How Open Letter of Credit and it Operates

Letter of credit is a grantee are an assurance on behalf of the importer (opener) in the favor of exporter(Beneficiary) under taking (pledging) the payment provided the merchandise is ship according to term and condition of the contract. Importer and exporter is a known to each other. It is the bank with Letter of credit which brings them close to each other. The importer approaches the bank opening with:

i. Valid import license
ii. Original copy contract
iii. Invoice or indent
iv. Insurance cover not

They give him a printed form. It covers all the documents. It prepares four copies of that. The original copy of letter of credit is sent to the exporter. Another copy is dispatched to his bank (intermediary). The third copy is give to the opener (importer). The fourth one is kept by the opening bank for record. This is how letter of credit opened. The bank also demands “margin requirements” from the importer. It is a percentage of imports value.

Kinds of Letter of Credit

Irrevocable Letter of Credit

If terms and condition of letter of credit could not be cancelled or modified by any party. Letter of credit is irrevocable change can be made with the mutual consent of both the party.

Revocable Letter of Credit

Any party can change or cancelled the contract by informing the other. The terms and conditions of the contract are kept in view.

Confirmed Letter of Credit

The intermediary bank undertakes responsibility of making payment to the exporter in all cases. The importer may be declared insolvent are merchandise is lost or damaged.

Unconfirmed Letter of Credit

The intermediary bank simply commits to pass on the trade document (Bill of lading and bill of exchange) to the importer through his bank. It takes no responsibility of payment.

Red and Green Clauses Letter of Credit

The Letter of Credit with red clause allows the exporter to get advances for the purchases of raw material merchandise and packing etc. Under the green clause he can also get the advance for transit and storage etc.
When the merchandise shipped the exporter get a bill of lading from a shipping company. He also repairs a bill of exchange. All such documents are sent to the importer through his bank. The opening bank gets the bill of exchange endorsed by the importers. It is sent back to the exporter. He can negotiate it from his bank. It is called discounting. The opening bank gets a trust receipt from the importer. It hands over the bill of lading to the importer for the clearance of the goods. The importer clearance the goods and sell it in the market. He deposits the amount to the bank before the expiry period to the bill of exchange. This is how the Letter of Credit operates

Advantages

For International Trade

Importer and exporter are brought closer to each other with Letter of credit . the bank opens the way for international Trade.

For Exporter

The exporter gets advances for the purchases of merchandise packing transit and storage form his bank under the Red and Green Clauses. It also discounts the bill of exchange and provides him finances for trade development.

For importer

The importer gets the delivery of goods without making any payment from his bank against the trust receipt. He sells the goods and extends the market. It helps in keeping the prices stable in both the market.

For Banks


The opening as well as intermediary bank earned commission, interest and profit in all such transaction. The opening bank gets the margin requirement at the opening of Letter of credit. Intermediary hank earns by advancing under green and Red Calluses. It also earned by discounting the bill of exchange.