consider

ourselves as an exporter and assume that we have just shipped our order. What we have to do

in order to prove that this shipment has been made. Of course, we must supply a relevant

transport document. Let us consider also that the shipment term was CIF incoterms 2000,

which obligate us to arrange the insurance for the shipment. Again, we must supply an

insurance document, as it is demanded in the L/C in order to fulfill our responsibility

1. Transport Documents:a) Transport Document (multimodal or combined transport document)

b) Bill of Lading

A bill of lading is a receipt issued by a carrier for goods to be transported to a named

destination, which details the terms and conditions of transit. In the case of goods

shipped by sea, it is the document of title which controls the physical custody of thegoods. There are two different types of bill of lading:

A STRAIGHT BILL OF LADING is one that names a specific consignee to

whom goods are to be delivered. It is a non-negotiable document.

Given that each bill of lading must be either straight or order, the

following is a list of more common types of bill of lading:

An OCEAN BILL OF LADING is one issued by an ocean carrier in sets,

usually three signed originals comprising a complete set, any one of which


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gives title to the goods. Ocean bills of lading may be issued in straight or

order form.

A SHORT FORM BILL OF LADING is one issued by a carrier which does

not indicate all the conditions of the contract of carriage. This is acceptable

unless otherwise specified in the letter of credit.

A CHARTER PARTY BILL OF LADING, is one which shippers may, when

large or bulk cargoes are concerned, lease the carrying vessel for a stated time

or specific voyage under a charter party contract with the owner. Goods

carried are then covered under a form of bill of lading issued by the charterer

and indicate as being shipped, subject to the term and conditions of the charter

party. Charter party bills of lading are not acceptable unless specifically

authorized by the letter of credit.

A MULTIMODAL TRANSPORT DOCUMENT is one covering shipments

by at least two different modes of transport.

c) Non-Negotiable Sea Waybill

d) Charter Party Bill of Lading

e) Air Transport Document

An air waybill is a receipt issued by an air carrier indicating receipt of goods to

be transported by air and showing goods consigned to a named party. Being a

non-negotiable receipt it is not a document of title.


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Checklist

Only the goods invoiced and specified in the letter of credit may be

covered by the air waybill.

If the letter of credit stipulates that freight is to be prepaid; or if the

invoice is priced CIF or CFR; or if freight is otherwise included in the

invoice: the air waybill must indicate that freight has been paid.

The airport of departure and airport of destination must be as stipulated in

the letter of credit.

The number of packages and gross weight shown on the air waybill must

be consistent with the other documents.

An air waybill issued by a forwarder is not acceptable.

f) Road, Rail or Inland Waterway Transport Documents

2. Insurance Documents:a) Insurance Policy

Under the terms of a CIF contract, the beneficiary is obliged to arrange insurance and

furnish the buyer with the appropriate insurance policy or certificate. The extent of

coverage and risks should be agreed upon between the buyer and seller in their initial

negotiations and be set out in the sales contract.

Since the topic of marine insurance is extremely specialized and with conditions

varying from country to country, the services of a competent marine insurance broker

are useful and well-advised.


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Checklist

If the letter of credit calls for an insurance policy, an insurance certificate is

not acceptable and the policy must be provided. Brokers cover notes are not

acceptable unless specifically allowed in the letter of credit.

If the insurance policy or certificate indicates that it is issued in duplicate,

both copies must be presented.

Unless the amount to be insured is stipulated in the letter of credit, the

amount should cover at least the CIF value plus 10 percent if invoiced in

those terms. Otherwise, the amount should be for the greater of the draft

amount or the total invoice value plus 10%.

The amount insured must be expressed in the same currency as the letter of

credit.The description of the goods insured must be consistent with that in

the other documents although not necessarily identical.

The number of packages comprising the shipment and shipping marks and

numbers must agree with those shown on the invoice and bill of lading.

The name of the carrying vessel, port of loading and port of discharge must

agree with those shown on the bill of lading.

The insurance document must cover transshipment if transshipment is

indicated on the bill of lading.

The insurance document must cover specifically those risks stipulated in the

letter of credit. The all risks clause in the insurance document does not

cover risks of war, which must be separately shown as covered, if required

by the letter of credit.

Unless the letter of credit specifies to whom loss is to be payable, the

insurance document must be endorsed by the party to whose order it is made

so as to be in negotiable form.

The date of the insurance document should not be later than the date of

shipment as shown by the bill of lading or other transport document.

However, the insurance document may be dated after the date of shipment


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provided it evidences that cover is effective from date of dispatch ie., by way

of warehouse to warehouse clause.

Any alterations or corrections to the insurance document must be initialed by

the party signing the document.

The insurance document must be signed by an authorized person.

b) Insurance Certificate

c) Open Cover

3. Financial Documents: Bill of exchange (Draft)

A draft is a bill of exchange and a legally enforceable instrument which may be regarded as

the formal evidence of debt under a letter of credit. Drafts drawn at sight are payable by the

drawee on presentation. Term (usance) drafts, after acceptance by the drawee, are payable on

their indicated due date.

Drafts must show the name of the issuing bank and the number and date of the letter

of credit under which they are drawn.

Drafts must be drawn and signed by the beneficiary of the letter of credit.

The terms of the draft must be expressed in accordance with the tenor shown in the

letter of credit; e.g., at sight or at a stated number of days after bill of

lading/shipment date.

The amount in words and figures must agree and be within the available balance of

the letter of credit and in the same currency as the letter of credit. The amount must

agree with the total amount of the invoices unless the letter of credit stipulates that

drafts are to be drawn for a given percentage of the invoice amount.


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4. Commercial Documents:a) Commercial Invoice

The commercial invoice is an itemized account issued by the beneficiary and

addressed to the applicant, and must be supplied in the number of copies specified in

the letter of credit.

Checklist

The invoice description of the goods must be identical to that stipulated in the

letter of credit.

Unit prices and shipping terms, ie., CIF, FOB, etc., must be as stipulated in

the letter of credit. Extensions and totals should be checked for arithmetical

correctness. For definitions of CIF, FOB etc.,

b) Packing List; Weight List

A packing list is usually requested by the buyer to assist in identifying the

contents of each package or container. It must show the shipping marks and

number of each package. It is not usually required to be signed.

c) Inspection Certificate

When a letter of credit calls for an inspection certificate it will usually specify bywhom the certificate is to be issued; otherwise, the same general comments as in

the case of the certificate of origin apply.

As a preventative measure against fraud or as a means of protecting the buyer

against the possibility of receiving substandard or unwanted goods, survey or

inspection certificates issued by a reputable third party may be deemed prudent.

Such certificates indicate that the goods have been examined and found to be as

ordered.


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5. Official Documents:a) Certificate of Origin

As the name suggests, a certificate of origin certifies as to the country of origin of the

goods described and should comply with any stipulations in the letter of credit as to

originating country and by whom the certificate is to be issued. The certificate should

be consistent with and identified with the other shipping documents by shipping

marks and numbers, and must be signed.

b) Health Certificate

c) Consular Invoice,

A consular or customs invoice is prepared by the beneficiary on forms either supplied

by the buyer or local consulate offices.

Checklist

Consular invoices must be visaed (officially stamped) and signed by a

consular officer of the importing country and be supplied in the official form

and number of copies as stipulated in the letter of credit.

All headings of the forms must be completed.

The value of goods required must agree with that shown on the commercial

invoice.


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IncotermsINCOTERMS (International Commercial Terms) have been created by the International

Chamber of Commerce in order to reach an uniform set of international rules for the

interpretation of trade terms in a global scale. First version of INCOTERMS published in

1936. These first rules were known as Incoterms 1936. In 1953, 1967, 1976, 1980, 1990

and finally in 2000 rules have been amended in order to bring the them in line with current

international trade practices.

INCOTERMS can only be applied to the sales contracts which are related to the trade of

tangible goods. Incoterms should not be used in other contracts, such as contract of carriage,

insurance etc... Reference to Incoterms 2000 in a sales contract defines clearly the parties

respective obligations and reduces the risk of legal complications.

INCOTERMS (International Commercial Terms) are rules about the delivery conditions for

goods. They are used to divide the costs of international business transactions and define the

responsibilities of both the buyer and seller, while reflecting the current practices in the

international transport of goods.

INCOTERMS are a set of international rules that are overseen by the International Chamber

of Commerce, which determines the extent of the commerce clauses included in international

sales contracts.

INCOTERMS are also called price clauses, since each INCOTERM determines the cost

elements of a goods transfer. The choice of INCOTERM affects the cost of a contract.

The purpose of INCOTERMS is to provide a set of international rules for the interpretation of

the terms used in international trade.


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INCOTERMS determine:

The scope of the price

At what time and where the risk for the goods transfers from the seller to the buyer

The place of delivery of the goods

Who hires and pays the transport

Who hires and pays the insurance

Which documents confirm each phase, and their cost.

Types of INCOTERMS

1. INCOTERM CFR - Cost and Freight (named port of destination)The seller fulfills his obligation when the goods pass the ship's rail at the shipping port. The

seller is responsible for all costs of export, customs clearance, freight and costs required to

bring the goods to the port of destination, not including insurance. Costs of unloading at thedestination port are borne by the buyer.

2. INCOTERM CIF - Cost, Insurance and Freight (named port of destination)The seller fulfills his obligation when the goods pass the ship's rail at the shipping port. The

seller must pay all costs of freight, insurance, export customs clearance and all necessary

costs to bring the goods to the port of destination.

The seller is required to obtain minimum insurance coverage only to the destination port for

the value of the goods.


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3. INCOTERM CIP - Carriage and Insurance Paid to (named place of destination)The seller pays the costs of freight transportation required to carry the goods to the place

agreed with the buyer. Additionally, the seller secures and pays for insurance (i.e., a policy

with minimum coverage) against the risk that the purchaser may have for loss or damage of

goods.

If the buyer wants more coverage, this must be arranged with the seller, or a separate

insurance policy must be purchased by the buyer.

4. INCOTERM CPT - Carriage Paid To (named place of destination)The seller pays the costs of freight transport required to carry the goods to the place agreed

with the buyer, including shipping and export permits, but not insurance costs.

This INCOTERM can be used in any mode of transport, including multimodal transport, with

the risk passing from seller to buyer when delivered to the first carrier.

5. INCOTERM EXW - Ex WorksFACTORYThis INCOTERM applies to transactions in which the seller (exporter) has complied with the

responsibility to deliver the goods while they are still in his establishment (e.g., factory,

workshop, warehouse, etc.) The goods are made available to the buyer (importer) but have

not been cleared for export or loaded on the vehicle provided by the buyer.

The buyer (importer) must bear all costs and risks of taking the goods from the address of the

seller (exporter) to the desired destination.


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6. INCOTERM FCA - Free Carrier (named place)This INCOTERM means that the seller fulfills his obligation to deliver the goods when they

are made available to the main carrier hired by the buyer at the agreed point. The seller is

responsible for export clearance of the goods.

If delivery occurs at the seller's premises, the seller is responsible for loading the goods on

the vehicle for the buyer and at that point transfers the costs and risks of shipment.

7. INCOTERM FAS - Free Alongside Ship - FREE ALONGSIDE SHIP (FreeAlongside Ship) (port of shipment)

The seller bears the transport costs and risks until the goods are placed alongside the vessel at

the port of shipment. Therefore, if a problem occurs during loading, the buyer must take

responsibility. The seller is responsible for clearing customs for export. If the parties have

agreed that the buyer is to perform this procedure.

8. INCOTERM FOB - Free on Board (port of shipment)The seller fulfills its responsibility to deliver the goods once they clear the ship's rail at the

port of shipment. The seller does not pay for shipment.

The seller is obligated to ensure the goods are cleared by customs for export.

9. INCOTERM DAF - Delivery at Frontier - (named place)The seller delivers to the agreed place at the border, but liability ends before the delivery is

cleared at customs and the goods are available to the buyer in the means of transport. It is the

buyers responsibility to unload them. The term "border" could imply that of the exporting

country, therefore this term must be specified.


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10.INCOTERM DDP - Delivery Duty Paid (... named place of destination)The seller delivers the goods to the buyer, cleared for export and import payments of all costs

but without unloading from the means of transport at the place of destination in the importing

country.

Limitations of INCOTERMS

Incoterms apply to the contract of sale and not to any other contract.

They may not describe all the duties of buyers and sellers which they would like to

incorporate in the contract.


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Advantages and Disadvantages of Letter of

Credit

Advantages to the Importer

Importer is assured that the Exporter will be paid only if all terms and conditions of

the Letter of Credit have been met.

Importer is able to negotiate more favourable trade terms with the Exporter when

payment by Letter of Credit is offered.

Disadvantages to the Importer

A Letter of Credit does not offer protection to the Importer against the Exporter

shipping inferior quality goods and/or a lesser quantity of goods. Consequently, it is

important that the Importer performs the appropriate due diligence to assess the

reputation of the Exporter. If the Exporter acts fraudulently, the only recourse

available to the Importer is through legal proceedings.

It is necessary for the Importer to have a line of credit with a bank before the bank is

able to issue a Letter of Credit. The amount outstanding under each Letter of Creditissued is applied against this line of credit from the date of issuance until final

payment.


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Advantages to the Exporter

The risk of payment relies upon the creditworthiness of the Issuing Bank and the

political risk of the Issuing Banks domicile, and not the creditworthiness of the

Importer.

Exporter agrees in advance to all requirements for payment under the Letter of Credit.

If the Letter of Credit is not issued as agreed, the Exporter is not obligated to ship

against it.

Exporter can further reduce foreign political and bank credit risk by requesting

confirmation of the Letter of Credit by a Canadian bank.

Assures the security of payment from an international bank once the terms of the

letter of credit are met.

Seller can determine when payment will be satisfied and ship the goods accordingly.

Bank bears the responsibility of oversight.

Seller does not have to open an account and grant payment terms to buyer. Credit risk

is nearly eliminated. The risk of exchange control created with payment delays is

greatly reduced.

Provides seller easier access to financing once the letter of credit has been issued.

Once the bank confirms the letter of credit, political and economic risk and questions

regarding the buyer's ability to pay are eliminated. The confirming bank is obliged to

pay, even if the buyer goes bankrupt, provided the terms of the letter of credit are met.

Disadvantages to the Exporter

Documents must be prepared and presented in strict compliance with the requirements

stipulated in the Letter of Credit.

Some Importers may not be able to open Letters of Credit due to the lack of credit

facilities with their bank which consequently inhibits export growth.


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Risks in Letter of Credit

Although letters of credit are a balanced payment method in terms of risk issues for both

exporters and importers, each letters of credit party bears some amount of risk. As we have

explained before letters of credit transactions are handled by banks. This responsibility makes

the banks one of the parties that bears risks in a letter of credit transaction.

Risks in letters of credit can be discussed under four groups; general risks in letters of credit,

risks to the applicant, risks to the beneficiary and risks to the banks.

General Risks in Letters of Credit:

1. Country Risk: (Political Risk)The first risk factor that can be mentioned in the general risks group is the country risk or the

political risk. Let us assume that we are an exporter located in a country X and we have a

customer from the country Y. Our customer, which is from the country Y, opened a L/C in

favor of us. We have checked the L/C conditions and they seem workable. We have produced

and shipped the order as per the L/C and transmit the required documents to the issuing bank

before the expiry date. The issuing bank found our presentation complying and informed us

that they will be honoring our payment claim at the maturity date. However, before the

maturity date due Country Y has changed its export regime, which makes it impossible for

the issuing bank to honor our presentation. This illustrative is a good example of a country

risks. Other examples of country risks are mass riots, civil war, boycott, sovereign risk and

transfer risk.


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2. Fraud Risk:As we have described before all conditions stated in a letter of credit must be connected to a

document, otherwise banks will disregard such a condition. In addition, banks deal with only

documents but not goods, services or performance to which the documents may relate. This

feature of the letters of credit is the source of the fraud risk at the same time. As an example,

a beneficiary of a certain letter of credit transaction can prepare fake documents, which looks

complying on their face, to make the presentation to the issuing bank. As the documents are

complying on their face, the issuing bank may honor the presentation and in this case, the

applicant must pay to the issuing bank for the goods it will never be receiving. Beneficiaries

of L/Cs bear also fraud risks. This happens if an applicant issues a counterfeit letter of credit.

In this case, the beneficiary never receives its payment for the goods it has shipped.

Risks to the Applicant:

Non-delivery of Goods

Short shipment

Inferior Quality

Early /Late Shipment

Damaged in transit

Foreign exchange

Failure of Bank viz Issuing bank / Collecting Bank

Risks to the Beneficiary:

In a letter of credit transaction, main risk factors for the beneficiaries are unable to comply

with letter of credit conditions, counterfeit L/C, issuing bank's failure risk and issuing bank's

country risk.

Failure to Comply with Credit Conditions

Failure of, or Delays in Payment from, the Issuing Bank


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Risks to the Banks:

Every bank in a L/C transaction bears risks more or less. The risk amount increases as

responsibility of the bank increases.

A.Risks to the Issuing Bank

Insolvency of the Applicant

Fraud Risk, Sovereign and Regulatory Risk and Legal Risks

B. Risks to the Reimbursing Bank

no obligation to reimburse the Claiming Bank unless it has issued a reimbursement

undertaking.


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Conclusion

Letters of credit prove that a business is able to pay and allow exporters to load cargo for

shipments with the assurance of being paid. Though routine in normal times, the letter of

credit of process is yet another example of how transactions between multiple financial

intermediaries introduce counterparty risk and the potential for trouble when confidence

flags.

The use of the letters of credit as a tool to reduce risk has grown substantially over the

past decade. Letters of credit accomplish their purpose by substituting the credit of the

bank for that of the customer, for the purpose of facilitating trade.

The credit professional should be familiar with two types of letters of credit:

commercial and standby. Commercial letters of credit are used primarily to facilitate

foreign trade. The commercial letter of credit is the primary payment mechanism for a

transaction.

The standby letter of credit serves a different function. The standby letter of credit

serves as a secondary payment mechanism. The bank will issue the credit on behalf of

a customer to provide assurances of his ability to perform under the terms of a

contract.


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Glossary

Acceptance Draft - payable at a fixed or determinable future date, upon the

face of which the drawee has acknowledged in writing his or her obligation to

pay at maturity. See also "banker's acceptance" and "trade acceptance".

Account Party - The party instructing the bank to open a letter of credit and on

whose behalf the bank agrees to make payment. In most cases, the account

party is the importer/buyer, and is also known as the applicant.

Advice of Fate - Notification of the status of a collection that is still outstanding.

When a draft bears this phrase, the time begins to run from its date. The date of

maturity is therefore fixed and does not depend on the date of acceptance of the

draft.

Advising Bank - A bank that accepts a letter of credit from the issuing bank,

verifies its authenticity, and forwards it to the beneficiary. The advising bank

does not take on any payment obligations.

After Sight - When a draft bears this phrase, the time begins to run from the

date of its acceptance.

Air Waybill (of lading) - A signed receipt and a contract to deliver goods by

air. Such bills are non-negotiable and do not convey title to the goods as do To

Order bills of lading used by ocean and land carriers. The title passes to the

party to whom the goods are consigned (the Consignee).


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Amendment - Change to terms of a letter of credit. Beneficiary has the right to

refuse the amendment under an irrevocable letter of credit.

Applicant - See "account party".

Assignment of Proceeds - A request by the beneficiary to pay all or part of the

funds due to him to a third party. This instrument does not transfer rights in the

letter of credit nor the title to the goods.

Back-to-Back Letter of Credit (L/C) - Letter of credit issued for the account

of a buyer who is already holding an L/C in his or her favor. The back-to-back

L/C is issued in favor of the supplier to cover the same shipment as stipulated in

the credit already held by the buyer. Terms of both L/Cs, except for the amount

and expiration date, are so similar that the same documents presented under the

back-to-back credit are subsequently applied against the credit in favor of the

buyer. However, the buyer/beneficiary of the first credit substitutes this draft

and invoice for those presented by the supplier. See also letter of credit.

Bankers Acceptance - Form of credit created when a bank accepts a time

draft typically drawn on the bank by a seller of goods. By accepting a draft, the

bank is obligated to pay the face amount at a specified time in the future, usually

six months or less after acceptance. A seller of merchandise can sell the banker's

acceptance for an amount less than face value and have immediate use of funds.

See also acceptance.

Bank Draft - A check drawn by a bank on another bank payable to the seller at

the request of the buyer. The check may be denominated in U.S. Dollars or most

foreign currencies.

Beneficiary - The party who receives payment as stipulated in a letter of credit.

This party is usually the seller/exporter.


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Bill of Exchange - Formal written order addressed by one person (drawer) to

another (drawee), signed by the drawer, and directing the drawee to pay on

demand or at a fixed or determinable future time, a certain sum in money to the

order of a specified person (payee).

Bill of Lading (Air, Ocean, Railroad, Truck) - A document of title issued by

the carrier (transport company) or its agent. Bill of lading is a receipt for the

merchandise in transit, as well as a contract for delivery to a specified party at a

specified destination.

BLANK ENDORSED - A negotiable bill of lading in which the title to the

merchandise is passed on to another party by means of an endorsement. The

holder of the blank endorsed bill of lading is entitled to take possession of the

merchandise.

CLEAN BILL OF LADING - One in which the goods are described as having

been received by the carrier in apparent good order and condition and without

qualification. LATE PRESENTATION (STALE): A bill of lading is presented to

a bank for payment or negotiation after the stipulated date in the letter of credit,

or later than 21 days after the date of its issuance.

NEGOTIABLE OR TO ORDER - A bill of lading in which the merchandise is

consigned directly to order or to the order of a designated party, usually theshipper or a bank. The phrase to order or to the order of (a designated party)

signifies negotiability permitting the title of the merchandise to be transferred

many times by means of appropriate endorsements.

NOTIFY - This phrase requires the carrier to notify a designed party upon

arrival of the merchandise, but does not transfer title of the merchandise to that

party.


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STRAIGHT OR NON-NEGOTIABLE - A bill of lading in which the

merchandise is consigned directly to a designated party, generally the buyer, but

not to his order. Delivery of the merchandise is made only to the designated

party, usually without surrendering the bill of lading.

THROUGH - A bill of lading issued by a shipping company or their agent

covering more than one mode of transportation.

Cash Against Documents (CAD) - Payment for goods in which an

intermediary (usually a bank) releases title documents to the buyer upon payment

in cash.

Cash in Advance (CIA) - A term of trade in which the exporter does not ship

goods until payment is received; offers the least risk to sellers and the most risk

to buyers.

Clean Draft - A sight or time draft (bill of exchange) which is not accompanied

by additional documents. Also referred to as "Clean Collection".

Collecting Bank- Bank that acts as an agent for a remitting bank that wishes to

have its collections handled. The collecting bank demands payment from the

buyer and handles the funds received as instructed; generally the funds are sent

back to the remitting bank.

Commercial Invoice - A written and signed list of merchandise and/or services

with associated quantities, prices and expenses. It contains the terms of the sale

and is prepared by the seller to show the total amount owed by the buyer.


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Confirmed Credit - A letter of credit in which the issuing banks obligation to

pay is backed (confirmed) by a second bank.

Deferred Letter of Credit (L/C) - Letter of credit that calls for payment at a

future date, but does not require a draft. See also letter of credit and usance

letter of credit.

Direct Collection - Method of payment for goods in which the seller sends a

draft drawn on the buyer, the shipping documents, invoices, insurance

certificates, other appropriate documents directly to the buyers bank for

collection. Only an information copy of the advice is sent to the exporters bank

to establish and monitor the collection transaction for the seller.

Discrepancy - Any deviation from the terms and conditions of a letter of credit

or from the documents presented under the letter of credit.

Documentary Credit - A letter of credit issued to support the movement of

merchandise supported by shipping documents presented by the beneficiary to

the Issuing Bank for payment or acceptance.

Documents Against Acceptance (D/A) - Instructions given by a shipper to his

or her acceptance bank that the documents attached to a time draft for collection

are deliverable to the drawee/payer against his or her acceptance of the draft.

Documents Against Payment (D/P) - Instructions given by a shipper to his or

her bank that the documents are deliverable to the drawee/payer only against his

or her payment of the draft.

Draft - A draft is a formal demand for payment. It is an unconditional order in

writing, addressed by one party (drawer) to another party (drawee), requiring

the drawee to pay, at a designated or determinable future date, a specified sum in

lawful currency (either in dollars or other currency) to the order of a named


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party (the Payee). In international trade, drafts are also known as Bills of

Exchange.

Eurodollars - A term used for U.S. dollars held on deposit or traded anywhere

else in the world except in the USA.

Eximbank (Export-Import Bank of the United States) - A U.S. government

agency that offers insurance/guarantees of commercial or political risks

associated with U.S. export transactions. These programs encourage U.S.

exports by reducing the exporters risk.

Expiry or Expiration Date - The date on which the draft and documents drawn

under a letter of credit must be presented to the negotiating, accepting, paying,

or issuing bank in order to effect payment. The issuing banks obligation ceases

on that date if the letter of credit is a straight credit. If the letter of credit is a

negotiable credit, the issuing bank must honor the credit, provided the

complying documents were submitted prior to the expiry (or expiration) date.

Foreign Exchange - The process of trading the currency of one country for

that of another.

Foreign Exchange Exposure - A situation in which a U.S. company,

selling/purchasing in a currency other than U.S. Dollars, runs the risk of

receiving a reduced dollar amount or paying an increased dollar amount due to a

fluctuating exchange rate.

Forward Transactions - Foreign exchange transactions settling between three

business days and one year (and sometimes longer).

Freight Forwarder - An independent business that arranges for the shipment of

export cargo and completes the necessary export documentation on behalf of the

exporter.


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Irrevocable Letter of Credit (L/C) - Letter of credit that cannot be changed or

cancelled without the consent of all parties involved. Almost all L/Cs are

irrevocable unless otherwise stated on L/C. See also letter of credit.

Issuing Bank- Bank that draws up and issues the letter of credit and that

makes payment according to the conditions

Letter of Credit - An instrument issued by a bank, at the request of the

applicant, promising to pay the beneficiary upon his presentation of stipulated

documents in accordance with the terms and conditions of the credit.

CONFIRMED: A letter of credit issued by one bankto which another bank

added its irrevocable confirmation to pay, thereby obligating itself in the same

manner as the opening bank.

STAND-BY: A letter of credit that generally guarantees payment due for an

unfulfilled obligation on the part of the applicant or another party. It is payable

upon presentation of a draft, as well as a signed statement or certification by the

beneficiary that the applicant has failed in his obligation.

Maturity Date - The date on which negotiable instruments become due for

payment.

Negotiate - Take action to verify that the documents presented under an L/C

conform to the requirements in order to release funds to the seller.

Negotiating Bank - The bank that reviews the documents required in the letter

of credit for compliance with its terms and remits payment to the beneficiary.

The bank may be specifically named in the letter of credit, or may be a bank

chosen by the seller.


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Opening Bank- See "Issuing Bank".

Paying Bank- Bank that effects payment of documents negotiated under a letter

of credit, customarily the buyer's bank. It is usually also the negotiating bank,

unless the L/C allows another bank to negotiate or the paying bank is unable to

negotiate. See also "negotiating bank".

Presentation - Presentation for acceptance or payment on a collection or letter

of credit.

Proforma Invoice - An invoice sent in advance of shipment, to enable the buyer

to obtain an import permit or exchange permit or both. The proforma invoice

gives a close approximation of the weights and values of the intended shipment.

Protest - Legal process of demanding payment of a negotiable item from the

maker who has refused to pay.

Red Clause - Clause in a letter of credit that authorizes the advising/negotiating

bank to make an advance payment to the beneficiary before presentation of

shipping documents, usually against a simple receipt.

Reimbursing Bank - The bank names in a letter of credit as the bank authorized

by the issuing bank to honor claims presented by the paying, accepting, ornegotiating bank.

Revocable Letter of Credit (L/C) - A letter of credit that can be modified or

canceled by the issuing bank without the beneficiarys consent unless the

negotiation of complying documents has already taken place. The issuing bank

must honor the draft(s) negotiated before the notice of revocation has been made.


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Spot Transaction - Foreign exchange transaction in which foreign currency is

bought at the current rate of exchange and delivered within two business days

after the transaction date.

Spread - The difference between the buying (bid) rate and the selling (offer) rate

of any foreign currency for any particular period.

Standby Letter of Credit (L/C) - Letter of credit issued to back an obligation

of the applicant, but typically not intended to be the primary method of payment.

Usually payable against drafts and statements, but not against commercial

documents. See also letter of credit.

Trade Acceptance - Draft drawn by the seller of goods on the buyer and

accepted by the buyer for payment at a specified future date. See also

acceptance.

Transferable Letter of Credit (L/C) - Letter of credit that permits the

beneficiary to transfer all or some of the rights and obligations under the credit to

a second beneficiary. See also letter of credit.

UCP - Uniform Customs and Practices for Documentary Credits. Publication

issued by the International Chamber of Commerce (2007 revision, ICC

Publication No. 600, or UCP 600) that outlines the rules and guidelinesinvolved in a letter of credit transaction.

Usance (Time) Credit - Letter of credit that calls for payment against drafts

calling for payment at some specified date in the future. Gives buyers time to sell

the goods to get the funds to reimburse the issuer.