All About Letter of Credit and How It Helps Exporters

Q: What is a letter of credit?

A letter of credit (LC) is a financial instrument that the buyer provides to a seller as a guarantee for payment once the goods or services are delivered, subject to the conditions outlined in the LC. Sellers often request an LC when the deal is significant, represents a certain risk to the seller, and the initial capital outlay is substantial.

Q: What is the process for obtaining an LC?

-> Transaction agreement -> Applying for the LC -> LC issuance -> Accepting and notifying -> Document submission -> Verifying documents -> Disbursing payment

As an exporter, one of the biggest concerns that will continue to affect you is proper financial management to ensure seamless international payments to India. This means streamlining your collections process with the right inward remittance platform to ensure speed, transparency, statutory compliance, and finding suitable financial instruments.

Often, in international transactions, you will need payment assurance. This is where a letter of credit or LC comes in. To understand the role of LC, we need to understand what a letter of credit is.

Related topics: Learn what role an LC can play in getting your business a working capital loan, bill discounting, or other trade finance solution.

What is a letter of credit?

The answer to the question of what is a letter of credit is that a letter of credit (LC) is a financial instrument that the buyer provides to a seller as a guarantee for payment once the goods or services are delivered, subject to the conditions outlined in the LC. Sellers often request an LC when the deal is significant, represents a certain risk to the seller, and the initial capital outlay is substantial.

Who issues the letter of credit?

If you are wondering who issues the letter of credit, then it is the bank or financial institution where the buyer has an account or is dealing with issues of the letter of credit. Letters of credit are generally issued for domestic and international transactions. The purpose of the LC is to secure both the seller and the buyer. The buyer is assured of the quality and quantity of the goods or services they have tied up with the seller for. It ensures that the seller is bound by the conditions outlined in the LC.

For the seller, the LC is an assurance that the buyer will pay the amount due once the goods or services are delivered as per the LC conditions. As an exporter, an LC can provide added confidence when dealing with a first-time buyer and across the border.

What are the various components of a letter of credit?

The letter of credit can have the following entities involved:

1. Applicant: This is the buyer who has requested the LC to be issued by the bank

2. Beneficiary: This is the seller who will get the payment guaranteed under the LC

3. Bank issuing: Buyer’s bank that issues the letter of credit

4. Bank advising: Seller’s bank liaises with the issuing bank, the applicant, and the beneficiary about the LC

What is the process for obtaining an LC?

1. Transaction agreement: The seller and buyer negotiate, agree, and formalize the transaction for sale. They also agree that the transaction will be conducted using an LC.

2. Applying for the LC: The buyer will contact their bank and request an LC be issued under their specified terms and conditions.

3. LC issuance: The issuing bank (the buyer’s bank) will review the terms and issue an LC to the advising bank.

4. Accepting and notifying: The advising bank will receive the LC and contact the seller about it and its terms.

5. Document submission: The seller will submit supporting documents for the transaction, including invoices, shipping papers, and other related papers to their bank.

6. Verifying documents: The issuing bank will evaluate and validate the documents to ensure they meet the terms and conditions of the LC.

7. Disbursing payment: Once all the checks are completed according to the issuing bank’s terms and conditions, payment will be released to the seller.

What are the benefits of a letter of credit?

The letter of credit has many benefits, especially in the export trade. From the seller’s point of view, payment is guaranteed when they complete the delivery as per the terms and conditions of the LC.

● Also Read: What are the Different types of letter of credit?

Moreover, the LC can also be leveraged to obtain short-term finance to keep the business running if necessary.

From the buyer’s point of view, the LC formalizes the terms and conditions of the contract. This, in turn, ensures that the seller understands their obligations for the quality, quantity, and timing of the goods or services to be delivered.

A letter of credit can mitigate concerns around risk and uncertainty about international trade for both parties involved in the transaction.

What are the guidelines that govern the letters of credit?

Apart from the standard rules the issuing bank follows, the International Chamber of Commerce (ICC) has a set of standardized rules that regulate the worldwide use of letters of credit.

What are the risks related to a letter of credit?

If the seller cannot provide the bank with documents that completely match the terms of the letter of credit, the seller risks non-payment. Moreover, the costs and fees associated with a letter of credit can also become a concern in some cases. Some business people feel that the process of getting an LC is complicated and can delay the transaction.

As you can see from the details above, letters of credit can play a critical role in the export business. At LeRemitt, our team is working constantly to ensure that we support your export business in our way. We provide you with a technologically-advanced platform to speed up the inward remittance process. Click here to get in touch with our team.