Elite Loan Capital | How it Works

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How It Works

A business called the InCosmetika from time to time imports goods from a business called BLISS, which banks with the ABC Bank. InCosmetika holds an account at the Commonwealth Bank. InCosmetika wants to buy $500,000 worth of merchandise from BLISS, who agrees to sell the goods and give InCosmetika 60 days to pay for them, on the condition that they are provided with a 90-day LC for the full amount. The steps to get the letter of credit would be as follows:

InCosmetika goes to the Commonwealth Bank and requests a $500,000 letter of credit, with BLISS as the beneficiary.
The Commonwealth Bank can issue a Letter of Credit either on approval of a standard loan underwriting process or by InCosmetika funding it directly with a deposit of $500,000 plus fees which are typically between 8% and 10% of the face value of the LC.
The Commonwealth Bank sends a copy of the LC to the ABC Bank, which notifies BLISS that payment is available and they can ship the merchandise inCosmetika has ordered with the full assurance of payment to them.
On presentation of the stipulated documents in the letter of credit and compliance with the terms of conditions of the letter of credit, the Commonwealth Bank transfers the $500,000 to the ABC Bank, which then credits the account of BLISS for that amount.
Note that banks deal only with documents required in the letter of credit and not the underlying transaction.

Many exporters have mistakenly understood that the payment is guaranteed after receiving the LC. The issuing bank is obligated to pay under the letter of credit only when the stipulated documents are presented and the terms and conditions of the letter of credit have been met.

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Basic Procedures for Establishing a Letter of Credit

The letter of credit process has been standardized by a set of rules published by the International Chamber of Commerce (ICC). These rules are called the Uniform Customs and Practice for Documentary Credits (UCP) and are contained in ICC Publication No. 500. The following is the basic set of steps used in a letter of credit transaction. Specific letter of credit transactions follow somewhat different procedures.

After the buyer and seller agree on the terms of a sale, the buyer arranges for his bank to open a letter of credit in favor of the seller. Note: The buyer will need to have a line of credit established at the bank or provide cash collateral for the amount of the letter of credit. The buyer's issuing bank prepares the letter of credit, including all the buyer's instructions to the seller concerning shipment and required documentation. The buyer's bank sends the letter of credit to the seller's advising bank. The seller's advising bank forwards the letter of credit to the seller. The seller carefully reviews all conditions stipulated in the letter of credit. If the seller cannot comply with any of the provisions, it will ask the buyer to amend the letter of credit.

After final terms are agreed upon, the seller ships the goods to the appropriate port or location.

After shipping the goods, the seller obtains the required documents. Please note that the seller may have to obtain some documents prior to shipment. The seller presents the documents to its advising bank along with a draft for payment. The seller's advising bank reviews the documents. If they are in order, it will forward them to the buyer's issuing bank. If a confirmed letter of credit, the advising bank will pay the seller (cash or a bankers' acceptance).

Once the buyer's issuing bank receives and reviews the documents, it either (1) pays if there are no discrepancies; or (2) forwards the documents to the buyer if there are discrepancies for its review and approval.

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Please call us to discuss your needs. We have many options available that are not listed on our site.

Types

There are two basic forms of letters of credit: Standby and Documentary.

Documentary letters of credit can be either Revocable or Irrevocable, although the first is extremely rare. Irrevocable letters of credit can be Confirmed or Not Confirmed.

Each type of credit has advantages and disadvantages for the buyer and for the seller, which this information we will review below.

Charges for each type will also vary. However, the more the banks assume risk by guaranteeing payment, the more they will charge for providing the service.

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Documentary Revocable Letter of Credit

Revocable credits may be modified or even canceled by the buyer without notice to the seller.

Therefore, the Revocable credits are generally unacceptable to the seller.

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Documentary Irrevocable Letter of Credit

Documentary Irrevocable Letter of Credit is the most common form of credit used in international trade. Irrevocable credits may not be modified or canceled by the buyer. The buyer's issuing bank must follow through with payment to the seller so long as the seller complies with the conditions listed in the letter of credit. Changes in the credit must be approved by both the buyer and the seller.

If the documentary letter of credit does not mention whether it is revocable or irrevocable, it automatically defaults to irrevocable. See Credit Administration, Sample Procedure for Administration of a Documentary Irrevocable Letter of Credit for a systematic procedure for establishing an irrevocable letter of credit.

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Please call us to discuss your needs. We have many options available that are not listed on our site.

Two Forms of Irrevocable Credit

Unconfirmed credit (the irrevocable credit not confirmed by the advising bank) - In an unconfirmed credit, the buyer's bank issuing the credit is the only party responsible for payment to the seller. The seller's advising bank pays only after receiving payment from the issuing bank. The seller's advising bank merely acts on behalf of the issuing bank and, therefore, incurs no risk.

Confirmed credit (the irrevocable confirmed credit) - In a confirmed credit, the advising bank adds its guarantee to pay the seller to that of the buyer's issuing bank. Once the advising bank reviews and confirms that all documentary requirements are met, it will pay the seller. The advising bank will then look to the issuing bank for payment. Confirmed Irrevocable letters of credit are used when trading in a high-risk area where war or social, political, or financial instability are real threats. Also common when the seller is unfamiliar with the bank issuing the letter of credit or when the seller needs to use the confirmed letter of credit to obtain financing from its bank to fill the order. A confirmed credit is more expensive because the bank has added liability.

Please call us to discuss your needs. We have many options available that are not listed on our site.