Letters of Credit
Documentary LCs
- require presentation of documents that comply w the terms and conditions set out in the LC before it can be negotiated - provides protection to the buyer and the issuing bank
Reimbursing bank
a final party commonly involved once a negotiation is completed - will claim reimbursement
Nominated bank
might be a local branch of the same name intended to accept a draft/bill or negotiate an LC
Parties that could be involved in a L/C
1. issuing bank 2. beneficiary 3. reimbursing bank 4. Beneficiary 5. Applicant 6. Advising bank 7. confirming bank 8. negotiating bank 9. nominated bank
Revocable vs **irrevocable LCs
1. revocable LCs - can be amended or cancelled by the issuing bank at any time without giving prior notice. provdes little protection so it is rarely used 2. irrecovable LCs - cant be amended or canceled without the agreement of the issuing bank, the confirming bank, and the seller. provides more protection to sellers as changes cant be made without their agreement
Types of risk sharing arrangements
1. syndications 2. club deals 3. risk sharing agreements
Full vs partial negotiations
Full: goods are shipped by the seller and the LC is negotiated once only, after which the issuing banks liability is canceled even if the full amt is not paid partial: where more than 1 shipment is made, an LC is partially negotiated each time a shipment takes place
Who is the beneficiary of an irrevocable sight LC?
Seller
What is a complying presentation
a presentation that is in accordance w the terms and conditions of the LC
D/A terms
documents against acceptance terms
What are letters of credit
long established payment method used for trade transactions particularly for international trade - secure but expensive - guarantee from issuing bank to the seller guaranteeing payment - doesnt necessarily mean the buyer will receive the goods
UCP definition of an L/C
- "any arrangement that is irrevocable and thereby constitutes a definitie undertaking of the issuing bank to honor a complying presentation
Clean L/Cs
- doesnt require documentation other than a draft in order for it to be negotiated - little protection for the buyer or issuing bank - issued infrequently
Red vs Green clause LCs
- red clause: authorizes an advance to be made to the beneficiary - green clause: allows an advance to be made only against warehouse recipients or similar documents
Give a circumstance where an irrevocable LC would not be paid
- the seller doesnt present the correct documents
Advantages of LC from Sellers point of view
1 .Safety - a safe payment means that open account trading 2. Amendments: an irrevocable LC cant be amended without the seller's permission 3. Confirmation: to mitigate credit risk on the issuing bank, and any risks the seller can request an LC to be confirmed 4. Ownership: if not paid, the seller retains title to the goods 5. established payment means 6. Obtaining funding: once a draft is accepted by a bank, a seller can easily discount it if funds are required before date
Lifecycle of an LC
1. Contract of Sale: describes goods to be delivered, specifies letters of credit as means of payment 2. LC issuance: buyer requests its bank to open LC in favor of seller. Will check for availability and terms and conditions 3. LC advising and confirmation: LC is forwarded to advising bank. confirms authenticity of credit and forwards to seller. 4. Shipment: seller arranges shipment of goods 5. negotiation: seller submits documents to negotiating bank who checks that the documents are in order. 6. payment: negotiating bank to make payment to seller
Risks that banks involved in an LC are exposed to
1. Credit risk 2. Operational Risk 3. Country Risk 4. Market Risk 5. Reputational Risk
Disadvantages of LC from sellers point of view
1. Discrepancies: buyers might use small discrepancies as an excuse to delay or not make a payment 2. Credit: granding DA terms means the seller doesnt receive payment until a later date 3. Credit risk 4. country risk 5. costs - bank fees accumulate 6. exchange rates 7. ST credit
Advantages of an LC from buyers perspective
1. LCs are aligned to a contractural agreement 2. Established payment means: they are a long established payment means and subject to UCP 600 3. Documentary proof: provide proof that goods have been shipped 4. negotiation: only possible once the required documents have been submitted by the seller 5. discrepancies: buyer can delay payment or acceptance if there are any discrepancies 6. Credit: terms provide the buyer w time to process/sell the goods before payment is due
Disadvantages of LC from buyers perspective
1. goods shipped might not be the same as ordered 2. Delays can result 3. exchange rate differences 4. costs: buyer incurs costs of issuing an LC 5. Locked in: no amendments or cancelations once issued
why would a seller be prepared to accept payments to be made on DA terms?
1. if the buyer is large it can usually set the terms on which it does business 2. If there are little sellers and product differentiation, a business may only be able to make sales by offering attractive terms of trade to buyers 3. Sales on DA terms are more attractive to sellers if they can obtain a higher price than if they sell of DP terms
Once issued LCs may be confirmed or unconfirmed
Confirmed: one that a bank has added its confirmation. Usually done by the advising bank but can be added by a different bank. means the confirmed bank will make payment Unconfirmed: hasnt been confirmed. Seller relies on the issuing bank to make payment where a valid submission is made
Back to back LCs
act as collateral and a source of repayment for a second LC issued by another bank many banks are reluctant to issue these bc of the level of risk theyre exposed to
Transferable LCs
allows the beneficiary to transfer its rights to one or more second beneficiaries only once w limited changes in terms and conditions
Revolving LCs
credits that are automatically renewed or reinstated after negotiation. lifecycle becomes extended for many years
Standby Letter of credit
demand guarantees. - differ from documentary credits: issuance isnt reliant on underlying movemnt of goods, claim is only made when applicant is in default - used to provide an alternative to issuing of bonds and guarantees, support open account arrangements, or enable a bank to provide credit facilities to a customer - doesnt involve confirmation or negotiation - issued to international standby practices
D/P terms
documents against payment terms
Sight LCs
enable the making of payment to the seller once the LC is negotiated - documents against payment transaction
Deferred Payment LCs
payment doesnt need to be made until a specified future date - used where the market is competitive
Confirming Bank
provides confirmation to the issuing bank
Advising bank
responsible for checking the authenticity of an LC and advising it to the beneficiary at the request of the issuing bank
Usance or term LCs
result in payment being made some time after negotiation
Difference btween transferable LC and back to back LC
rights are transferred under a transferable LC but not w a back to back LC
Negotiating bank
the bank that receives and checks the documents submitted by the beneficiaries
Who bears the cost of opening an LC?
the buyer
Issuing Bank
the party that issues an LC - usually an LC is a contract btwn the issuing bank and the beneficiary
Applicant
the party that requests an LC to be issued by its bank. responsible for the costs of issuing an LC
Beneficiary
the party whose favor an L/C is issued