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When working in the field of import and export related to payment, we cannot help but mention LC. Simple to understand, LC is a payment method also called payment by letter of credit or letter of credit. Letter of Credit (L/C) to be issued must be issued by a reputable organization capable of guaranteeing payment and guaranteeing valuable purchases and sales in order to create assurance for buyers and sellers.
Banks act as intermediaries in LC . payments
Naturally, buyers and sellers both want to gain their own safety, so the question “prepayment or pre-delivery?“is always laid out in any transaction. Letter of credit is issued by an intermediary (bank) to solve the above question.
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As such, the LC is issued by a financial institution or financial intermediary. Organizations that meet these specific requirements are usually Bank, has financial capacity and reputation for buyers and sellers to trust.
Of course, when buyers and sellers use LC . payment method There is an intermediary fee for the bank. Therefore, this business is also a business segment at banks and is handled by the international payment department.
Advantages and disadvantages of paying by L/C
What is LC? Documentary Letter of Credit
LC is a letter written by Representative bank of the importer (buyer) established at the request of the importer (buyer) promise to pay a certain amount to the exporter (the seller) at a particular time, if the exporter (the seller) presents appropriate set of payment documents with the terms set forth in the letter of credit.
The seller also has a bank representing him and the seller will forward this set of valid documents to its representative bank in the exporting country.
LC (Letter of Credit) is a letter of credit issued by a bank
Thus, the buyer, the seller and the bank are the individuals involved in the payment process by LC. LC stands for the word Letter of Credit. In addition, to emphasize the payment, the bank will keep the set of documents, it is also known as Documentary Letter of Credit to emphasize vouchers and payment methods.
Payment process by L/C
In this part we will learn documentary credit (L/C) payment process. However, for ease of understanding, I give the simplest and most general process.
The parties involved in this process include four parties:Importer (buyer): The importer is also known as the buyer. In the LC called the person requesting the opening of the LC (the applicant)Exporter (Seller): The exporter or the seller. In the LC, it is called the beneficiary. Issuing bank: This is the bank representing the importer. Advising bank: The seller’s bank Advising bank
This process includes 10 steps. To simplify the problem, I will present this chart in the form of an image. The steps in the figure are specified as a number in brackets. For example step 1 would be denoted as (1).
LC payment process – Documentary Credit
*(0)* The seller and the buyer sign a commercial contract (Commercial Contract). In the contract, the exporter and the importer must accept payment method LC. In addition, the contract is also specify the requirements in the LC. Even periods and commas must be clearly and uniformly specified. However, we also need to understand that the LC is not necessarily the same as the foreign trade contract in terms of all regulations. These are two separate and non-binding documents.
*(first)* The buyer (importer) based on the contract signed with the seller, makes an application for opening L/C and sends it to his bank – Issuing Bank (THE ISSUING BANK). Dossier includes:+ Application for opening L/C.+ Decision on establishment of enterprise, business registration, registration of import-export code – if any (for first transaction).+ Foreign contract + Import license.+ Commitment to pay (in case of opening L/C with deferred payment).+ In case the buyer deposits the L/C under 100% of the L/C value, an explanation must be provided by the credit department. The application of the established branch shall be approved by the branch manager.
Application for opening LC
Normally, applications for opening L/Cs are made according to the bank’s form. And not all businesses are allowed to open LCs. It depends on the contract value, the policy of each bank, and the reputation of the business that requires opening the LC. Normally, in this step, the business that requires opening an LC must make a deposit.
*(2)* The Issuing bank will consider and, if approved, will send the LC to the advising bank to send to the beneficiary. And note that the advising bank must have an agency relationship with the issuing bank. Thus, the advising bank has the ability to check the authenticity of the LC.
*(3)* The advising bank will evaluate the LC and forward the original L/C to the seller, the seller checks the ability to meet the L/C and can recommend amendments (if necessary).
*(4)* Beneficiary (exporter) conducts LC check, if everything is correct, will deliver the goods to the importer.
*(5)* After delivery, the exporter must prepare a valid set of documents to send to the advising bank and accompanied by a notice of claim. In this step appear documents and payment so this method is called “Letter of Credit”. Deliver documents and request payment.
*(6)* After receiving the set of documents. Is the advising bank responsible for checking if the documents are valid? In the payment of documentary credits, the set of documents must comply UCP (The Uniform Customs and Practice for Documentary Credits) and ISBP (International Standard Banking Practice for the Examination of Documents Under Documentary Credits). In the following articles, I will write about UCP and ISBP.
In the article about learning how to import and export, I mentioned the profession of international payment. Therefore, if you want to follow this industry, you must learn deeply about UCP and ISBP.
*(7)* After receiving the set of documents at the end of step (6), the issuing bank will check the set of documents. After the inspection process, the inspection results must be reported to the advising bank.
*(8)* After this process, the set of documents is in the hands of the issuing bank. If this set of documents is incorrect, the advising bank is responsible for requesting correction. If valid, the advising bank is responsible for notifying the beneficiary (exporter) and making payment.
*(9)* When the advising bank has paid the exporter. The bank opening the LC will issue the payment to the importer.
*(ten)* The money will be officially transferred to the LC issuing bank account. That is, credit to the account of the LC issuing bank.
Thus, we have generalized the LC payment process. However this is the simplest case with only 4 parties involved in the process. There are also other entities involved in the process.
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L/C payment process in practice
Here I will give the log of a shipment. However, due to information security issues, it is not possible to post the names of the units in the payment with this process. The following is a sample and information of the foreign trade contract of this shipment
Commercial contract in LC . payment
This is the log (historical record, like the journey record) of an LC payment shipment with the above foreign trade contract.
A. L/C is confirmed and confirmed by the confirming bank 1May, the seller receives the L/C from the representative bank. The bank indicates that it has confirmed the L/C. L/C is effective at the same time as confirming bank.
15May, the seller delivers the goods according to the terms of L/C (from that date, the seller has 21 days to submit the set of words to the bank).
20May, the seller presents the documents to the confirming bank. (from that date, the confirming bank has 5 working days to verify the documents.)
23May, the bank confirms to the seller’s response that the document is valid with the terms of L/C and the bank will pay on 26May.
On the same day, the confirming bank transfers the documents to the issuing bank.
On May 26, the seller is paid for the goods.
On May 28, the document arrives at the issuing bank (from that day on, the issuing bank has 5 days to check the document)
On 2Jun, the issuing bank accepts the document, pays the confirming bank, and reclaims the money from the purchaser.
Letter of Credit Sample LC and Contents of Letter of Credit
In general, the L/C letter form is very simple. Even when sending LC draft and LC via email to each other, they send it by text file (note page). The patterns are very simple, mostly lines of text. When printed, the bank will have the logo and name of the issuing bank.
Sample letter of credit LC
Above you see it is a relatively old LC model and it is no different from the current banks are using. Simple but great value.
Normally, on 1 LC, the following contents are required:
Number and opening date: All L/Cs must have their own number specified by the L/C opening bank, Letter of Credit opening date: is the date on which the issuing bank’s commitment to the seller begins.
Names, addresses and phone numbers of both parties: Information of the person requesting the opening of the LC and the beneficiary of the LC
Amount to be paid: amount and currency
Important timelines: Delivery term, expiration date, payment term.
Contents about transportation, freight forwarding
– Incoterms: FOB, CIF or CIP? – Place of shipment, place of receipt (POL: Port of Loading, POD: Port of Discharge ) – Allow transshipment or not? (Transshipment allowed/not allowed or Permitted/Not permitted).– Is partial delivery allowed? (Partial shipments allowed/not allowed)
License– Documents include: commercial invoice (Commercial Invoice), packing list (Packing List), bill of lading (Bill of Lading), cargo insurance (Insurance) if delivery CIF, quarantine certificate, …,– The latest time limit for presentation of documents.
Advantages and disadvantages of paying by L/C
In international payment there are types of payment methods such as: Money transfer method, Open account method, Collection of payment method, Documentary credit method (L/C). Each type has its own advantages and disadvantages.
Advantages and disadvantages of documentary credit payment LC
In the following, I will analyze the advantages and disadvantages of the documentary credit method (Letter of credit – L/C).
Advantages of documentary credit
For SellersThe bank will pay exactly as in the letter of credit regardless of whether the buyer pays or not. Limiting delays in document delivery Customers can discount the L/C to have money in advance to use for contract performance. copper.
For BuyersOnly when the goods are received will the buyer pay. The importer can rest assured that the seller will have to comply with the provisions of the L/C to ensure payment, otherwise the seller will lose money.
For the BankService fee collection (L/C opening fee, money transfer, L/C modification fee, ..) Expand international trade relations.
Disadvantages of documentary credit
For SellersIf you do not present the set of documents as specified in the L/C, payment will not be made.
For BuyersLetters of credit operate independently of the sales contract and work according to the set of documents. Therefore, if the exporter presents the appropriate set of documents, the issuing bank is obligated to pay, regardless of whether the actual goods are properly delivered or not, even if the goods are not.
Special features of L/C
L/C works independent with a foreign trade contract, although the L/C is formed on the basis of a sales contract between the two parties.
Banks work with each other on the basis of documents, not goods.
The buyer opens the L/C, and the beneficiary claims the bank that issued the L/C.
LC stands for Letter of Credit aka documentary credit. This is a payment method that has the participation of a bank to ensure that international purchases take place more securely.
The importer is the one requesting the opening of the LC and usually makes a deposit upon opening. The issuing bank of the L/C is the bank representing the importer, in addition, the correspondent bank is the advising bank. The advising bank acts as the seller’s (exporter’s) bank.
In this article, only the simplest LC payment process is given. In the next post I will talk more about the parties pay LC and types of LC.
Thank you for reading the article!Wish you always success and happiness in life!
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