What is Letter of Credit?

Letter of Credit (L/C): A Letter of Credit is an undertaking/instrument issued by a bank on behalf of the Buyer/Importer in favor of the exporter whereby the bank undertakes to pay the exporter a certain fixed amount against delivery of documents specified in the credit within a stipulated time if the terms and conditions of the credit are compiled with. According to Article 2 of UCPDC 600, Credit means any arrangement, however named or described, that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honour a complying presentation. A more wider and comprehensive definition of a Letter of Credit has been given in Article-2 of UCPDC 500 as under:For the purpose of these article, the expression, documentary Credit(s) and stand by Letter(s) of credit (hereinafter referred to as Credit(s) mean any arrangement, however named or described whereby a bank (the issuing bank) acting at the request and on the instruction of a customer the Applicants) on or its own behalf. i) Is to make a payment to or to the order of a third party (the Beneficiary) or is to accept and Pay bills of exchange (Drafts) drawn by the beneficiary, or ii) Authorise another bank to effect such payment or to accept and pay such bills of exchange or (Drafts), or iii) Authorise another bank to negotiate against stipulated document(s) provided that the terms and conditions of the credit arc complied with.

Kinds of letter of Credit L/C Letter of Credit can be divided into broad categories. 1. Letter of Commercial credit 2. Letter of Travelers facility. 1. Letters of Commercial Credit: These credits are used for business purposes.they are of the following types: Confirmed or Irrevocable Credit: By issuing this type of credit the bank gives an undertaking to accept and pay the bill of exchange drawn on it. Unconfirmed or Revocable Credits: When the bank does not give an undertaking to accept and pay the bill drawn on it,it is called unconfirmed credit. It simply states that the bank is willing to honor the bill drawn under the credit unless the credit is cancelled Acceptance Credits: When the credits provide for bills to be accepted by the bank instead of the importer, it is called acceptance credit. Such credits save time and risk of lose of bill during tansit. Document Credits: Such credits provide for bill to be accompanied by necessary documents indulding railway receipts,shipping papers,insurance receipt,and bill of landing. Clean or non Documentary credits: When the credit dose not require attaching necessary documents with the bill, it is known as clean or nondocumentary credit. Omnibus Credits: It is granted to those exporters who possess high credit standing.They can draw full amount on a bank against the pledge of general lien on their goods. Fixed Credits: When credits are available for fixed total amount wither in one or several bills, it is called fixed credits. Revolving credits: Where credits are automatically renewable under certain conditions, they are known as revolving credits. Divisible Credit: Where the credit allows its holder to transfer drawing rights in parts of the total amount of credit to the other party, it is known as divisible credit.

Letters of Travellers Facility: Such letters issued to the travelers. It is risky to carry money in foreign country and may be lost ,stolen,or robbed.These letters are substillutue to ther money and can be cashed at designated bank at the place of visit.these are of following types Travellers Cheque: These cheques are draft which are issued to tourists.The are used for noncommercial purposes and these are drawn by the holder on the issuing bank for round sums.These are Specialized cheques made available to overseas travellers and converted into the currency of the country of destination.Travellers cheques are issued in several denominations in a local or forign currency.The issuing bank accepts the return of unused cheques at a little Comission. At the time od issue , the holder signs the cheque in the presence of manager of issuing bank and then the cashing bank and the rwo signatures must agree. Travellers cheques can only be issued after fulfilling exchange control regulations set by the central bank of a country. Circular Cheque/Credit: banks issue such cheques to their agents branches,or correspondents in foreign countries to sell them to visitors to country of the issuing bank.For instance, Habib bank, Karachi issues circular cheques to its branch in London to sell them to resident Pakistanis who want to visit Pakistani.These cheques are issued under the foreign exchange law of great Britain. Travellers Commercial Letter of credit: These Cheques are issued to businessman who want to make purchases abroad but are reluctant or afraid to carry with them huge amount in cash.these cheques are accompanied by necessary shipping documents. Limited letter Credit: unlike circular L/C which is useful in many countires at a time, the limited letter of credit is issued only on a branch or an agent of specified country.It is useful in other places. Circular or World-wide letter of credit: This type of Cheque is available with any of the banks correspondents and agents abroad.

Tenor of the Letter of Credit (L/C): All credits must clearly indicate whether they are, available by sight payment, by deferred payment, by acceptance or by negotiation1) Sight payment .. to pay at sight. 2) Deferred payment .. to pay on maturity date(s) determinable in accordance with the stipulation of the credit 3) By acceptance .. maturity date will be counted from the date of acceptance of draft by the applicant 4) By negotiation ..maturity date will be counted from the date of negotiation of document. If the credit provides for negotiation to pay without recourse to drawers and/or bonafied holders, draft(s) drawn by the beneficiary and/or document(s) presented under the credit. A credit should not be issued available by draft(s) on the applicant. If the credit & nevertheless calls for draft(s) on the applicant, bank will consider such draft(s) as an additional document(s).