Documentary Credit/Letter of Credit represents the most common form of a documentary financing.
A letter of credit is a document through which a bank substitutes its credit for that of another obligor. The basic structure of a letter of credit is a legally enforceable commitment by the “issuing bank” to pay money to a second party (known as the “beneficiary”) on behalf of a third party (known as the “account party” or “opener”).
The account party is the initiator of the transaction. Terms and conditions, upon which the bank’s obligation will be invoked, are specified in the letter of credit.
A letter of credit transaction involves three agreements:
· The Agreement between the account party and the beneficiary which gives rise to the use of a letter of credit;
· The Agreement between the account party and the issuing bank which spells out their mutual obligations, including that of the account party to reimburse the issuing bank when payments are made to the beneficiary in accordance with the terms of the letter of credit;
· The Agreement between the issuing bank and the beneficiary (in the body of the letter of credit) which specified the conditions that must be met before the payments will be made.
LETTERS OF CREDIT
Irrevocable Letter of Credit
An irrevocable letter of credit is a letter of credit that cannot be revoked once it has been issued. Almost all L/Cs used in the international trade are irrevocable.
Advised Letter of Credit
When the opening bank is in a different location from that of the beneficiary of a L/C, L/C will usually be sent to a bank (known as “advising bank”) in the beneficiary’s location with the request that the beneficiary of L/C be advised.
The advising bank gives the L/C to the beneficiary, with no responsibility on its part. It is the opening bank’s credit that the beneficiary is relying upon.
Confirmed Letter of Credit
When the seller is unwilling to rely on the credit of the opening bank (for whatever reason), he/she asks the buyer to request that the L/C be confirmed by a bank in the location whose credit seller is willing to rely upon.
The opening bank sends the L/C to a bank in the seller’s location requesting that bank to confirm the L/C to the seller. The confirming bank adds its confirmation (for a fee), thereby guaranteeing that it will pay if the terms of the L/C are met, regardless of the opening bank’s ability to pay.
Sight Letter of Credit
A sight letter of credit provides for payment to the beneficiary immediately upon his presentation of the documentsin conformity with the terms and conditions of the letter of credit or “at sight” of the documents.
APPLICATION FOR LETTER OF CREDIT
All applications for letters of credit must be made on our pre-printed form addressed to Bank. The application form is to be filled in properly and signed by the client, setting forth the terms under which the proposed commercial L/C will be issued. Signatures in the application must be verified.
The application must be completed in full giving all the required details and further cover the following points and enclose the required documentation.
The following are the only types of guarantees currently allowed to be given by the Bank.
· Bid Bond;
· Performance Bond;
· Advance payment guarantee;
· Customs guarantee;
· Payment (financial) guarantee.