How To Open a letter of credit

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

PEL goes to The HBL and requests a Rs. 500,000 letter of credit, with Jing Ji as the beneficiary.

The HBL can issue an LC either on approval of a standard loan underwriting process or by PEL funding it directly with a deposit of Rs. 500,000 plus fees which are typically between 1% and 8% of the face value of the LC.

The HBL sends a copy of the LC to the Bank of China, which notifies Jing Ji that payment, is available and they can ship the merchandise PEL 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 and conditions of the letter of credit, the HBL transfers the Rs. 500,000 to the Bank of China which then credits the account of Jing Ji 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 assumed 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.

Some of the Documents Called for under a LC Financial Documents

Bill of exchange Commercial Documents

Invoice Shipping Documents

Transport Document, Insurance Certificate Official Documents

License Transport Documents

Bill of Lading, Delivery challan etc

Parties to a Letter of Credit

The parties to a letter of credit transaction are as follows:

a. Issuing bank, The bank that issues the letter of credit.

b. Applicant i.e., the customer on whose behalf the letter of credit is issued. In relation to

export – import transaction, the customer is the importer.

c. Beneficiary i.e., the third party to whom the payment shall be made. In relation to

export- import transaction, the beneficiary is the exporter.

d. Negotiating bank i.e., the bank authorized to negotiate the documents stipulated in the

letter of credit.