Letter of credit is a very popular international payment method in import and export activities because it is safer than some other payment methods. What is the procedure for opening a letter of credit (LC)? How is the payment process? This article will answer those questions for you.
1. What is a Letter of Credit?
Letter of credit (L/C) is a payment method with the participation of a bank to ensure that international purchases take place more securely.
In simpler terms, a letter of credit is a letter of commitment from the bank to pay the exporter. The individuals involved in the payment by letter of credit include the buyer, the seller and the bank.
2. Main content of letter of credit (L/C)
Typically, a letter of credit will have the following basic contents:
2.1 Credit number
All letters of credit must have its own number, in order to facilitate the exchange of letters, telegrams in the execution of the letter of credit, or recorded in the relevant document in the payment documents. letter of credit.
2.2 Date of opening letter of credit (L/C)
Opening a letter of credit will show the ability of the importer to pay before the exporter. Therefore, the exporter sees the letter of credit with peace of mind to deliver the goods. Meanwhile, importers are always hesitant to open letters of credit because they don’t want to be detained/deposited in the bank early.
Therefore, the two parties should clearly agree on the time of opening the letter of credit, as well as the responsibility for the delay in opening the letter of credit, leading to late delivery and penalties for late opening the letter of credit in the sales contract.
2.3 Place of issue of letter of credit (L/C)
Where the issuing bank undertakes to pay the beneficiary. This location is very important as it relates to the reference to national law dealing with letter of credit disputes.
2.4 Names and addresses of persons involved in the letter of credit (L/C)
Merchants: Claimant, Beneficiary
Banks: Issuing bank, confirming bank, advising bank
Agencies and organizations: The agency that issues relevant documents such as: Ministry of Trade, Chamber of Commerce and Industry, Customs authority, etc.
2.5 Amount, currency, quantity, unit price (Credit currency and amount ) of the letter of credit (L/C)
The amount of the letter of credit (L/C) is both written in numbers and in words and must be consistent with each other. Also, the name of the currency should be clear.
2.6 Validity period of letter of credit (L/C)
The period within which the opening bank undertakes to pay the exporter presenting the documents within that period and in accordance with the conditions stated in the credit. The validity period of the letter of credit starts from the date of opening of the letter of credit to the expiry date of the letter of credit.
2.7 Payment term of letter of credit (L/C)
Is the time to pay immediately or pay later. This completely depends on the provisions of the contract. The payment term may be within or outside the validity period of the letter of credit (L/C).
2.8 Shipment period in the letter of credit (L/C)
The delivery term is stated in the L/C and is determined by the sales contract. The delivery term is closely related to the validity period of the L/C.
In addition, in the L/C, it is necessary to have more documents such as commercial invoice, packing slip, cargo insurance, bill of lading, certificate of animal quarantine or certificate of plant quarantine, etc. ..
3. Letters of Credit (L/C)
Here are some common types of Letters of Credit:
+ Confirmed letter of credit (Confirmed L/C)
Revocable Letter of Credit (Revocable L/C)
+ Revolving Letter of Credit
+ Irrevocable Letter of Credit (Irrevocable L/C)
+ Transferable letter of credit (Transferable L/C)
+ Back to Back L/C
Red Clause L/C Letter of Credit
Standby Letter of Credit
+ Reciprocal Letter of Credit (Reciprocal L/C)
4. Letter of Credit Payment Process
The letter of credit implementation process will be carried out sequentially according to the following steps (related to the responsibility of each party to the letter of credit).
Step 1: The importer will ask the bank to open a letter of credit (L/C).
Step 2: The bank opening the letter of credit will base on the application file to consider opening the letter of credit (L/C) and send a notice to the bank advising the letter of credit.
Step 3: The advising bank checks the letter of credit (L/C) and sends it back to the exporter
Step 4: The exporting party delivers the goods to the importer according to the terms of the letter of credit (L/C).
Step 5: The exporting party completes the documents of the shipment, notifies and sends it to the bank advising the letter of credit.
Step 6: The bank advising the letter of credit checks and sends the set of documents to the bank opening the letter of credit
Step 7: The bank opening the letter of credit checks the legitimacy of the documents, if the information is appropriate, it will proceed to pay the bank advising the letter of credit.
Step 8: The advising bank confirms the money received to the exporter
Step 9: The bank opening the letter of credit sends back the set of documents to the importer
5. Advantages and disadvantages of letter of credit payment method
5.1 Advantages of payment of letters of credit in import and export activities For sellers (exporters)
The bank will be responsible for paying in accordance with the terms of the L/C, regardless of whether the importing party pays or not.
The delay in transferring documents and records will be limited.
Customers can discount letters of credit to receive funds in advance.
For the importing party
Only when it is certain that you have received the goods, will you pay.
There is an assurance from the seller that the payment must be made in accordance with the provisions of the L/C, if there are any problems, the seller will be responsible.
There is an assurance from the seller that the payment must be made in accordance with the provisions of the L/C, if there are any problems, the seller will be responsible.
For the bank
Service fee (L/C opening fee, money transfer fee, payment fee…).
There are opportunities to expand international trade relationships, build reputation in the hearts of customers.
5.2 Disadvantages of payment of letters of credit in import and export activities
The most notable disadvantage is that L/C is not an absolutely safe form of payment, because the payment is based on the transaction of written documents. Payment based on written documents leads to the following limitations:
Expensive document costs; The bank must check the accuracy of the documents; Manual testing will have many errors; Slow payment speed; Easy to face risks in payment, disputes occur; The funding and payment chains have not been linked together yet…
Above is all information related to letter of credit (L/C) for import and export activities. If you have any questions, please contact DAT directly, our staff is always ready to serve you.