How is a letter of credit helpful in an import and export business?

Overview of How the Letter of credit helpful in an Import and export business

A letter of credit is a type of financial contract in which a bank guarantees a seller that the payment of the buyer will be received on time with the correct amount. This credit letter is issued by the bank of the importer and this contract is between a bank, a bank’s customer, or the client of the bank and an exporter or beneficiary. This letter of credit guarantees the seller about the buyer’s correct amount of payment once the credit conditions have been met. 

In case the payment of the purchase is not made by the buyer, then the bank is responsible to cover the amount of the purchase. This amount can be either full or remaining purchase amount, this amount is offered by the bank as a facility meaning in the form of financial assistance that is in the form of a loan. 

The letter of credit plays an important role in international trade. International dealing is based on many factors such as distance, variation of law, and not being aware of each country’s party, under such an unknown atmosphere the use of letters of credit is very beneficial. 

Read More: Everything you need to know about credit score

Working on the Letter of Credit in the import-export business

The letter of credit is needed by the major purchase buyers who want to assure the seller about the payment. This letter of credit is issued by the bank guaranteeing the seller’s payment, or in a nutshell, the bank takes responsibility for the payment of the seller, and the seller will be paid. Before making this financial contract the buyers need to prove their assets or credit sufficiency to the bank, only then the bank guarantees the seller for its correct payment. The letters of credit are supervised by the International Chamber of Commerce’s Uniform Customs and also Practises for Documentary Credit oversees it.

The payment conditions are outlined by the letter of credit under which the seller pays to an exporter. The bank that is in charge of issuing the credit letter takes responsibility for the buyer and will ensure that all the necessary conditions have been met before releasing the funds from the seller. 

The letter of credit involves the bank, the client of the bank, or the bank’s customer who is the importer or we can say who is the buyer of the goods and it involves the exporter or beneficiary or we can say the supplier of the goods. All of them are in the letter of credit contract. 

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Usage of the Letter of Credit in import-export Business 

The letter of credit is used to minimize the risk of international trade transactions because in import export business the buyers and the sellers do not know each other personally. 

For an importer the letter of credit acts like an evidence of shipping, this credit letter ensures that the import company only pays for the supplier after the exporter provides the evidence of the goods and services that have been shipped. It also saves the importer from different cash flow, because the importer does need not to pay any kind of advance or deposits to the exporters. Additionally, it also makes an importer creditworthy in the eyes of the exporter. 

For an exporter, the letter of credit acts as insurance, and the exporter uses it as evidence in case the payment of shipped goods is not made. If the buyer fails to make payment the amount of the exporter that is outstanding will be covered by the financial institution. The credit letter also minimizes your legal risk and protects you from unpaid credit since you are sure that once the delivery conditions meet your payment will be made. 

Read More: How to get LUT, and how will it benefit an exporter?

Types of Letters of Credit 

Sight Credit Letter 

Sight credit letters are available immediately, it is famous for being the most instant credit letter, hence this type of credit letter is more immediate than other credit letterforms. Under this LC the entrepreneur or a businessman can present a bill of exchange plus a sight letter to the lender and can get the funds right away with the help of a letter of sight. 

In order to make the payment at sight, the credit on sight requires the advising bank or seller’s bank. The documents are submitted by the seller as per the rules and regulations of the credit on sight. Once the verification is completed by the bank, the due payment is immediately released by the bank to the supplier. 

Time Credit Letter 

In time credit letters a certain time period is involved, this type of letter of credit is also known as usance credit letter. It is a kind of document guaranteeing the exporter that he will receive the buyer’s full payment on time. This guarantee in this process is the bank that pays the bills of exchange once the terms are met. A time credit letter is a process of exchange of bills that are paid after a period between the lender and the borrower. 

Time of credit gives a time advantage to the company, meaning if the supplier provides the company with the material, after receiving the material the company will get the bill of material with the shipment of goods. But the company can pay the bill after a certain time period that is involved in the credit letter, this time period marks the time for the Sale. 

Revocable Credit Letter 

Revocable Letter Credit is a type of letter credit in which there is a procedure of amending or cancellation of terms and conditions by the issuing bank. This amendment can be done by the issuing bank without telling or noticing the beneficiaries. But the reverse is the case in irrevocable credit, in irrevocable Letter credit no amendments or cancellation is possible, in this letter credit the bank is bound by the letter Credit commitments. The issuing bank can not disobey the letter credit commitments or direction. 

Transferable Credit Letter 

This is another type of Letter of Credit in India, this letter of credit deals with the transfer of credit. The exporter can transfer the right to a third party or parties. The conditions can vary as per the type of industry and trade.

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Indian Banks Offering Letters of Credit 

In India, there are many different banks that provide the letter of credit, the names of the leading banks/NBFCs that are offering credit letters in India are 

  • State Bank of India or SBI Bank.
  • Industrial Credit and Investment.
  • Corporation of India or ICICI Bank.
  • Housing Development Finance Corporation Limited or HDFC Bank.
  • Axis Bank.
  • Kotak Mahindra Bank.
  • Lendingkart Finance.
  • Union Bank of India.
  • Bandhan Bank.
  • Industrial Development Bank of India Limited and many others. 
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Conclusion 

A letter of credit is very important in international trade and business. The Guidelines for any form of Letter of Credit are issued by the International Chambers of Commerce that is abbreviated as ICC. Issuing banks take necessary precautions before paying like they check the buyer’s name, the name of the product, the date of shipping, etc. Details in the letter should be correct if there is a slight mistake in the letter the bank will deny the payment. In India, there are different letters of credit that are used according to different circumstances.

Who are the parties involved in the letter of credit?

What are the different types of letters of credit in India?

What is the difference between Revocable Credit Letter and irrevocable Credit Letter?

What is the Usage of the Letter of Credit in the import-export business?

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