How does Letter of Credit work?

Mechanism of Letter of Credit

LC is a common term used in all trade.    

• When talking of LC, there may have many questions among traders. 
• What is Letter of Credit? 
• How does Letter of Credit work? 
• How many types of LC are there? 
• How do these types of Letter of Credit work? 
• Which type of Letter of credit is safe for Exporter?  
• Which type of LC is safe for Importer? 
• How to provide credit period to buyer under Letter of Credit? 
• Can we get my products immediately up on shipping goods under Letter of Credit?

What is LC Letter of Credit in export import business?/ What is Letter of Credit?

Letter of credit is an assurance given by the buyer’s bank to remit the amount to the seller through seller’s bank on maturity, as per the terms and conditions of document based on the contractual agreement between buyer and seller. Now in simple words, If LC opened on your name as beneficiary, you will receive amount though the buyer’s bank (opening bank)  on the agreed time. All Letters of Credit for export import trade is handled under the guidelines of Uniform Customs and Practice of Documentary Credit of International Chamber of Commerce (UCP 600).  I know, the above explanation about Letter of Credit is not perfect. 

There are various types of letters of credit like Revocable, Irrevocable, Confirmed, Unconfirmed, Clean & Documentary, Fixed, Revolving, Transferable, Back to Back etc. Most common and safe LC is Irrevocable Letter of Credit for both buyer and seller.

When can exporter get money under LC?

As per the agreed terms between buyer and seller, the period of credit is decided. Based on such period of credit,  the time to effect payment by opening bank (buyer’s bank) is determined. 

What is Sight LC and how does LC at sight work?

Now let us discuss the mechanism of working LC at sight.  How does sight letter of credit work? 

Procedures to get money under Letter of Credit at sight.

Opening a Letter of Credit at sight is common practice in the export business. Under sight LC, the payment of export proceeds sent to seller’s bank by buyer’s bank immediately up on receipt of original shipping documents as per the terms and conditions mentioned on LC.

Once after completion of export customs clearance procedures, the exporter prepares all required documents as per the terms and conditions of letter of credit. These documents will be submitted with exporter’s bank, along with the original LC. Bank verifies all documents and make sure, the documentation is in order as per LC conditions. These documents will be sent to buyer’s bank and in turn to the buyer after necessary approval in documentation by seller’s bank. Once the buyer’s bank receives the documents, the export sales amount as per the said documents will be sent to exporter’s bank.   However, the documentation of each consignment must be as per the conditions of LC at sight and the buyer’s bank has the right to reject payment on any violation of such documentation.  This is the procedures under letter of credit at sight.

How long is the Credit period under Letter of Credit:

The credit period of LC can be determined my mutually agreed terms and condition by buyer and seller before sales takes place.

Some time, the foreign buyer may demand credit period of  30 days, 60 days, 90 days, 120 days etc. However as per government regulation, the total period of credit should not exceed more than 180 days.

Normally the credit period is calculated from the date of shipment.  The date of shipment is determined on the basis of date of bill of lading or airway bill.