International trade between an Exporter and Importer would entail multiple transactions in terms of documentation exchange, physical cargo movement as well as settlement of payment which have to be clearly defined and setup in order to ensure smooth business transaction.
Over the years international trade has established various methods and payment mechanisms that are accepted globally by all financial institutions and other related parties.
Normally when the Customer is new to the Exporter, the business transactions are done either based on advance payment or Letter of Credit option. LC is one of the safest mechanisms available for an Exporter to ensure he gets his payment correctly and the importer is also assured of the Exporters adherence to his requirement in terms of quality, quantity, shipping instructions as well as documentation etc.
A letter of Credit is the Buyers Bankers promise to the Bank of the Seller / Exporter that the bank will honor the Invoice presented by the Exporter on due date and make payment, provided that the Seller/Exporter has complied with all the requirements and conditions set by the Importer in the said letter of credit or the Buyers Purchase Order and produced documentary evidence to prove compliance, along with the necessary shipment related documentation.
A Letter of Credit is always sent by the Buyers bank to the Sellers Bank or any bank that is becomes an advising bank. Normally the Sellers bank becomes an advising bank when a normal LC is received and it delivers or advises the buyer regarding the receipt of LC with no responsibility towards it. In case of a Confirmed LC, the Sellers bank checks out the authentication of the LC from the Buyers bank and confirms to stand responsible for negotiating, collecting payment from the Buyers bank and making payment to the seller in line with the terms and conditions stipulated in the LC. By adding confirmation to the LC, the Sellers bank too becomes equally responsible to make payment for the transaction under the LC.
Sellers Bank in turn will charge and collect service charges from the Seller for the same.
Normally the Letter of Credits issued is irrevocable, which means that no single party can unilaterally make any changes to the LC, unless it is mutually agreeable to both the parties involved. However an LC is said to be revocable if the terms allow any one single party to be able to make changes to the LC unilaterally.
However it is in the interest of the buyer that he should always insist on irrevocable Letter of Credit.
When the LC is opened, stipulating the condition that, on presentation of the negotiable set of shipping document by the seller as per the terms of the LC are made, the buyers bank will make payment at sight meaning immediately to the sellers bank subject to fulfillment of terms and conditions of the LC being fulfilled, the LC is called Sight LC.
If the payment schedule under the said LC stipulates payment at certain future dates after presentation of negotiable set of shipping documents by the Seller and fulfilling the LC terms and conditions, such an LC is termed Future LC or Credit LC. It is quite normal for sellers to extend credit of 30 days to 60 days under LCs. However the shipping documents would have to be presented to the bank immediately so that they documents reach the buyer well ahead in time before the consignment reaches the foreign shores and the buyer is able to clear the consignment and take delivery.