This is a written document issued by the importer’s bank, on behalf of the importer, to the exporter’s bank. This gives an assurance to the exporter that the issuing bank will pay the exporter for the trade that is happening.
In simple words, the issuing bank agrees to pay the amount according to the agreed timeline. The exporter is known as the beneficiary of the LC and the importer is called the applicant.
“The LC is the foremost instrument that guarantees safety of payment by importers. This is one of the most important and sensitive documents between an exporter and an importer,” says Puran Dawar, President of Agra Footwear Manufacturers and Exporters Chamber (AFMEC).
Agreeing with his statement, Ajay Sahai, Director General and CEO, Federation of Indian Export Organisation (FIEO), says the LC is the best way of establishing trust between the two parties, especially when the exporters and importers are not related and are in far-off places.
“If you are a buyer located in Australia and I am a supplier in India, you will open an LC through your bank which will come to my bank. This LC will say that if I supply this much product by this date, then you will ensure the payment. My bank gives an instruction to your bank and your bank gives me the money,” he says.
Process
Explaining the process, Sahai says after the importer goes to his bank (issuing bank) to issue an LC, the exporter’s bank (advising bank) checks its authenticity and sends it to the importer.
Once the exporter has received confirmation that the importer’s bank will pay for the shipment, he will get the goods ready for dispatch, along with the necessary documents such as bill of lading. These will be sent to a negotiating bank (an international bank as a middle man) which will verify if the consignment has indeed been shipped, following which it will send these documents to the issuing bank.
Once the issuing bank gets a verification from the importer, it will pay the agreed amount to the exporter.
While the process can be done online, both Sahai and Dawar say it is better to be done in physical presence as the importer has to give some security.
“You can avail it online also but, basically when you are opening a letter of credit at your bank, the responsibility of payment is with your bank. So, if the other side is not defaulting, then the bank is duty bound to make the payment. Therefore, you often have to give some kind of guarantee, maybe a fixed deposit or some other payment,” he says.
While there are different types of LCs such as confirmed LC, unconfirmed LC, transferable LC and revolving LC, among others, Sahai says the most common ones are revocable and irrevocable LCs.
As the name suggests, an irrevocable LC is one that cannot be revoked once it has been issued. An exception here works only when both the parties ask for a modification, says Dawar.
This is one of the reasons he says that both parties must ensure there are zero mistakes in this process. “From spelling names to delivery date timeline, there is almost no room for error in this process as it can harm the trust building process and the other side might lose confidence in the trading contract,” he says.
Sahai says before finalising the LC, the exporter should go through the issued LC to make sure it is viable.
“Go through the terms of LC and if you think that any term is written vague or any term cannot be implemented, please make an advance request for change of LC, because once you accept it, then you will have to abide by it,” he adds.
