For the purpose of ensuring the timely payment of the buyer to the seller, the Bank issues a Letter of Credit to the buyer. As a guarantee on behalf of the buyer, it ensures that the buyer pays the seller in full, as per the defined timeline. In the case that the buyer is unable to repay the amount to the seller on time, the bank will pay on his or her behalf.
Requirements for documentation
A Letter of Credit application requires the following documents:
- A duly filled out application form with a passport-sized photograph is required
- (Passports, voter ID cards, Aadhar cards, driving licenses, etc.) for applicants, co-applicants, partners, directors
- An exchanged bill
- Invoice for goods or services
- Authentication Certificate
- Original certificates of health insurance and health care
- Documents related to the buyer’s finances
- Documents related to packing, shipping, and transportation
- A landing airway bill, a cargo receipt, etc.
- Documents related to commercial transactions – Certificates of Incorporation
- Buyer’s/seller’s official documents
- The lender may require any other document
BG vs. LC: what’s the difference?
BGs are very similar to Letters of Credit, but their main difference is that the process of the letter of credit will continue even if the buyer fails to make payment. If the transaction does not perform as planned, the bank reduces the loss incurred, in the case of a BG.
How Term Loans and Letters of Credit differ
An EMI is a repayment plan of a lump sum amount borrowed to be repaid over a defined period of time. transferable letter of credit is a credit or loan limit issued by a bank to a borrower in which small amounts from the total sanctioned limit may be withdrawn by the borrower. Unlike a loan, a letter of credit is backed by the bank, whereas a loan requires no guarantor.
Involved Parties in a Letter of Credit
- An applicant is the buyer (importer) of the goods and services on whose behalf a letter of credit is issued
- Issuing banks are Indian banks that hold accounts where the applicant holds a letter of credit, and they guarantee that they will pay on the applicant’s behalf.
- A letter of credit is issued to the seller of goods or services in whose favor it is issued. Generally, the beneficiary is a business partner of the applicant overseas. He or she exports the goods and receives payment later.
- Advising banks are international banks that verify the authenticity of letters of credit and inform exporters and recipients
- Exporters who receive or negotiate documents under a line of credit with their bank are identified as Nominated Banks by the Indian bank. The Indian bank authorizes the Nominated Bank to accept and negotiate the documents on their behalf.
A consumer must provide certain documents to the issuing bank (Indian Bank) in order to obtain a letter of credit. A letter of credit guarantees that if the buyer cannot make the payment, the seller will receive the payment. If this happens, the bank may be at risk, but an advisory bank (Indian Bank) can assist, paying on behalf of the issuing bank if needed.
It Generally, commercial and standby letters of credit can be divided into two types: commercial is a primary instrument, and standby is a secondary instrument.
Frequently Asked Questions
Letters of credit carry what risks?
As a result of a Letter of Credit, there are several risks involved:
- The non-delivery of goods
- Products of low quality
- The exchange rate for goods
- There is no return option
- The bankruptcy risk of a bank
- Concerns about currency exchange rates
- The alteration of Letters of Credit by fraud.
How much do banks charge for Letters of Credit?
A bank’s interest rate for a letter of credit differs from case to case depending on the volume of business, the nature of the business, the relationship between the bank and the buyer, the financial stability of the buyer, and the type of goods.