JARGON YOU NEED TO KNOW WHILE DEALING WITH LETTER OF CREDIT
In the world of business and trade, there are a lot of terms that might seem unfamiliar to you. To fully grasp the knowledge, basic terminology has to be addressed first. The following are some of the most common terms used:
- Beneficiary – Who is the beneficiary? It’s usually the seller or an individual who has to receive the payment. One or more people can be beneficiary in the transferable and back-to-back letter of credits. The LC is opened on Beneficiary party’s favor.
- 2. Confirming Bank – Previously mentioned as a second bank who agrees to honour a letter of credit issued by another bank and receives reimbursement from that bank.
- Applicant – Usually, the buyer who asks the bank to issue a letter of credit which is to be paid to the beneficiary. Applicant is the party who applies for the letter of credit. Letter of credit is issued to him as per his instruction and necessary payment is arranged to open Letter of credit with his bank.
The applicant arranges to open letter of credit with his bank as per the terms and conditions negotiated and agreed between the buyer and seller. So , applicant is one of the most important parties in letter of credit.
- Issuing Bank – The bank that creates or issues the letter of credit at the applicant’s request.
- Intermediary – A company that connects buyers and sellers, he is the middle man between the two parties. Intermediaries often use back-to-back letters of credit or transferable letters of credit (as many banks don’t issue back-to-back LC)
- Negotiating Bank – The beneficiary of LC delivers necessary documents to bank who will negotiates the documents. Negotiating bank also verifies the documents and confirms the agreed terms and conditions mentioned under LC on behalf of beneficiary to avoid any future chaos and disagreement.
- Reimbursing Bank – Reimbursing Bank is one of the parties involved in an LC. Reimbursing bank is the bank that will authorize the honor of reimbursement claim derived out of negotiation and then later, acceptance.
- Advising Bank – Advising bank, has the responsibility to communicate with necessary parties under letter of credit and other required authorities. The advising bank is the one who sends documents mentioned in Letter of Credit to opening bank.
We have covered what is a letter of credit and the importance of loc in business, trade and maintaining relations with both parties; buyer and seller. If you don’t know the basics of letter of credit or want to have an overview of it? Check out :
There are different types of letters for different purposes which include different conditions, parties and coverage.
1. Irrevocable Letter of Credit
An irrevocable letter of credit cannot be changed without the consent of all parties involved. No alterations or modifications can be made secretly; permission of all parties has to be taken.
2. Revocable Letter of Credit
A revocable letter is the exact opposite of irrevocable letter and changes can be made by the issuing bank without the consent or giving prior notice to the beneficiary. A revocable letter of credit is not ideal as it provides no security and can be revoked or cancelled by the bank on various circumstances.
3. Commercial Letter of Credit
It is the most common type of letter of credit which is used in the trading world for financial guarantee. It’s a good standard LC which ensures protection of parties, coverage of different laws etc.
4. Transferable Letter of Credit
As the name suggests, transferable LC allows the beneficiary to transfer all or part amount of payment to another beneficiary. This is usually used in the case where the original beneficiary has to pay to the original supplier.
5. Non- transferable Letter of Credit
As the name suggests, non-transferable letter of credit does not allow any third-party beneficiary, it only allows payment to the seller who has been mentioned.
6. Stand by letter of credit
An LC that assures that the seller would get his payment when the buyer is unable to pay. SBLC can be considered one of the most important LC because the issuing bank comes through to make the payment. The beneficiary has to provide appropriate details and documents to prove that he has not received the payment as promised. Upon review, the bank will pay the beneficiary (i.e. the seller)
7. UNCONFIRMED LC
An LC where the issuing bank is liable for payment and does not need a guarantee from the second bank or the second bank is not liable to pay the beneficiary.
8. Confirmed Letter Of Credit
An LC where along with the guarantee of issuing bank, a second bank or also called as confirming bank also gives the guarantee of payment. If the first bank fails to pay then the second bank is liable to pay to the beneficiary.
9. REVOLVING LC
In revolving LC, when a single LC is issued for covering multiple transactions in place of issuing separate LC for each transaction.
10. BACK TO BACK LC
This LC type considers issuing the second LC based on the first letter of credit. LC is opened in favour of the intermediary as per the Buyer’s instructions and based on this LC and instructions of the intermediary a new LC is opened in favour of Seller of the goods. For eg: A wholesaler received an LC from a retailer whereupon receiving an LC, the wholesaler will transfer the amount to the original manufacturer.
11. Sight Letter of Credit
As soon as the beneficiary submits acceptable documents to the appropriate bank, payment is made by the bank. The bank will check the documents and check other existing conditions, only after the beneficiary has fulfilled all the conditions. The bank makes its payment and this type of letter of credit is ideal for sellers.
12. Red Clause Letter of Credit
The seller can request an advance from the buyer before shipment of products and submission of required documents. The red clause was named because of the detail that is red in color so that they can draw attention to the fact that an advance payment has pr had been made.
13. Green Clause Letter of Credit
This LC is the same as red clause LC, but the only difference is proof of warehousing is also given to the seller. This type of extension is given in businesses related to commodities where warehousing is as important as other product functions.
14. Term (Usance)
In this case, payment can be deferred with a Usance Letter of Credit, which gives time for the buyer to inspect or even sell the goods.