INLAND LETTER OF CREDITBASIC OPERATIONSTYPESDOCUMENTSRISKSREGULATIONS

BYAshima

BASIC OPERATIONSDocumentary credits, otherwise, popularly

known as “letter of credit” or L/C, is an financial instrument of settlement of trade related payments.

‘High degree of involvement by banks in the documentary credit process build

LETTERS OF CREDITFacilitates trade – domestic & internationalHelps in reducing working capital requirement

for buyerHelps seller to get immediate paymentBank intermediates lend its creditworthiness

for which it charges the applicantTransactions are guided by UCPDC (ICC

Uniform Customs and practices for Documentary credits)

Total no. of articles = 39Publication : UCP 600 (2007 Revision w.e.f. July 1,

2007)

An arrangement by means of which a bank (issuing bank) acting at the request of a customer (applicant) undertakes to pay to a third party (beneficiary) a predetermined amount by a given date according to agreed stipulations and against presentation of stipulated documents

MECHANICS OF DOCUMENTARY CREDIT

IMPORTER EXPORTER

CONTRACT

OPENINGBANK

ADVISING/NEGOTIATING

BANK

SHIPPINGCOMPANY

GOODS

DOCS

DOCUMENTS

OPEN CREDIT

DOCUMENTS

PAYMENT PAYMENT

GOODS

DOCS

DOCUMENTS UNDER LCBill of exchange.Invoice.Bill of lading / Airway Bill / LR / RR.Insurance Policy.Certificate of origin.Packing List.Weight list.

DOCUMENTS UNDER L/CTHE DOCUMENTS ARE BROADLY CLASSIFIED

AS :

NEGOTIABLE DOCUMENT (BILL OF EXCHANGE, BILL OF LADING, R/R, L/R)

LEGAL DOCUMENTS (CERTIFICATE OF ORIGIN,INSURANCE CERTIFICATE, ETC)

QUASI-NEGOTIABLE DOCUMENT (AIRWAY BILL)

OTHERS (COMMERCIAL INVOICE, PACKING LIST AND WEIGHT LIST)

BASIC OPERATIONS (INTER BANK COMMUNICATION)

SFMS IS “STRUCTURED FINANCIAL MESSAGING SYSTEM” WHICH TERMS AS SECURED MEDIUM FOR TRANSMITTING TRADE FINANCE MESSAGES FOR SENDING/RECEIVING LCs/BGs.

SFMS MESSAGES ARE PRESET AND REFERRED TO BY A CATEGORY NUMBERED CALL “MT” NUMBER.

IN THE LETTER OF CREDIT THE NUMBER STARTS FROM 700.

IN PROCESS MT-700 AND 701 REFERS TO ISSUE OF THE DOCUMENTARY CREDIT.

MT-707 REFERS TO AMENDMENT TO L/CMT-720 REFERS TO TRANSFER OF L/CMT-760 REFERS TO ISSUE OF BANK

GUARANTEEMT-792 REFERS TO CANCELLATION OF L/C

PARTIES TO A LETTER OF CREDIT

Applicant (Buyer)Issuing Bank (Opening Bank)

Beneficiary (Seller)Advising BankNegotiating Bank (Paying Bank)

TYPES OF LETTERS OF CREDIT

REVOCABLEIRREVOCABLESIGHT/

PAYMENTUSANCE/

ACCEPTANCE

NEGOTIATION TRANSFERABL

E

REVOCABLE CREDITSARTICLE- 6 UCP- 500

(No mention in UCP 600- Art-3- Interpretation)

CAN BE REVOKED/ AMENDED/ WITHDRAWN WITHOUT NOTICE TO OR CONSENT OF BENEFICIARY

IS ONLY AN ADVICE AND NOT AN UNDERTAKING

CAN NOT BE CONFIRMED

NOT PERMITTED BY RBI

IRREVOCABLE CREDITS

AN UNCONDITIONAL UNDERTAKING BY ISSUING BANK

AMENDMENTS SUBJECT TO THE CONSENT OF ALL PARTIES TO THE CREDIT

ALL CREDITS UNDER UCPDC DEEMED TO BE IRREVOCABLE UNLESS OTHERWISE SPECIFIED

SIGHT/ PAYMENT

WHERE THE OPENING BANK AND/OR CONFIRMING BANK UNDERTAKES TO PAY ON THE PRESENTATION OF CONFORMING DOCUMENTS

IT ALSO ALLOWS THE CONFIRMING OR NOMINATED BANK TO DEBIT THE ACCOUNT OF THE OPENING BANK

USANCE/ ACCEPTANCE

WHERE THE UNDERTAKING IS TO PAY AFTER A CERTAIN PERIOD AS DEFINED IN THE CREDIT ITSELF

TO ACCEPT DRAFTS, WHERE CALLED FOR, DRAWN ON THE OPENING BANK AND TO PAY THEM ON MATURITY

WITH/WITHOUT RECOURSE L/C

In “with recourse” letter of credit, if the buyer fails to pay bank after the specified period the bank can have recourse on the exporter.

There is no such provision in the “without recourse” letter of credit.

CHECKLIST FOR BANKSFull Set Original is PresentedNot a Charter Party- Unless PermittedConsignee as per terms of CreditProper Endorsement as RequiredName of the Shipper or its AgentName and Address if any of Notifying

PartyDescription of Goods as per CreditUnclaused and Freight Details

CHECKLIST FOR BANKSShipping and Presentation of

documents within specified time

Documents are consistent with each other

Material Alterations/ Corrections are properly authenticated

BANK’S OBLIGATION & RESPONSIBILITIES

Issuing Bank (opening bank)( UCP Article 7)

-the prime obligator-to ensure credit-worthiness and trust-worthiness of the applicant- Once credit is opened, the bank is placing itself as a substitute for the buyer.

BANK’S OBLIGATION & RESPONSIBILITIES

Advising Bank has the obligation to authenticate the credit once it is received and passing it promptly on to the beneficiary ( Art.9).

Confirming Bank takes over the responsibilities of the issuing bank as far as the beneficiary is concerned though it has got recourse to the Issuing Bank (Art 8).

BANK’S OBLIGATION & RESPONSIBILITIES

Negotiating Bankto examine docs. Within 5 banking days

after receipt of the documents at their counters(Art 14b).

to ensure compliance of credit terms ( on the basis of documents alone) as well as consistency of docs with each other.

PROTECTION TO BANKSBanks are not responsible :for the genuineness or contents of any

documents submitted (Art. 34)For losses etc. arising from transmission

problems (Art. 35)Force Majeure ( Art. 36)For the failings of their correspondent Banks

(Art. 37)

PROTECTION TO BANKS

Issuing Bank is responsible for all Bank charges and other costs at home or abroad even if they are supposed to be paid by other party (Art. 37 c).

Applicant is responsible for any adverse consequences of foreign laws (Art. 37d).

RISKS IN LETTER OF CREDIT1) FINANCIAL STANDING OF THE BUYER

In letter of credit the issuing bank primarily guarantees to pay on behalf of the buyer on fulfillment of certain conditions. Thereby the bank has to look to the buyer to pay the bills drawn under L/C and should be sure that the latter has or will have the funds to pay.

RISKS …

2) THE GOODS

Trade finance is supposed to be self-liquidating and the goods ust be readily saleable. Consideration should also be given to the risks associated with perishability of the goods, possible obsolescence, import regulations, packing and storage, etc.

RISKS….

3) THE STATUS OF SELLER

Although bank deals with documents but there is always the risk that an errant seller could ship sub-standard goods, and one always guards against this by finding out as much as possible about the seller using status reports and other confidential information from banks or rating agencies.

RISKS…. 4) COUNTRY RISK

The factors usually associated with this type of risk are the political and economic stability of a country, exchange controls etc.

INCOTERMS ICC Rules 2010 (w.e.f. 1/1/2011)

EXW - Ex Works (Any Mode) FCA - Free Carrier (Any Mode)CPT - Carriage Paid To (Any Mode)FOB - Free On Board (Sea, inland water)CFR - Cost and Freight (Sea, inland

water)CIF - Cost Insurance Freight (Sea, inland water)CIP - Carriage and Insurance Paid to (Any

Mode) DAP - Delivered at Place (Any Mode) DDP - Delivered Duty Paid (Any Mode)

IMPORTANT PROVISIONS GOVERING LETTER OF CREDIT

ARTICLE NO. 1:

THE UNIFORM CUSTOMS AND PRACTICE FOR DOCUMENTARY CREDITS 2007 REVISION.

ICC PUBLICATION NO. 600 APPLY TO ANY DOCUMENTARY CREDIT WHEN THE TEXT OF THE CREDIT EXPRESSLY INDICATE THE SAME.

ARTICLE NO.4 :

A CREDIT BY NATURE IS A SEPARATE TRANSACTION FROM THE SALE OR OTHER CONTRACT ON WHICH IT MAY BE BASED.

ARTICLE NO.6

CREDIT MUST STATE THE BANK WHICH IT IS AVAILABLE WITH.

CREDIT MUST STATE WHETHER PAYABLE ON SIGHT/DEFFERED PAYMENT OR ACCEPTANCE OR NEGOTITATION.

CONTINUED..

….CONTINUED

A CREDIT MUST NOT BE ISSUED AVAILABLE BY DRAFT DRAWN ON APPLICANT.

A CREDIT MUST HAVE AN EXPIRY DATE FOR PRESENTATION AND NEGOTIATION.

ARTICLE NO. 14

A NOMINATED BANK COMPLYING AS A NOMINATED BANK ON THE BASIS OF THE DOCUMENTS ALONE COMPLY , WHETHER OR NOT THE DOCUMENTS APPEAR ON THEIR A FACE TO CONTITUTE A COMPLYING PRESENTTION.

ARTICLE NO.9

A CREDIT AND ANY AMENDMENT MAY BE ADVISED TO A BENEFICIARY THROUGH AN ADVISING BANK, WHO SIGNIFIES THAT IT HAS SATISFIED ITSELF AS TO THE APPARENT AUTHETICITY OF THE CREDIT AND THAT THE ADVISE ACCURATELY REFLECTS THE TERMS AND CONDITIONS OF THE CREDIT RECEIVED.

ARTICLE NO. 16

IF THE NOMINATED BANK AS NOMINATED FOR NEGOTITAION OF THE DOCUMENTS DETERMINES THAT THE PRESENTATION DOES NOT COMPLY WITH THE CREDIT, MAY REFUSE TO HONOUR OR NEGOTIATE THE DOCUMENTS.

ARTICLE NO. 17

AT LEAST ONE ORIGINAL OF EACH DOCUMENT STIPULATED IN THE CREDIT MUST BE PRESENTED.

ARTICLE NO. 30

THERE MAY BE A TOLERANCE NOT TO EXCEED 10% MORE OR LESS THAN THE AMOUNT.

A TOLERANCE NOT EXCEED 5% MORE OR LESS THAN THE QUANTITY OF GOODS IS ALLOWED.

ARTICLE NO. 33

A BANK HAS NO OBLIGATION TO ACCEPT A PRESENTATION OUTSIDE OF ITS BANKING HOURS.

ARTICLE NO. 35

A BANK ASSUMES NO LIABILITY OR RESPONSIBILITY FOR THE CONSEQUENCES ARISING OUT OF DELAY, LOSS IN TRANSIT OR OTHER ERRORS ARISING OUT IN THE TRANSMISSION OF ANY MESSAGES OR DELIVERY OF L/C.

ARTICLE NO. 36

A BANK ASSUMES NO LIABILITY OR RESPONSIBILTY FOR THE CONSEQUENCES ARISING OUT OF INTERRUPTION OF ITS BUSINESS BY THE ACT OF GOD, RIOTS, CIVIL COMMOTIONS, WAR,ACTS OF TERRORISM, STRIKES OR LOCKOUTS,ETC.