(A) Defines what it is
Letter of credit is a written undertaking by a bank given to a seller at the request and on the instruction of the buyer. To pay at sight or at determinable future date up to a state sum of money against stipulated document and compliance of the terms and conditions within a prescribed time limit.
An irrevocable letter of credit can be amended or cancelled only with the agreement of the:
1) Issuing bank
2) The confirming bank (if the credit has be confirmed) and ;
3) The seller (as beneficiary)
(B) Purposes and why it is created
-The objective of this document is to facilitate payment as well as finance for overseas trade. It is designed to protect the trading partners in the transaction by ensuring the following requisites:
a) The buyer can be assured of receiving all the necessary shipping documents giving full title to the goods and evidencing their existence.
b) The seller can be assured of payment for his goods.
-To convince the seller that some capital has been allocated to pay the seller (it is safe to start production of the order.
-To list the document that the buyer will need in order to clear the consignment, and specify the details the document must bear.
- To bridge the gap between payment in advance and open account terms.
-The buyer cannot be amended the letter of credit. So, it is safer to use for the seller.
-A revocable letter of credit is very limited security for the seller. An irrevocable letter of credit requires the consent of both the buyer and seller.
-When the seller are less entrust the buyer, irrevocable letter of credit are the best method to use in international trade.
(C) How it is created
-Applicants request the letter of credit from the issuing bank.
-To get the letter of credit, applicant must have :
a. Sales contract
b. Account in the issuing bank
-Applicants fill the letter of credit form.
-Issuing bank approve the letter of credit.
-Applicant will be charged of
a. Telex
b. Stamp duty
c. Courier
d. Cable
-In addition, applicant must be liable to the issuing bank for all risks and costs of the letter of credit.
(D)What are its salient features?
The salient features for irrevocable letter of credit is :
-Letter of credit is used UCP 600 as a official guideline
-In letter of credit, the seller will be pay by the bank that acts on behalf the buyer. And the buyer will pay it back later to the bank. It’s different from bank guarantee. In case of bank guarantee, the seller will be paid by the bank if the buyer did not pay for him.
-Under letter of credit, bank is direct undertaking to the beneficiary to pay; the issuing bank does not wait for the buyer to default. To be distinguishing, bank guarantees only pay on behalf of the applicant to the beneficiary when the buyer is unable or unwilling to make payment.
-In Irrevocable letter of credit, seller should prepare all the documents needed then give it to the advising bank to get the payment. To be different, in red clause letter of credit seller or beneficiary are able to obtain financing before shipment of goods.
-Application form of irrevocable letter of credit is state an “irrevocable documentary credit” on the form.
(E)How does an importer and exporter use
-The buyer will be used letter of credit because :
a. He did not know well about the beneficiary.
b. He wants to minimize the risk because he deals with big transactions.
c. He does not have sufficient money to pay the beneficiary.
d. By using letter of credit, the exporter will respect the applicant because he has a good reputation.
e. He wants to continue operating his business when he does not have the funds at the moment to do so.
(F)Who are the parties directly related to the products and services
Only two parties that related with this products/services:
1) BUYER/IMPORTER/APPLICANT
2) ISSUING BANK (like MAYBANK)
-The contractual relations regarding the technical, commercial and financial aspects are defined by the buyer or applicant.
(G)What are the obligations of each party?
APPLICANT
-To pay the bank
-The applicant for the credit shall be bound by and liable to indemnify the banks against all obligations and responsibilities imposed by foreign laws and usages.
ISSUNG BANK
-Issue the credit at the request and on the instructions of the applicant.
-Examine all the documents with reasonable care to ascertain that they appear on their face to be in accordance with the terms and conditions of the credit.
(H) What are the rights of each party?
APPLICANT
-Applicant has paid the bank for the L/C services, so, he has the right to give the instruction the issuing bank to ensure that all the documents are in order.
ISSUING BANK
-Obtain payment from the applicant for payment already made to the confirming bank.
-The Issuing bank assures payment on the basis of documents alone and not based on the goods or services to which it may refers.
(I)Cost of creating the instruments to the issuers
-Cost of creating involves indirect cost including:
a. Printing d. Administration
b. Photocopy e. Telephone
c. Salary f. Cable charges
(J)Cost of holding the instruments to the subscriber
-0.1% per month (ABM Role) of the letter of credit amount.
(K)Risk and Returns to the issuer
RISK
-Insolvency of the Applicant.
-Fraud Risk, Sovereign and Regulatory Risk and Legal Risks.
RETURN
-Bank will get the commission when issue the letter of credit.
-Issuer will charges fee to the applicant.
(L)Risk and return to the subscriber
RISK
-Late shipment.
-Credit amount exceeded.
-Description of goods on invoice differs from that of the credit.
-Correct documents but not necessarily correct goods.
-Non-delivery of goods.
-Inferior quality.
-Foreign exchange.
RETURN
-Ability to negotiate more favorable trade terms with the exporter when payment by letter of credit is offered.
-Obtain financing to pay the beneficiary.
-Ability to negotiate favourable terms from the seller.
-Minimizes language barriers with the foreign seller as the whole transaction will be routed through and handled by the bank.
(M)Other cost elements (are there any other hidden cost?)
-For Irrevocable letter of credit product, there is indirect cost involved:
1) Building
2) Utility bills
(N)What is the pricing mechanism (any formula?)
(P*R*T)
P = Principal amount
R = Rate
T = Time
(O)Is there any official guideline for its establishment?
-UCP 600
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