Letter of Credit is an important topic for Business in Bangladesh as we are export and import oriented country.
Letter of Credit?
A financial instrument that is used for international trade is called a Letter of Credit (LC), and its usual abbreviation is LC. The word was derived from the Italian phrase “Lettera di credito,” the French word “accreditation,” and the Latin word “accreditivus,” all of which are associated with the idea of trust. When a buyer and a seller are located in different nations, there is typically a degree of ambiguity and distrust between the two parties involved in the transaction.
Act as a guarantee
Both the buyer and the seller may be concerned that they will not receive the correct item, but the seller may also be concerned about being paid. A Letter of Credit serves as a guarantee and helps to alleviate these concerns by reducing risk. The participation of the bank in the transaction helps to ensure that the seller will be paid after they have complied with their contractual responsibility to deliver the items to the purchaser. In other words, the Letter of Credit functions as a sort of intermediary between the buyer and the seller, assisting in the development of credibility between the two parties and lowering the possibility of monetary loss.
Importance of the Letter of Credit in the Export Import business?
- LC protects buyers and sellers in export-import transactions.
- International trading can be challenging to create confidence between parties in various nations who may not know each other.An LC guarantees a secure, fair transaction for both parties.
- An LC guarantees the seller will be paid for their goods after they are dispatched and match the agreed-upon requirements. This reduces the danger of not getting paid for their goods or having to sue for payment.
- An LC guarantees that the customer will only pay for the items after receiving them and verifying that they satisfy the agreed-upon standards. This reduces the danger of buying substandard items or being duped.
How To Open A LC From Bangladesh
An importer must approach a bank they’ve done business with to open an LC. Banks are vital to LC. When specific conditions are met, banks issue LCs on behalf of the buyer (importer) and guarantee payment to the seller (exporter). LCs require two banks. One is the LC issuing bank, where the importer deposits the money, and the other is the advising bank, also known as a confirming bank, which guarantees and collects the payment on behalf of the exporter. The issuing bank’s responsible officer will help the importer fill out the paperwork. To open an LC from the issuing bank, a copy of the export or buy contract and other documentation are required.
The documents include –
Business Trade license
Bank Account for a Business
Application for opening a LC
Certificate of Importer from IRC
Indent / Performa invoice
Income tax clearance
The local chamber of commerce membership certificate
VAT registration certificate
Remember, the bank will ask the importer to keep the margin amount on the bank when opening an LC. The margin amount is the total worth of imported goods the issuing bank holds as security. The advisory bank receives the money after the importer receives the product. Then the exporter takes the money. The bank will block and issue a letter of credit for the importer after submitting the margin amount.
Types Of Letter Of Credit
Depending on the type of business, a Letter Of Credit also varies. The types are mentioned below –
- Revocable: The buyer or the issuing bank may revoke this form of LC at any moment. Giving the beneficiary notice in this situation is not necessary.
- Irrevocable: Without the consent of both parties, the Issuing Bank may not modify the Letter of Credit in any way.
- Confirmed: When the Advising Bank guarantees payment to the seller.
- Unconfirmed: Only through the Issuing Bank, and no confirmation of the bank’s consent is necessary.
- Standby: A standby LC ensures that the seller will be paid in the event that either the purchasers or the issuing bank make a mistake.
- Direct Pay: In this letter of credit, the beneficiary gets paid directly by the issuing bank rather than via the advisory bank.
- Revolving: Revolving LCs are used to satisfy some importer-exporter loans.
- Back-to-back: When the exporter lacks the necessary funds to ship the goods after opening the LC in their favor, a back-to-back LC is issued. An exporter arranges the money required for the acquisition, processing, assembly, and packaging of the items for export through a Back to Back LC.
- Deferred Payment: This LC permits a payment deferral. It also goes by the name Usance LC.
How Does Letter Of Credit Work?
The importer will initiate the opening of an LC with the issuing bank once they have reached an agreement on the terms of the trade with the exporter. The letter of credit is then verified by the exporter’s advising bank, which receives a copy of the LC from the issuing bank. The letter of credit is then delivered to the exporter after the advisory bank has validated its authenticity. The exporter will double-check the terms and conditions of the LC to confirm that they are consistent with the agreement, and if everything is in line, they will begin the shipping procedure. In the event that there is a mismatch, the exporter has the right to request that the importer correct the LC. After the items have been sent and the importer has received all of the relevant documentation, the payment will be transferred from the issuing bank to the advised bank, and then the exporter will finally receive their payment.