LETTER OF CREDIT

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• LETTER OF CREDIT

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LETTER OF CREDIT /DOCUMENTARY CREDIT

• Letter of Credit is an undertaking issued by a
  Bank (Issuing Bank), on behalf of the buyer (the
  importer), to the seller (exporter) to pay for
  goods and services provided that the seller
  presents documents which comply with the terms
  and conditions of the Letter of Credit

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LETTER OF CREDIT

• UCPDC 600 Edition effective from 1st July
  2007
• Documentary Credit means any arrangement that is
  irrevocable and thereby constitutes a definite
  undertaking of the issuing bank to honour a
  complying presentation.

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• Complying presentation
• a presentation that is in accordance with
• the terms and conditions of the credit,
• the applicable provisions of these rules (UCP
  600) and
• international standard banking practice.

Honour a. to pay at sight if the credit is
available by sight payment. b. to incur a
deferred payment undertaking and pay at maturity
if the credit is available by deferred
payment. c. to accept a bill of exchange
("draft") drawn by the beneficiary and pay at
maturity if the credit is available by
acceptance.
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LETTER OF CREDIT

• Three main contracts underlying LC
• - Sale Contract between Buyer Seller
• - Application-cum-Guarantee between
  Applicant(Buyer) and Issuing Bank
• - LC itself (contract between Issuing
  Bank and Beneficiary/Seller)
• ( LC independent of other two contracts)

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Mechanics of Documentary Credit
CONTRACT
GOODS
DOCS
DOCS
Advising bank
Negotiating Bank/ Confirming Bank
Reimbursing Bank
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Parties to Letter of Credit

• Opener/Buyer
• Issuing Bank
• Advising Bank
• Beneficiary/Seller
• Nominated Bank/Negotiating Bank
• Confirming Bank
• Reimbursing Bank

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Documents under Credit

• Financial documents Drafts
  (ISBP Para 43 to 56)
• Transport documents BL, AWB etc
• (UCP Articles 19 to 27, ISBP Para 68 to 169)
• Insurance documents Certificate/ policy
  
• (UCP Article 28, ISBP Para 170 to 180)
• Commercial documents Invoices
  
• (UCP Article 18, ISBP Para 57 to 67)
• Miscellaneous documents All other documents
• Certificate of origin, Packing list, Quality
  certificate etc.
• Documents other than invoices, transport and
  insurance documents are not defined by UCPDC
• Only Certificate of Origin dealt with under ISBP
  Para 181 to 185

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Types of credit

• Security to beneficiary
• Confirmed
• Mode of settlement
• Payment/ deferred payment
• Acceptance
• Negotiation
• Involving middlemen
• Transferable
• Back to back
• Involving advances
• Red Clause Credit
• Green Clause Credit
• Involving repeated transactions
• Revolving
• Stand by

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Transferable Credits

• Credit has to be opened as transferable
• The beneficiary is normally a trader or agent
• He transfers credit to his supplier - second
  beneficiary.
• Transferred by a bank at the request of first
  beneficiary
• Second beneficiary can supply goods and negotiate
  documents as if he had received the credit.
• He may pay commission to first beneficiary for
  the order
• There can be more than one second beneficiary.
• No third beneficiary is permitted.

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Transferable Credits

• The following parameters may be changed while
  transferring a credit
• Amount of credit, unit price and quantity of
  goods
• Date of expiry, last date of shipment and last
  date of negotiation can be brought forward
• of insurance cover may be increased.
• First beneficiary has the right to substitute
  documents negotiated by second beneficiary.

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Back to Back Credits

• Exporter receives a credit from his buyer (
  Selling credit)
• He has to procure goods from other suppliers
• He opens a credit for purchase of the goods (
  buying credit)
• Second credit is said to be back to back to the
  first one.
• Bill proceeds of the export LC (Selling LC) will
  be used to meet liabilities under the second
  (Buying LC)
• Amount of back to back credit will be lower.
• Usance period of the back to back credit should
  be equal to or more than that of the export
  credit.
• Bank still at risk if the customer fails to
  export
• No concession in margin and security norms.

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Revolving Credits

• Credit is opened to cover a series of regular
  transactions over a longer period
• Beneficiary will submit a series of documents
• Maximum value of each document will be fixed and
  is the revolving limit
• LC amount is the maximum value of documents that
  can be handled under the credit.
• The credit may be reinstated automatically or
  after payment of earlier bill.
• It can be opened as cumulative or non cumulative.

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Standby Letters of Credit

• Credit is issued for a particular amount and for
  a particular period
• Trade takes place on running account basis.
• Beneficiary does not submit documents to bank.
• If there is a default, he can claim funds from
  opening bank giving a certificate of default
• No quibbling over discrepancies and documents
• Opening bank will pay on demand
• Works like a bank guarantee
• UCPDC is applicable if so declared in the credit

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LC Regulations

• Foreign Trade Policy requirements.
• FEMA requirements.
• Credit norms of Central Bank.
• UCPDC 600 Provisions.
• Banks Internal Credit Policies/ procedures.
• Public notices issued by DGFT
• Uniform Rules for bank-to-bank reimbursements 525
• Incoterms 2010

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Banks 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.

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Banks 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).

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Banks Obligation Responsibilities

• Negotiating Bank
• to 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.

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Protection to Banks

• Banks 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)

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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).

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LETTER OF CREDITAppraisal / Assessment

• satisfactory track record.
• dealings with only one bank.
• Liabilities of the applicant to the Bank and
  third parties.
• Means by which the applicant is expected to meet
  his commitment once the bills arrive.
• Margin he should deposit.

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Appraisal Issues..

• Limit to be commensurate with turnover and CC
  limits.
• Should be for genuine trade/ manufacturing
  activity.
• Usance period of the LC should ordinarily have
  relation to the working capital cycle.
• Level of inventory carried should be commensurate
  with industry norms / past trends.

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Appraisal Issues.

• LCs for purchase of machinery / capital goods
  should be backed by borrowers own funds or a
  term loan sanctioned for the purpose.
• Wherever warranted, in addition to margin, where
  prescribed, we may also retain a lien on the
  undrawn portion of the CC limit for the value of
  bills to be received under the LC.

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Appraisal Issues

• Sister concerns
• Where the opener and beneficiary are sister
  concerns, LCs should not normally be necessary.
• Take care of kite-flying operations.
• Standing of the beneficiary.
• D/A facilities to applicants of undoubted
  standing and where security available is much
  more than the value of LC.

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Appraisal Issues

• While computing purchase of imported material on
  LC basis take net of import duty.
• Assess limits for usance and sight LC separately.
• Usance period should not exceed the production
  cycle excepting in the case of bulk imports.
• Keep in mind the accepted projections regarding
  Sundry Creditor levels.
• Margins security depending on track record.
• Cash budget monitoring to track availability of
  funds.

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Appraisal Issues.

• Revolving LCs
• To be valid for not more than 1 year
• The limit should be a sub-limit.
• The LC value should be restored for further
  negotiation only after the advice of retirement
  of the previous bill has been received from the
  issuing bank by the beneficiary bank.

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ASSESSMENT OF LC LIMIT

• While assessing Letter of Credit Limit, the
  following points need to be noted
• Purchases of RM on LC basis should be net of
  Import Duty LC amount should cover FOB, CIF or
  CF value of goods- should not include customs
  duty and other charges payable in India. Payment
  of these charges should be taken care of by the
  main working capital(CC) A/C of Applicant.
• Transit time should be treated as Nil if usance
  period starts from shipment date.

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Other issues

• Arriving at D.P
• Ensure that the stocks covered by bills which
  have been received under LCs opened by us, and
  not yet retired, are not included for computing
  the D.P. in CC account.
• Devolvement of LCs
• In case of irregularity in CC account do not open
  further LCs.
• Take adequate margins and step up in case of it
  becoming a habit in worse cases stop further
  issues.
• Mark lien on DP so that usance bills are properly
  retired on due date.

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Treatment of stocks covered by Usance LC

• Lien should be earmarked against advance value of
  stocks for the outstanding usance LC bills.
• This ensures provision of margins on the stocks
  covered by usance LCs right from the time the
  stocks are bought on credit backed by the Banks
  commitment.
• Thus, it ensures that the margin is available
  well before the CC a/c is debited for the matured
  LC bill.

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Treatment of stocks covered by Usance LC

• In some cases it is quite possible that the units
  may not be in a position to provide margins right
  from the time of purchases against LCs. In such
  cases, based on merits, earmarking of lien for
  the value of usance LC bills outstanding may be
  permitted against the aggregate market value of
  stocks (including the LC stocks) instead of
  against the advance value of securities.

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Precautions

• The limits for demand LCs and usance LCs should
  be assessed separately with ample justifications.
  
• The usance period should not, generally, exceed
  the production cycle.
• In case of bulk imports, establishment of LCs for
  longer usance period may be considered
  selectively.
• When liability under LC is met by creating an
  irregularity in the Cash Credit account, the
  relative LC limit should not be released for
  opening further LCs till the account is adjusted.
  
• Frequent Devolvement's Warning signal!

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Assessment of LC Limit

• We assume that
• - Annual consumption of material to be
  purchased under LC C (Rs..)
• Lead time from opening LC to
• shipment
  L (months)
• - Transit time
  T (months)
• - Credit (usance) period available U (months)
  

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Assessment of LC Limit

• L T U Purchase Cycle P (months)
• LC Limit P x C/12
• Say, lead time, i.e. time from order
  placement to shipment
  10 days
• Transit period
  20 days
• Usance period from arrival of goods 3m
• Total Purchase Cycle
  4m
• Monthly consumption of material Rs 100
  lacs
• LC Limit(4 x 100) Rs 400 lacs
  

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ASSESSMENT OF LC LIMIT

• M/s XYZ COMPANY LIMITED
• LETTER OF CREDIT LIMIT OF Rs. 20 CRORES
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  (Rs. in crores)

Total purchase of Raw Materials (RM) 172.64
Purchase of RM under LC 69.41
Average monthly purchase of RM A 5.78
Average usance period B 3 months
Lead time transit period C 1 month
Total of B C D 4 months
Requirement of LC Limit A x D 23.12
LC Limit recommended 20.00
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Assessment of LC Limit

• Let us assume as follows (Rs in lacs)
• i) Annual purchase of RM 3200
• ii) RM purchase under LC(50) 1600
• iii) Purchase under demand LC 800
• iv) Purchase under usance LC 800

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Assessment of Demand LC Limit

• Time gap from opening till shipment 1 m
• Transit period from date of shipment
• till date of retirement
  0.5 m
• Demand LC Limit 800 x 1.5/12 Rs 100 lacs
• 
  

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Assessment of Usance LC Limit

• Lead Time, i.e from opening
  LC till shipment
  1 month
• Transit Period, i.e. from date
• of shipment till date of receipt of documents
  by importer
  0.5 months
• Average usance period 2 months
• Usance LC Limit 800x3.5/12 Rs 233 lacs

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THANK YOU