Letter of Credit is a sort of open letter that requires some person to advance certain money to the other party named therin with a promiose to refund the money to the person advancing the money or accepts the bill drawn upon himself. It is denoted by LC.
Contents of a LC
Normally, a letter of credit document contains the following information:
date of expiry – there should be a expiry date mentioned on the LC document.
Amount – amount that is covered under the credit.
Applicant – Name and Address of purchaser
Beneficiary – Name and Address of seller
Instructions for reimbursement are also included in the Letter of Credit.
Advantages / Utility of LC
- In LC transaction, the banker agrees to take responsibilty to pay cash or accepts the bill of exchange drawn upon himself,
- There is a reduced risk for supplier as bankers are invloved on both side by the buyer and seller.
- Letter of credit is the best document that enables the global trading very easy and secure.
- The exporter of the goods can get the cash from doing the LC transaction by discounting the bill of exchange.
- The financial instituion may decide to advance amount even the goods are at manufacturing stage. This is possible because sale and payment of such sale is assured completely.
- LC may be general or specific. When it is addressed to all merchants or persons, it is r eferred to as General Letter of Credit. On the other hand, when it is associated with a particular person, it is called Special Letter of Credit.
Types of Letter of Credit
There are variety of forms of LC. Most commons are:
Letter of commercial credit
These are mostly used in buying and selling of goods and services from one country to another. So, in export and import transaction, this is the common LC document. LC Commercial Credit is further divided into following kinds:
Fixed Credit – When LC is issued for a fixed a mount to b e used with a fixed period, it is called fixed credit LC.
Revolving Credit – When t he credit is renewed automatically after it has been used fully.
Revocable LC – This is the type of LC which can be cancelled by the banker at any time at its own will.
Irrevocable Letter of Credit – this is the LC which cannot be cancelled by the banker alone and in order to make the cancellation process complete, the request of beneficary is essentials. The banker has to honour such credit even the beneficiary becomes insolvent.
Confirmed LC – When the banker obtains the acceptance of its overseas branch for bill of exchange drawn by the seller or exporter. This LC gets legal effect only when the overseas branch or agent of the bank gives its acceptance.
Unconfiemd Letter of Credit – when the banker does not get confirmation from its overseas branch or agent, it is called unconfirmed LC.
Open Credit – it is a LC which is financed on simple draft without the need of any shipping document. It is also called Clean letter of credit.
Anticipatory LC – This is the type of LC that contains two clauses, that is, red clause and green clause. In red clause, the expoter is allowed to have advance money from the banker before the shipment of goods. But the exporter is made liable to pay duties, tax and freight charges. In green clause, the exporter is allowed to get advance money not just to finance the shipping charges but to cover any shortages.
Letter of non-commercial credit
This type of LC are also called Encashment credit or personal credit. It is divided into following types as follows:
Direct LC – It is addressed to an indivisual person and requires him or her to provide loan to t he bearer of the negotiable instrument.
Circular Letter of Credit – When LC is addressed to more than one person accompanied with a letter of indication.
Travelers Cheque – It is the document which is issed by the banker to its curtomers who are going for a travel. It is a secure way of doing transaction without the need to carry hard cash in the pocket. N ormally, banks charge small amount as commission while issuing these travellers cheques. Just like order cheques, traveller’s cheque are honoured only when it matches with the specimen signature of the customer.