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Issuing of Letter of Credit back
The documentary letter of credit (also known as a documentary credit) has been used for more than 150 years to facilitate trade by providing payment against presentation of documents relating to the transaction as specified in the credit.
What is a Letter of Credit ? :
A Letter of Credit is a written undertaking by the Importer’s bank, known as the Issuing Bank, on behalf of its customer, the Importer (Applicant), promising to effect payment in favor of the Exporter (Beneficiary) up to a stated sum of money, within a prescribed time limit and against stipulated documents. A key principle underlying Letters of Credit is that banks deal only in documents and not in goods. The decision to pay under a Letter of Credit will be based entirely on whether the documents presented to the bank appear on their face to be in accordance with the terms and conditions of the Letter of Credit. It would be prohibitive for the banks to physically check whether all merchandise has been shipped exactly as per each letter of Credit.
The documentary credit---letter of credit, documentary letter of credit, or commercial letter of credit--- is an arrangement whereby the applicant (the importer) requests and instructs the issuing bank (the importer's bank) or the issuing bank acting on its own behalf-
  • Pays the beneficiary (the exporter) or accepts and pays the draft (bill of exchange) drawn by the beneficiary, or
  • authorizes the advising bank or the nominated bank to pay the beneficiary or to accept and pay the draft drawn by the beneficiary, or
  • authorizes the advising bank or the nominated bank to negotiate.
Types of Letter Of Credit :
Irrevocable versus Revocable Letters of Credit
Irrevocable Letter of Credit
An irrevocable letter of credit cannot be amended or cancelled without the consent of the issuing bank, the confirming bank, if any, and the beneficiary. The payment is guaranteed by the bank if the credit terms and conditions are fully met by the beneficiary. The words "irrevocable documentary credit" or "irrevocable credit" may be indicated in the L/C.
In some cases, an irrevocable L/C received by the beneficiary may become invalid without the amendment or cancellation of such L/C, for example, when the trade between importing and exporting countries is suspended such as in a trade sanction, or when the issuing bank has ceased operation.
There have been cases of an irrevocable L/C being amended without the consent of the beneficiary in the OEM arrangements. The beneficiaries affected were export-manufacturers from a developing country. The importers were able to convince and instruct the issuing bank to amend the latest date for shipment in the L/C, changing to a date earlier than the agreed upon date, at which time the beneficiary would not be able to ship the OEM products. The importers used sneaky tactics that aimed to cause the beneficiaries to default in the delivery. The intention of the importers was to cancel the orders from the existing OEM suppliers and buy from other suppliers in another developing country where the prices had become lower.
In the event of an amendment like the above-mentioned case, the beneficiary must give notification of rejection of amendment to the bank that advised the amendment at once.
Irrevocable and Without Recourse Letter of Credit

A revocable letter of credit can be amended or cancelled by the issuing bank at any time without the consent of the beneficiary, often at the request and on the instructions of the applicant. There is no security of payment in a revocable letter of credit (L/C). The words "this credit is subject to cancellation without notice", "revocable documentary credit" or "revocable credit" usually are indicated in the L/C.

Revocable Letter of Credit :
A revocable letter of credit can be amended or cancelled by the issuing bank at any time without the consent of the beneficiary, often at the request and on the instructions of the applicant. There is no security of payment in a revocable letter of credit (L/C). The words "this credit is subject to cancellation without notice", "revocable documentary credit" or "revocable credit" usually are indicated in the L/C.
The revocable L/C was not uncommon in the 1970's and earlier when dealing with less developed countries. It is rarely seen these days in international trade.
Confirmed Irrevocable versus Unconfirmed Irrevocable Letters of Credit :
Confirmed Irrevocable Letter of Credit

An irrevocable letter of credit (L/C) opened by an issuing bank whose authenticity has been confirmed by the advising bank and where the advising bank has added its confirmation to the credit is known as confirmed irrevocable letter of credit. The words "we confirm the credit and hereby undertake ..." or "we add our confirmation to this credit and hereby undertake ..." normally are included in the L/C.

An exporter whose method of payment is a confirmed irrevocable L/C is assured of payment even if the importer or the issuing bank defaults. The confirmed irrevocable L/C is particularly important from buyers in a country which is economically or politically unstable.
In a confirmed letter of credit, the exporter or the importer pays an extra charge called the confirmation fee, which may vary from bank to bank within a country. The fee usually is added to the exporter's account. The exporter may indicate in the sales contract that the confirmation fee and other charges outside the seller's country are on the buyer's account.
Unconfirmed Irrevocable Letter of Credit
An irrevocable letter of credit (L/C) opened by an issuing bank in which the advising bank does not add its confirmation to the credit is known as an unconfirmed irrevocable letter of credit. The promise to pay comes from the issuing bank only, unlike in a confirmed irrevocable L/C where both the issuing bank and the advising bank promise to pay the beneficiary.
Restricted Negotiable versus Freely Negotiable Letters of Credit :
Restricted Negotiable Letter of Credit
In a restricted negotiable letter of credit, the authorization from the issuing bank to pay the beneficiary is restricted to a specific nominated bank.
Freely Negotiable Letter of Credit
In a freely negotiable letter of credit, the authorization from the issuing bank to pay the beneficiary is not restricted to a specific bank, any bank can be a nominated bank as long as the bank is willing to pay, to accept draft(s), to incur a deferred payment undertaking, or to negotiate the L/C. The words this credit is not restricted to any bank for negotiation or this credit may be negotiated at any bank or similar words, may be indicated on the L/C.
Revolving Letter of Credit
When a letter of credit (L/C) is specifically designated revolving letter of credit the amount involved when utilized is reinstated, that is, the amount becomes available again without issuing another L/C and usually under the same terms and conditions.
The revolving L/C may be used in shipments of a wide range of goods to a buyer within a period of time (several months to one year usually).
How does a Letter of Credit work ? :
The mechanics of a Letter of Credit are easily understood when separated into the following three steps :
  • Issuance
  • Flow of Goods
  • Flow of Documents Payment
Issuance :
After the trading parties agree on a sale of goods where payment is made by Letter of Credit, the Importer requests that its bank (the Issuing Bank) issue a Letter of Credit in favour of the Exporter (Beneficiary). The Issuing Bank then sends the Letter of Credit to the Advising Bank. A request may be included for the Advising Bank to add its confirmation. The Advising Bank is usually located in the country where the Exporter does business and may be the Exporter’s bank, but does not have to be.Next, the Advising/Confirming Bank verifies the Letter of Credit for authenticity and sends it to the Exporter.
Flow of Goods :
Upon receipt of the Letter of Credit, the Exporter reviews the Letter of Credit to ensure that it corresponds to the terms and conditions in the purchase and sales agreement; that the documents stipulated in the Letter of Credit can be produced; and that the terms and conditions of the Letter of Credit can be fulfilled. Assuming the Exporter is in agreement with the above, it arranges for shipment of the goods.
Flow of Documents & Payment :
After the goods are shipped, the Exporter presents the documents specified in the Letter of Credit to the Advising/ Confirming Bank. Once the documents are checked and found to comply with the Letter of Credit (i.e. without discrepancies), the Advising/ Confirming Bank forwards these documents to the Issuing Bank. The drawing is negotiated, paid or accepted as the case may be.
In turn, the Issuing Bank examines the documents to ensure they comply with the Letter of Credit. If the documents are in order, the Issuing Bank will obtain payment from the Importer for payment already made to the Confirming Bank.
Documents are delivered to the Importer to allow it to take possession of the goods.
Risk Analysis: Letters of Credit :
Advantages : Advantages :
  • Importer is assured that, for the Exporter to be paid, all terms and conditions of the Letter of Credit must be met.
  • Ability to negotiate more favourable trade terms with the Exporter when payment by Letter of Credit is offered.
  • An undertaking from the Issuing Bank that you will receive payment under the Letter of Credit provided that you meet all terms and conditions of the Letter of Credit.
  • Shifts credit risk from the Importer to the Issuing bank.
  • Not obligated to ship against a Letter of Credit that is not issued as agreed.
Disadvantages : Disadvantages :
  • A Letter of Credit assures correct documents but not necessarily correct goods.
  • Ties up line of credit.
  • Documents must be prepared in strict compliance with the requirements stipulated in the Letter of Credit. Non-compliance leaves Exporter exposed to risk of non-payment.
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