Letter of Credit (LC) is an international trade finance-related document issued by a bank. It is of utmost importance when it comes to providing a secure framework for buyer-seller interactions across borders. This financial document helps ensure seamless payment exchange once the terms of trade mentioned in the bank letters of credit are fulfilled. However, despite the importance of this crucial financial document, it has several complexities while documenting them. Today, we are going to give brief information on navigating the complex documentation process of a letter of credit.
4 Key Players in an LC Transaction
Certain key players facilitate smooth and secure international trade transactions. It is their responsibility to ensure both the buyer and seller are protected by the bank letters of credit. Moreover, they also ensure that the specified terms of the Letter of Credit are met in accordance with the agreed-upon conditions. Here are the four key players:
- Importer/Buyer
The importer, or the buyer, is the party that initiates the Letter of Credit. They are the entity seeking to purchase goods or services from an overseas seller. Here, the buyer agrees to pay the seller for the successful delivery of goods and compliance with the terms and conditions of bank letters of credit.
- Exporter/Seller
The entity shipping the goods or providing the services is the exporter or the seller. They expect to receive payment once the Letter of Credit requirements are fulfilled.
- Issuing Bank
The issuing bank is a crucial player in an LC transaction. The buyer’s bank is responsible for issuing the bank letters of credit. It acts as the guarantor for payments smoothly and securely.
- Advising Bank
The advising bank operates from the seller’s side. It serves as an intermediary between the seller and the issuing bank. Their primary role is to authenticate the bank Letters of Credit. Once verified, the advising bank notifies the seller of the existence of the LC. This notification provides the seller with the assurance that a valid and genuine LC has been issued in their favour.
Apart from these four major key players in an LC transaction, there is an additional entity known as confirming banks. They are included as per applicability and help by providing an extra layer of security for payments. Now, let us move forward to understand what are the required documents to bank letters of credit for carrying out international trade transactions.
Documents Required for an LC Transaction
- Commercial Invoice
This document, necessary to obtain the Letter of Credit, contains important details about the goods or services being sold. It may include information like quantity, price, and total value. This piece of document serves as the primary reference for the transaction.
- Bill of Lading or Airway Bill
A BoL, also known as a bill of lading, is a document for shipping goods across borders. It acts as evidence that the goods have been shipped. This document from bank letters of credit contains information about the destination of export/import, what goods are being transported, and the terms of shipment.
- Packing List
This is an itemised list of shipping contents of each package with their details. It may include individual quantity, weight, and dimensions. Such essential documents, necessary for bank Letters of Credit, help in verifying that the goods received match what was ordered.
- Insurance Certificate
Often, a certificate is issued to insure while exporting overseas. This document acts as evidence that the goods are insured during transit. It basically protects against loss or damage.
- Certificate of Origin
It is a certificate that confirms the country where the goods originate. It may be necessary for customs and tariff purposes.
- Bill of Exchange or Draft
This is a payment instrument often used in Letter of Credit transactions, where the seller can request payment at a specified future date.
Having the above-mentioned documents is not only essential but also imperative for secure bank Letters of Credit transactions. Now, let’s see how it works.
How Does LC Transactions Work?
There is a structured process when it comes to a letter of credit usage. Here is how it works:
- Initiation
The process begins when the buyer and seller agree to use an LC for their transaction. The buyer’s bank, known as the issuing bank, is then approached to issue the LC.
- Terms and Conditions
It is a formal document outlining the specific terms and conditions that the seller must meet to receive payment. It includes details like the quantity and description of goods, their price, shipment method, or any other required documents.
- Presentation of Documents
The seller prepares and ships the goods as per the agreed-upon terms. Afterwards, they provide the necessary documents to their bank, known as the confirming bank. It can be a commercial invoice, bill of lading, packing list, etc.
- Verification
The advising or confirming bank reviews the documents to ensure they comply with the terms of the Letter of Credit. If everything is in order, the bank forwards the documents to the issuing bank.
- Payment
The issuing bank makes the payment to the seller after verifying if the documents meet the specified criteria. The funds are then transferred to the advising or confirming bank, which passes them on to the seller.
- Transfer of Goods
With payment secured, the seller then releases the goods to the buyer.
Decoding LC Documents
The complexity of understanding the Letter of Credit documentation is a critical skill for businesses engaged in international trade. By understanding the key players and important documents, businesses can easily prepare for LC transactions. This knowledge helps make transactions smooth and build trust between trading partners. So, if you are looking for banks that help secure trade transactions or obtain an LC (e.g., transferable Letter of Credit, revocable LC, etc.), consider HDFC Bank. Among many financial institutions, HDFC Bank stands as a trusted partner for international trade and LC documentation support. For detailed information, visit the website today!