LETTER OF CREDIT (LC)
The ICC (International Chambers Of Commerce) in the UCPDC (Uniform Custom Practices for Documentary Credit) defines LC (Letter of Credit) as:
“An arrangement, however named or described, whereby bank (the Issuing Bank) acting at the request and on the instructions of the customer (the applicant) or on its own behalf:
a) is to make a payment to or to the order of a third party(beneficiary) or is to accept bills of exchange(drafts) drawn by the beneficiary), or,
b) Authorizes another bank to effect such payments or to aceept and pay such bills of exchange(drafts), or,
c) Authorizes another bank to negotiate against stipulated documents provided that the terms are compiled with.”
Or in simple words, LC can be characterized as “an arrangement of Making Payment against Documents”. Banks in India normally opens Import LC under following circumstances:
Ø When a resident in India is importing goods into India.
Ø When a resident merchant trader is purchasing goods from one country, for sale to another country, for purpose of merchandising trade.
Ø When an Indian exporter who is executing a contract abroad requires importing goods from a third country to the country where he is executing the contract.
The inter-bank communication and transaction in LCs take place through SWIFT (Society for Worldwide Inter-bank Financial Telecommunication) network. SWIFT is industry owned cooperative supplying secure messaging services and interface software to over 7,000 financial institutions in 196 countries.
SWIFT messages are preset and referred to by category numbers called MT numbers. For example, MT300’s only deal with Forex transactions, MT800’s deal with Traveler’s cheques, etc. Each type of message in each category is preset as well. For instance, there are 89 different messages available under category 0f MT500.
How LC is a “Source of Earning for Bank”
Letters of credit are used nowadays primarily in international trade transactions of significant value, for deals between a supplier in one country and a wholesale customer in another.
From the bank's point of view, the LC they have issued can be called upon at any time (subject to the relevant terms and conditions), and the bank then looks to reclaim this from the applicant.
Banks earn commission from the applicant for making payment on his behalf to his exporter. Commission charged by Bank, on opening of LC or at the amendment is to be realized Upfront and no refund is being allowed. Commission charges concerned with LC(Bank normally) are given as follows:
1. Commitment charges At the time of opening of LC, commission of 0.15% is charged for every quarter and part thereof
2. Usance charges
Name of the Item
Rate of interest
For Bill Upto 10Days sight
For Bills upto 3months
For Bills over 3months
0.30% for first 3months+0.10% per month in excess of 3 months sight