Benefits of LCs

Letters of Credit offer certain advantages to both the exporters and the
importers. These are explained below:
To exporters
• LC minimizes the credit risk provided the issuing bank is reputed
and carries a sound track record.
• LC eliminates risk of payment delays due to uncertain factors like
political instability.
• LC affords financing for the exporter. All nationalized banks in India
are more than willing to finance an exporter who has an export
order backed by an LC from a reputed foreign bank.
• LC normally will have a stabilizing effect on production by the
exporter as the exporter is bound to ship by a certain date as per
the LC, failing which the order will stand cancelled.
• LC minimizes uncertainty and provides a clear picture to the
exporter regarding all the requirements for payments.
To importers
• The importer placing orders on exporters backed by LCs commands
a great respect and bargaining power. He is in a position to ask for
better prices and faster deliveries.
• Use of LCs will attract a large number of goods suppliers offering
the importer a lot of choice.
• The importer is assured of timely shipment of the specified quality
and quantity of ordered merchandise. Documents under LC like on-
board Bill of Lading (B/L) and Inspection Certificate by a buyer
nominated agency will serve this purpose well.
• The importer can refuse payment if he finds any and even a very
minor mistake/oversight (referred to as a Document Discrepancy) in
any of the required documents. This affords him a very tight control
over the exporter, ensuring accuracy of shipment and related
paperwork.
• Importer’s risk of losing money in case the supplier is unable or
unwilling to effect a proper shipment is totally eliminated.
Types of LCs
Documentary and Clean LCs: A documentary LC is the one that requires
the exporter to submit certain documents like commercial invoice,
packing list, customs invoice, inspection certificate, certificate of
origin, etc. together with the draft to the issuing bank. A clean LC, on
the other hand, is the one that does not require presentation of any
documents. Clean LCs are normally used for escrow arrangements and
bank guarantees.

Revocable and irrevocable LCs: An LC is revocable when it is used only

as a means of arranging payment and carries no guarantee. It can be
withdrawn without any notice at any time up to the time of
presentation of drafts under LC for payment to the issuing bank. An
irrevocable LC, to the contrary, carries both a payment arrangement
and guarantee of payment and therefore, cannot be revoked without
the consent of all parties involved including the exporter. Most
international transactions use irrevocable LCs.
Confirmed and Unconfirmed LCs: A letter of credit may be
confirmed or unconfirmed. A confirmed letter creates
obligations on both the issuing as well as confirming bank to
honour the commitment under the LC. In fact, it works as a
double protection for the beneficiary. An unconfirmed LC
creates this obligation only on the issuing bank.
The confirming bank could either be a local bank in the
country of the exporter or a foreign bank, depending on the
arrangements that the issuing bank has. The issuing bank
issues the LC and another bank confirms it. Thus, both these
banks undertake to comply with the provisions of the LC.
Special LCs

• Revolving LCs are those where the maturity period or the

amount prescribed automatically gets renewed subject to the
mutually agreed terms and conditions at the time of setting
up of the LC under the export contract.
Revolving LCs can be of two types—Cumulative and Non-
Cumulative.
Cumulative revolving LCs will automatically apply/add the
unutilized amount during a given time and the same will be
carried over to the next period.
Non-cumulative LCs will consider the unutilized amount in a
given time as lapsed and will not add this to be carried over to
the next period.
• Transferable LCs are those under which beneficiary is given
the right to transfer the benefits available under the LCs to
one or more secondary beneficiary. No LC can be transferred
unless it specifically authorizes the beneficiary to do so. The
LC itself has to contain transferability clause.
The exporter can use the LC transfer to enable his suppliers
to raise working capital on the strength of the LC. This saves
him from the entire process of arranging finance to pay his
suppliers to buy goods from them.

• Back-to-Back LCs are those where exporters are able to use

the original LC as a cover to open another LC in favour of
their local suppliers. The original LC serves as a security to
the bank issuing the back-to-back LC in favour of the
exporter’s suppliers. This arrangement is quite convenient as
the exporter is able to use his buyer’s credit to finance his
suppliers’ operations.
Useful tips to exporters regarding LCs
I. Always go for an irrevocable, confirmed LC issued by a prime bank.
II. Ensure that the LC is transferable and allows transshipments.
III. Before the LC is actually opened, please ask the importer to fax you a
draft. Go through the draft yourself carefully covering the following
points:
• The names and addresses are correct and complete.
• The description and quantity of goods are correct.
• Terms of Shipment like FOB/C&F/CIF are stated and are as agreed upon.
• The price per unit is correct and is the same as in the export order.
• The total amount is correct.
• The LC currency is correct and is as agreed upon.
• Partial shipments are allowed (if agreed upon)
• The last date of shipment is as agreed upon.
• The expiry date of the LC allows sufficient time for presentation of
documents to the bank.
• The documents required are understood and compliance thereof is
possible.
• Inspection agency is correctly specified and is the same as agreed upon.
• All other terms and conditions are same as agreed upon and can be
fulfilled without incurring additional expenses.
• Discrepancy charges are clearly mentioned.
• Charges for the buyer and the exporter are clearly demarcated.
• Penalty, if any, for delays in shipment is clearly spelt out.
• Finally, the LC must conform to UCP 500 of the ICC and be governed by its
provisions.

IV. The exporter must also show this draft to his banker and the C&F agent to
make sure that no unusual conditions are present and that everything is in
order.

V. This exercise is important because any changes in an LC(known as

Amendment) once it is established, is very difficult to make and carries high
bank charges at the buyer’s end. Certainly, this will not please the buyer at
all. So the exporter must ask for any changes at this stages itself.