In today’s guide, you’re going to learn about yet another important item in import and export documents tool kit – export letter of credit.
So, if you intend to use export letter of credit, read this guide so that you don’t make any mistake.
- What is an Export Letter of Credit?
- What is the Purpose of an Export Letter of Credit?
- How does an Import Letter of Credit compare to an Export Letter of Credit?
- What are the Advantages of Export Letter of Credit Financing?
- Is an Export Letter of Credit (L/C) the same as a Bank Guarantee (BG)?
- What Documents do you need to Open an Export Letter of Credit?
- How does an Export Letter of Credit Work?
- How Secure is Letter of Credit as a Payment Method in the Export Business?
- What is a Documentary Letter of Credit?
- Who are the Main Parties to an Export Letter of Credit?
- What is the Difference Between an Export Letter of Credit and a Loan?
- How much Does it Cost to Acquire a Letter of Credit?
- Who Pays for the Cost of a Letter of Credit?
- How Long does it take for a Letter of Credit to Open?
- At what Point is an Export Letter of Credit considered Revolving?
- Is an Export Letter of Credit the same as an Export Credit Insurance?
- What is a Letter of Acceptance, and how Different is it from a Letter of Credit?
- What are the most Common Discrepancies in an Export Letter of Credit Document?
- How can you Reduce the Risks Associated with Export Letter of Credit?
- What is the Difference Between a Confirmed and Unconfirmed Letter of Credit?
- Is a Sales Agreement Part of an Export Letter of Credit?
- When does a Seller get Paid when Using an Export Letter of Credit?
- Can you Transfer an Export Letter of Credit?
- Can you Amend an Export Letter of Credit?
What is an Export Letter of Credit?
It is a financial instrument, which a bank issues to represent its commitment on importer’s behalf.
It guarantees payment will be made to the exporter provided the specified terms and conditions are met.
Ordinarily, the specified conditions on export letter of credit are evidenced by presentation of particular documents.
The issuing bank relies on the creditworthiness of the importer to issue export letter of credit.
Sample letter of credit
What is the Purpose of an Export Letter of Credit?
Its purpose is to guarantee the exporter regarding the payment for goods the importer is purchasing.
It acts as a conditional guarantee, which the importer’s bank offers to the exporter upon purchasing goods.
It acts as a contractual payment agreement between the importer’s bank and exporter to facilitate shipment of goods upon purchase.
It also serves to protect the importer.
The documents needed for triggering the payment provide evidence that products have been shipped accordingly.
How does an Import Letter of Credit compare to an Export Letter of Credit?
There is a thin line between import and export letters of credit.
Ideally, the importer’s bank issues import letter of credit with the supplier as the beneficiary.
On the other hand, once the exporter’s bank receives the same letter of credit, it becomes an export letter of credit.
In simple words, an import letter of credit is issued by the importer’s bank, whereas the exporter’s bank receives an export letter of credit.
However, the terms and conditions in the import letter of credit are legally binding.
Comparatively, the terms and conditions in export letters of credit are more flexible.
Import letter of credit tends to increase creditworthiness of the importer.
On the other hand, export letter of credit seemingly enhances cash flow of the exporter.
Materially, both import and export letters of credit are similar.
They only vary in terms of perspective.
What are the Advantages of Export Letter of Credit Financing?
It offers a wide range of benefits both to the importer and exporter.
Some of the advantages include the following;
- Risk mitigation – It reduces risks of non-payment to almost zero. The exporter is wholly guaranteed of the payment provided they meet the demands of the letter.
- Flexible terms and conditions – It provides room for negotiating the stipulated terms and conditions. It can be tailored to meet the exporter’s requirements. This makes it easy to facilitate the purchase and shipping of particular products.
- Enhances exporter’s cash flow – Ordinarily, the more payment the exporter receives, the higher the cash flow they experience. This mode credits payment on exporter’s account, thus improving their cash flow.
- Upfront payment – It allows the exporter to receive payment way ahead before the consignment arrives to the buyer. The exporter is guaranteed the payment prior to shipment.
- Increases importer’s creditworthiness – It enhances the solvency of the importer, thus making it easy to obtain such facilities for future business financing.
- It offers access to post-shipment non-recourse funding and reduces the need for a credit control instrument.
Is an Export Letter of Credit (L/C) the same as a Bank Guarantee (BG)?
To some extent, in regards to business application and instilling confidence in the transaction and participating parties.
Even so, they vary slightly in regards to the terms and conditions on which they apply. Here are some of the differences;
An export letter of credit is more or less like a commitment a bank takes to pay the beneficiary once particular criteria are met.
A bank guarantee is a bank’s commitment to honor the beneficiary’s payment should the opposing party fail to fulfill their contractual compulsions.
Export letter of credit protects both parties in the transaction but leans more towards the exporter.
Bank Guarantee, on the other hand, covers both parties in the sale but favors the importer more.
Export letter of credit is commonly used with merchants involved in the business of imports and exports of goods.
Bank guarantee, however, is often used by contractors who bid on larger projects like infrastructure.
Export letter of credit reduces the risk involved by confirming a transaction goes ahead.
Bank guarantee, on the other hand, mitigates incurred loss should the transaction fail to go to plan.
Export letter of credit is comparatively affordable than a bank guarantee.
BG is seemingly costly since it protects both parties and covers wide-ranging high-value transactions.
What Documents do you need to Open an Export Letter of Credit?
In an export L/C, the buyer must request different types of documents from the seller to facilitate the entire process.
Some of these documents include the following;
- Commercial invoice – It is necessary to demonstrate proof of the value of order.
- Packing list – It shows the items packed in the shipment
- Bill of lading – It shows proof of shipment
- Certificate of origin – It acts as proof of origin of the items you are purchasing.
- Health certificate – It is necessary to prove the goods meet stipulated health and sanitation requirements.
- Inspection certificate – It proves the product conforms to the required quality standards.
- Insurance certificate – It shows the shipment is covered in case of any risks.
- Bill of Exchange – It is a negotiable tool issued to the bank to facilitate payment.
Primarily, the documents required for opening and processing an export letter of credit fall into various categories.
The categories include; commercial, financial, shipping insurance, and customs documents.
How does an Export Letter of Credit Work?
The process starts when the importer requests for the export letter of credit for financier, creditor, or bank.
Here, the buyer submits all the necessary documents required for opening the Export L/C.
The importer arranges for the issuing bank to open a letter of credit in favor of the exporter.
Also, the importer’s bank issuing the instrument then transmits the L/C to the exporter’s nominated bank.
Besides, the exporter then releases the items and forward them to the freight forwarder.
Next, the goods are dispatched for shipping.
The exporter or dispatcher then take the documents to the nominated bank.
Then, the bank confirms the documents to ensure compliance with the L/C and collects payment from the issuing bank.
Next, the importer’s account is then debited accordingly.
The importer’s bank then releases the documents to the importer to enable him/her to claim the goods from the shipper
It is the same documents that the importer also uses to facilitate customs clearance.
How Secure is Letter of Credit as a Payment Method in the Export Business?
It is a highly secure payment method, which guarantees safety and can be used for almost any international business transaction.
It safeguards the exporter or seller, which is critical, especially in terms of reducing non-payment risks.
The buyer can never cancel or alter the terms and conditions of export L/C without the consent of the exporter.
However, this payment method only becomes risky should the issuing bank fail to credit the payment to the exporter’s bank account.
This often arises should the exporter fail to meet all the set-out conditions on the export L/C.
Even so, it doesn’t imply the seller will never get paid at all.
It only leads to delayed payment or non-payment until the conditions are met.
Letter or credit
What is a Documentary Letter of Credit?
It refers to an arrangement in international trade in which the importer’s bank facilitates exporter’s payment for goods upon receipt of relevant documents.
The buyer’s bank must receive documents showing the commodities have been dispatched and shipped.
It is the responsibility of the importer’s bank to pay the seller according to the terms of a letter of credit.
This only happens upon provision of relevant documents by the seller, which must meet the conditions of L/C.
It should also confirm the shipment of goods within a specific time-frame.
Who are the Main Parties to an Export Letter of Credit?
Letter of credit has several parties with different undertakings, which include the following;
The opener – this refers to the importer, who is responsible for opening the export L/C upon request. You can also refer to it as the buyer.
The issuer – This is the institution where the buyer opens the request for export L/C. It is the bank in the importer’s country, which issues the letter of credit.
The beneficiary – Also referred to as the seller or exporter. The export L/C is issued in favor of the beneficiary.
Confirming bank – This is the primary party to the credit, which assumes all the obligations of the bank issuing export L/C.
Notifying bank – It is the party, which alerts the beneficiary regarding credit, which has been opened to their favor. This player advises the beneficiary accordingly upon confirmation of the export L/C.
The paying bank – It is the ultimate party responsible for crediting the amount into the beneficiary’s account. In many instances, the paying bank is usually the confirming and notifying bank.
The negotiating bank – It is the party, which accepts or pays the draft to the beneficiary. The seller is obliged to go to his preferred bank, present the draft and relevant documents under the credit.
It happens where there is no specified paying bank in the export letter of credit.
What is the Difference Between an Export Letter of Credit and a Loan?
Export letter of credit is a letter from a bank or financier guaranteeing to pay the seller on behalf of the buyer for goods purchased.
It is submitted to the seller upon verification that commodities have been shipped.
A loan refers to a sum amount of money borrowed from a third party to facilitate payment of purchased goods or products.
The transaction for a loan is usually directly between the importer and the exporter.
A loan facility ordinarily accrues interest, unlike the export letter of credit facility, which is usually on fixed terms.
How much Does it Cost to Acquire a Letter of Credit?
It is wholly dependent on the fee policy of a specific bank you are requesting this facility from.
Different banks charge different rates for issuing the export letter of credit.
Some factors, which determine the chargeable rates, include importer’s credit rating, export letter of credit margin, and tenor, among others.
Even so, most banks often charge a range of about 0.25 to 2% based on varying deliberations.
Who Pays for the Cost of a Letter of Credit?
It depends on different aspects surrounding the customs and practices of jurisdictions where export L/C is issued and advised.
It is also dependent on the sales contract binding the applicant and the beneficiary.
In most instances, though, both the seller and the buyer incur some cost related to opening and completing the export L/C.
The entire process is negotiable.
It makes it easier to find common ground on who pays or how to share the cost of letter of credit.
The buyer pays opening, advising, and related bank charges.
Seller, on the other hand, pays for negotiation, amendment, discrepancy, and completion fees of the L/C.
Nonetheless, the buyer tends to incur more costs compared to the seller.
How Long does it take for a Letter of Credit to Open?
It depends on the specific bank, which is issuing the export letter of credit.
However, the duration is pegged on various prevailing and underlying issues between the bank and the applicant.
The applicant’s L/C limit and bank’s approvals from the checker, as well as other authorized signatories, determine how long it takes.
However, if all factors remain constant, the export letter of credit should open within a few minutes to two days upon request.
At what Point is an Export Letter of Credit considered Revolving?
When the export L/C recurs every month for a similar transaction in a predetermined period.
The value of the L/C remains the same, but you can use it for different transactions over some time.
It is when the amount of money you can withdraw is reinstated and becomes available until the agreed time frame.
The duration and maximum value for the credit can revolve in is often outlined beforehand.
Moreover, the revolving credit also captures the replenishment clause and maximum amount of credit utilization.
Is an Export Letter of Credit the same as an Export Credit Insurance?
Not at all!
Export credit insurance covers the seller from the risks associated with non-payment by a foreign buyer.
It mitigates the risks arising from non-payment when doing international business.
This facility gives the exporter a conditional assurance regarding payment of the commodities in case the foreign buyer forfeit.
It covers risks such as insolvency and bankruptcy of the buyer.
On the other hand, the export letter of credit provides conditional assurance to the exporter regarding payment of the commodities by the buyer.
It gives the seller surety of payment for goods delivered as long as the demands of the document are met.
Letter of credit
What is a Letter of Acceptance, and how Different is it from a Letter of Credit?
Letter of acceptance is a document, which confirms mutual agreement between the buyer and the seller for purchasing specified items.
The buyer lists and sends all the items with all the documents duly signed to the exporter.
The exporter confirms the deal and terms and conditions in form of documentary evidence.
It is different from the export letter of credit since it does not necessarily guarantee payment of the commodities purchased.
It only demonstrates the exporter’s acknowledgment and comprehension of the buyer’s conditions, including mode of payment.
What are the most Common Discrepancies in an Export Letter of Credit Document?
Discrepancies in an export letter of credit refer to errors or defects usually arising as a result of human err or general paperwork mismatch.
Some of the usual discrepancies you are likely to encounter include;
- Inconsistent documents – All the documents submitted for opening an export letter of credit must be consistent. Any inconsistency identified at any stage of processing this document is considered a discrepancy.
- Expiry of letter of credit – It happens when there is a delay in presentation of the relevant documents.
- Insufficient documents – All the required documents for opening and completing a letter of credit should be submitted accordingly.
- Insufficient insurance coverage
- Inconsistency in description of goods or it is stated differently from the letter of credit
- Unauthorized charges on the invoice contrary to the letter of credit.
- Unsigned invoice or it hardly specifies the terms of shipment as quoted in the export letter of credit
How can you Reduce the Risks Associated with Export Letter of Credit?
- As an exporter, ensure to consult with the bank before the buyer requests for export letter of credit.
- Assess all rectify all the elements leading to discrepancy opportunities to prevent delay or non-payment
- Establish that all the terms of letter of credit can be met within the specified time limits.
- Determine whether or not the export letter of credit is necessary for the transaction.
- Negotiate with the importer and agree on detailed terms and conditions to include in the letter of credit.
- Make sure all the documents are consistent with the terms and demands of the export letter of credit.
What is the Difference Between a Confirmed and Unconfirmed Letter of Credit?
Confirmed is the type, which a second obligation is added to the export L/C by a different bank.
Unconfirmed is the type, which only carries the obligation of the issuing bank to guarantee paperwork is in order.
In a way, this helps to guarantee payment to the exporter.
Is a Sales Agreement Part of an Export Letter of Credit?
Not at all!
A sales agreement is a contract between the buyer and the seller regarding the purchase of commodities.
It may also capture other details such as mode of payment.
If need be, you may include it in the documents for opening an export letter of credit, but it is not part of it.
When does a Seller get Paid when Using an Export Letter of Credit?
Once there is a confirmation that the commodities have been shipped, the seller can initiate the process of completing the export letter of credit.
Thus the seller is legible for payment upon confirmation of shipping the items and meeting other demands of the export L/C.
The payment can be within a few minutes or after a few days once the issuer confirms the seller has met the stipulated conditions.
Can you Transfer an Export Letter of Credit?
You can request for transfer of export letter of credit.
It creates a secondary beneficiary, which allows you to transfer part or all of the credit to.
In this case, you become the primary beneficiary given you are the first party to accept the transferable letter of credit from the bank.
Can you Amend an Export Letter of Credit?
Absolutely correct! You can always amend an authorized export letter of credit anytime as many times as possible.
Even so, it has to before it expires.
You only need to instruct the issuing bank on the ideal amendments you want to incorporate in the export letter of credit.
However, it is not advisable to amend it too many times since it stands chances of causing discrepancies due to inconsistent data.
And in case you have any questions regarding export letter of credit contact BanSar now.