* LETTER OF CREDIT

LETTER OF CREDIT /DOCUMENTARY CREDITLetter of Credit is an undertaking issued by a Bank (Issuing Bank), on behalf of the buyer (the importer), to the seller (exporter) to pay for goods and services provided that the seller presents documents which comply with the terms and conditions of the Letter of Credit*

*LETTER OF CREDIT UCPDC 600 Edition effective from 1st July 2007Documentary Credit means any arrangement that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honour a complying presentation.

*Complying presentation

a presentation that is in accordance with

the terms and conditions of the credit, the applicable provisions of these rules (UCP 600) and international standard banking practice.

Honour

a. to pay at sight if the credit is available by sight payment.

b. to incur a deferred payment undertaking and pay at maturity if the credit is available by deferred payment.

c. to accept a bill of exchange ("draft") drawn by the beneficiary and pay at maturity if the credit is available by acceptance.

*LETTER OF CREDITThree main contracts underlying LC - Sale Contract between Buyer & Seller - Application-cum-Guarantee between Applicant(Buyer) and Issuing Bank - LC itself (contract between Issuing Bank and Beneficiary/Seller) ( LC independent of other two contracts)

*Mechanics of Documentary CreditCONTRACTDOCSGOODSDOCSNegotiating Bank/Confirming BankReimbursing Bank Advising bank

*Parties to Letter of CreditOpener/BuyerIssuing BankAdvising BankBeneficiary/SellerNominated Bank/Negotiating BankConfirming BankReimbursing Bank

Documents under CreditFinancial documents Drafts (ISBP Para 43 to 56)Transport documents BL, AWB etc (UCP Articles 19 to 27, ISBP Para 68 to 169)Insurance documents Certificate/ policy (UCP Article 28, ISBP Para 170 to 180)Commercial documents Invoices (UCP Article 18, ISBP Para 57 to 67)Miscellaneous documents All other documents Certificate of origin, Packing list, Quality certificate etc.Documents other than invoices, transport and insurance documents are not defined by UCPDCOnly Certificate of Origin dealt with under ISBP Para 181 to 185

*Types of creditSecurity to beneficiaryConfirmed Mode of settlementPayment/ deferred paymentAcceptance NegotiationInvolving middlemenTransferableBack to backInvolving advancesRed Clause CreditGreen Clause CreditInvolving repeated transactionsRevolvingStand by

*Transferable CreditsCredit has to be opened as transferableThe beneficiary is normally a trader or agentHe transfers credit to his supplier - second beneficiary.Transferred by a bank at the request of first beneficiarySecond beneficiary can supply goods and negotiate documents as if he had received the credit.He may pay commission to first beneficiary for the orderThere can be more than one second beneficiary.No third beneficiary is permitted.

*Transferable CreditsThe following parameters may be changed while transferring a creditAmount of credit, unit price and quantity of goodsDate of expiry, last date of shipment and last date of negotiation can be brought forward% of insurance cover may be increased.First beneficiary has the right to substitute documents negotiated by second beneficiary.

*Back to Back CreditsExporter receives a credit from his buyer ( Selling credit)He has to procure goods from other suppliersHe opens a credit for purchase of the goods ( buying credit)Second credit is said to be back to back to the first one.Bill proceeds of the export LC (Selling LC) will be used to meet liabilities under the second (Buying LC)Amount of back to back credit will be lower.Usance period of the back to back credit should be equal to or more than that of the export credit.Bank still at risk if the customer fails to export No concession in margin and security norms.

*Revolving CreditsCredit is opened to cover a series of regular transactions over a longer periodBeneficiary will submit a series of documentsMaximum value of each document will be fixed and is the revolving limitLC amount is the maximum value of documents that can be handled under the credit.The credit may be reinstated automatically or after payment of earlier bill.It can be opened as cumulative or non cumulative.

*Standby Letters of CreditCredit is issued for a particular amount and for a particular periodTrade takes place on running account basis.Beneficiary does not submit documents to bank.If there is a default, he can claim funds from opening bank giving a certificate of defaultNo quibbling over discrepancies and documentsOpening bank will pay on demandWorks like a bank guaranteeUCPDC is applicable if so declared in the credit

*LC RegulationsForeign Trade Policy requirements.FEMA requirements.Credit norms of Central Bank. UCPDC 600 Provisions.Banks Internal Credit Policies/ procedures.Public notices issued by DGFTUniform Rules for bank-to-bank reimbursements 525Incoterms 2010

*Banks Obligation & ResponsibilitiesIssuing Bank (opening bank)( UCP Article 7)-the prime obligator-to ensure credit-worthiness and trust-worthiness of the applicant- Once credit is opened, the bank is placing itself as a substitute for the buyer.

*Banks Obligation & ResponsibilitiesAdvising Bank has the obligation to authenticate the credit once it is received and passing it promptly on to the beneficiary ( Art.9).Confirming Bank takes over the responsibilities of the issuing bank as far as the beneficiary is concerned though it has got recourse to the Issuing Bank (Art 8).

*Banks Obligation & ResponsibilitiesNegotiating Bankto examine docs. Within 5 banking days after receipt of the documents at their counters(Art 14b). to ensure compliance of credit terms ( on the basis of documents alone) as well as consistency of docs with each other.

* Protection to BanksBanks are not responsible :for the genuineness or contents of any documents submitted (Art. 34)For losses etc. arising from transmission problems (Art. 35)Force Majeure ( Art. 36)For the failings of their correspondent Banks (Art. 37)

* Protection to BanksIssuing Bank is responsible for all Bank charges and other costs at home or abroad even if they are supposed to be paid by other party (Art. 37 c).

Applicant is responsible for any adverse consequences of foreign laws (Art. 37d).

*LETTER OF CREDITAppraisal / Assessmentsatisfactory track record.dealings with only one bank. Liabilities of the applicant to the Bank and third parties.Means by which the applicant is expected to meet his commitment once the bills arrive.Margin he should deposit.

*Appraisal Issues..Limit to be commensurate with turnover and CC limits.Should be for genuine trade/ manufacturing activity.Usance period of the LC should ordinarily have relation to the working capital cycle.Level of inventory carried should be commensurate with industry norms / past trends.

*Appraisal Issues.LCs for purchase of machinery / capital goods should be backed by borrowers own funds or a term loan sanctioned for the purpose.

Wherever warranted, in addition to margin, where prescribed, we may also retain a lien on the undrawn portion of the CC limit for the value of bills to be received under the LC.

*Appraisal IssuesSister concerns:Where the opener and beneficiary are sister concerns, LCs should not normally be necessary. Take care of kite-flying operations.Standing of the beneficiary.D/A facilities to applicants of undoubted standing and where security available is much more than the value of LC.

*Appraisal IssuesWhile computing purchase of imported material on LC basis take net of import duty.Assess limits for usance and sight LC separately.Usance period should not exceed the production cycle excepting in the case of bulk imports.Keep in mind the accepted projections regarding Sundry Creditor levels.Margins & security depending on track record.Cash budget monitoring to track availability of funds.

*Appraisal Issues.Revolving LCs:To be valid for not more than 1 yearThe limit should be a sub-limit.The LC value should be restored for further negotiation only after the advice of retirement of the previous bill has been received from the issuing bank by the beneficiary bank.

*ASSESSMENT OF LC LIMITWhile assessing Letter of Credit Limit, the following points need to be noted:Purchases of RM on LC basis should be net of Import Duty; LC amount should cover FOB, CIF or C&F value of goods- should not include customs duty and other charges payable in India. Payment of these charges should be taken care of by the main working capital(CC) A/C of Applicant. Transit time should be treated as Nil if usance period starts from shipment date.

*Other issuesArriving at D.P:Ensure that the stocks covered by bills which have been received under LCs opened by us, and not yet retired, are not included for computing the D.P. in CC account. Devolvement of LCs:In case of irregularity in CC account do not open further LCs.Take adequate margins and step up in case of it becoming a habit in worse cases stop further issues.Mark lien on DP so that usance bills are properly retired on due date.

*Treatment of stocks covered by Usance LC Lien should be earmarked against advance value of stocks for the outstanding usance LC bills. This ensures provision of margins on the stocks covered by usance LCs right from the time the stocks are bought on credit backed by the Banks commitment. Thus, it ensures that the margin is available well before the CC a/c is debited for the matured LC bill.

*Treatment of stocks covered by Usance LCIn some cases it is quite possible that the units may not be in a position to provide margins right from the time of purchases against LCs. In such cases, based on merits, earmarking of lien for the value of usance LC bills outstanding may be permitted against the aggregate market value of stocks (including the LC stocks) instead of against the advance value of securities.

*PrecautionsThe limits for demand LCs and usance LCs should be assessed separately with ample justifications. The usance period should not, generally, exceed the production cycle. In case of bulk imports, establishment of LCs for longer usance period may be considered selectively.When liability under LC is met by creating an irregularity in the Cash Credit account, the relative LC limit should not be released for opening further LCs till the account is adjusted. Frequent Devolvement's: Warning signal!

*Assessment of LC LimitWe assume that:- Annual consumption of material to be purchased under LC C (Rs..)Lead time from opening LC to shipment: L (months)- Transit time: T (months)- Credit (usance) period available: U (months)

*Assessment of LC LimitL+ T+ U = Purchase Cycle: P (months)LC Limit = P x C/12 Say, lead time, i.e. time from order placement to shipment = 10 days Transit period = 20 days Usance period from arrival of goods= 3m Total Purchase Cycle = 4m Monthly consumption of material = Rs 100 lacs LC Limit(4 x 100) = Rs 400 lacs

*ASSESSMENT OF LC LIMIT :M/s XYZ COMPANY LIMITEDLETTER OF CREDIT LIMIT OF Rs. 20 CRORES (Rs. in crores)

Total purchase of Raw Materials (RM)172.64Purchase of RM under LC69.41Average monthly purchase of RM [A]5.78Average usance period [B]3 monthsLead time & transit period [C] 1 monthTotal of [B] & [C] [D]4 monthsRequirement of LC Limit [A] x [D]23.12LC Limit recommended20.00

*Assessment of LC LimitLet us assume as follows: (Rs in lacs) i) Annual purchase of RM: 3200 ii) RM purchase under LC(50%): 1600 iii) Purchase under demand LC: 800 iv) Purchase under usance LC: 800

*Assessment of Demand LC Limit

Time gap from opening till shipment: 1 mTransit period from date of shipment till date of retirement: 0.5 m Demand LC Limit: 800 x 1.5/12 = Rs 100 lacs

*Assessment of Usance LC LimitLead Time, i.e from opening LC till shipment: 1 monthTransit Period, i.e. from date of shipment till date of receipt of documents by importer: 0.5 monthsAverage usance period: 2 monthsUsance LC Limit: 800x3.5/12= Rs 233 lacs

*transferable documentary credit is a credit under which the beneficiary (the first beneficiary) - usually a middleman - may request the nominated bank to transfer credit in whole or in part to the second beneficiary.When transferring the letter of credit the beneficiary transfers his rights to perform under the credit to the third person - usually to a producer of goods. (See scheme.)The middleman has rights to change the following terms and conditions of the letter of credit:reduce the amount of the credit reduce unit price if it is stated make shorter the expiry date of the letter of credit make shorter the last date for presentation of documents make shorter the period for shipment of goods increase the amount of the cover or percentage for which insurance cover must be effected substitute the name of the applicant (the middleman) for that of the first beneficiary (the buyer) Documentary credits are subject to "Uniform Customs and Practice for Documentary Credit" (UCP), International Chamber of Commerce Publication No 500, 1993 Revision.What advantages the transferable letter of credit gives to the customers?To the middleman the transferable letter of creditassures payment for mediation excludes necessity for a credit line gives chance to have the commitment of Nordea Bank Finland Plc to pay, provided Nordea Bank Finland Plc Latvia branch has added its confirmation to the letter of credit To receive more information you are welcome to Nordea Bank Finland Plc Latvia branch. Trade Finance Unit, phone 670196219, fax 67 820 325.*Revolving Letter of CreditWhat is a revolving letter of credit?A revolving letter of credit is a letter of credit where under the terms and conditions the amount is renewed without specific amendments.The revolving letter of credit is issued when the delivery of the goods is made in instalments and at the stipulated intervals.The applicant of the letter of credit (the buyer) requests his bank to add the so-called revolving clause in the letter of credit that can be formulated in different ways. For example, the credit amount USD 10 000.00 is revolving every month for the same amount, for the first time in January, for the last time in May. Maximum amount payable under this credit is USD 60 000.00.Documentary credits are subject to "Uniform Customs and Practice for Documentary Credit" (UCP), International Chamber of Commerce Publication No 500, 1993 Revision.What advantage the revolving letter of credit gives to the customers?To the buyer the revolving letter of creditgives a chance to receive goods by instalment shipments and within definite periods.

*What is a stand-by letter of credit?A stand-by letter of credit is very similar in nature to a bank demand guarantee. Under a stand-by letter of credit the beneficiary can claim payment in the event the principal does not fulfil his obligations.The stand-by letters of credit may be used for many different purposes: instead of documentary credit; as bid bond, performance bond, advance payment guarantee, payment guarantee; to guarantee repayment of loans.A stand-by letter of credit is subject to "Uniform Customs and Practice for Documentary Credit" (UCP), International Chamber of Commerce Publication No 500, 1993 Revision, or "International Standby Practices" (ISP), International Chamber of Commerce Publication No 590, 1998.What is the basic difference between a documentary credit and a stand-by letter of credit?Documentary creditpayment instrument made for utilization short term goods are to be shipped in compliance with the terms and conditions of the letter of credit commercial documents are to be presented with the bank in compliance of the terms and conditions of the letter of credit. Stand-by letter of creditsecurity instrument made for no utilization long term goods are to be shipped in accordance with the sales agreement request is to be submitted stating that the payment has not been made.