Letters of credit (L/C) are one of the most versatile and secure payment instruments available to you in international trade. A letter of credit is a commitment by the bank of the importer that payment will be made to you (exporter), once the terms and conditions stated in the letter of credit (L/C) have been met. Also referred to as drafts, L/Cs are used to help protect both the buyer and the seller.
What are the steps involved in a L/C (Letter of Credit) transaction?
After the exporter and the buyer have agreed on the terms of a sale, the importer arranges for its bank to open a letter of credit that specifies the documents needed for the payment.
The importer determines which documents will be required.
The importer’s bank issues its irrevocable letter of credit and includes all instructions to the exporter related to the shipment.
The importer’s bank sends its irrevocable letter of credit to the exporter's bank and requests confirmation. The exporter may request that a particular home country bank be the confirming bank, or the foreign bank may select an Indian correspondent bank.
The exporter's bank prepares a letter of confirmation to forward to the exporter, along with the irrevocable letter of credit.
The exporter carefully reviews all conditions in the letter of credit. The exporter’s freight forwarder is contacted to make sure that the shipping date can be met. If the exporter cannot comply with one or more of the conditions, the customer is alerted at once because an amendment may be necessary.
The exporter arranges with the freight forwarder to deliver the goods to the appropriate port or airport.
When the goods are loaded aboard the exporting carrier, the freight forwarder completes the necessary documentation.
The exporter (or the freight forwarder) presents the documents, evidencing full compliance with the letter of credit terms, to the exporter's bank.
The bank reviews the documents. If they are in order, the documents are sent to the importer’s bank for review and then transmitted to the importer.
The importer (or the importer’s agent) uses the documents to claim the goods.
A sight or time draft accompanies the letter of credit. A sight draft is paid on presentation; a time draft is paid within a specified time period.
When preparing quotations for prospective customers, you should keep in mind that banks pay only the amount specified in the letter of credit even if high charges for shipping, insurance, or other factors are incurred and documented. On receiving a letter of credit, you should carefully compare the letter’s terms with the terms of the proforma quotation. This step is extremely important because if the terms are not precisely met, the letter of credit may be invalid and you may not be paid.
Familiarize yourself with the different tools and options for the transmission of payment with Ximpex. We support MSME's in India venturing into the international market and overcoming the challenges faced during the process.
Author: Sachin Yadav Co-Author: Lisa Goel