Letter of Credit Fees

How to Cancel a Letter of Credit?

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How to Cancel a Letter of Credit?

According to the letter of credit rules, a letter of credit should be issued in an irrevocable form, as a result it cannot be cancelled without the written consent of the beneficiary.

Definition of Irrevocability Concept and Its Effects on Cancellation of Letters of Credit:

According to letter of credit rules, a credit can neither be amended nor cancelled without the agreement of the issuing bank, the confirming bank, if any, and the beneficiary.

Letter of credit is a conditional payment method, which means that the payment can be made only against a complying presentation, but the terms and conditions of the credit cannot be amended or else cannot be cancelled by the issuing bank without the consent of the beneficiary.

As a result issuing banks cannot cancel letters of credit by themselves alone.

In order to cancel a letter of credit, an issuing bank has to receive a written declaration from the beneficiary certifying that the letter of credit will not be utilized.

If the letter of credit has been confirmed by another bank, the confirming bank’s written declaration should also be received before the cancellation.

cancellation letter of credit

How to Cancel a Letter of Credit?

There are two ways to cancel a letter of credit.

Actually the first scenario should be treated as a “termination” rather than a “cancellation”.

Cancellation of a letter of credit which is not utilized by the beneficiary within the validity period:

Every letter of credit must have a expiry date and place.

If the beneficiary elects not to use the letter of credit within the validity period, which starts with the issuance of the letter of credit and ends with the expiry date, the letter of credit will be no longer valid.

This type of cancellation should be called as termination of letter of credit by the beneficiary.

What are the factors that may have forced the beneficiary to terminate the letter of credit?

There would be couple of factors that leads to termination of an L/C. Below you can find some reasons of termination that I can think of.

  • The unit prices may have increased too much since the opening of the letter of credit and the beneficiary may perceive the transaction not profitable any more.
  • The beneficiary may find the terms and conditions of the letter of credit not doable.
  • Beneficiary may not be able to find required finance to perform under the letter of credit.

Cancellation of a letter of credit by the beneficiary’s written declaration within the validity period of the letter of credit:

As explained above an irrevocable letter of credit cannot be cancelled without the written consent of the beneficiary and the confirming bank, if any.

As a result, a letter of credit cancellation process should be started with the beneficiary’s written declaration.

This can be done by a letter which is issued by the beneficiary and sended direct to the issuing bank or else a swift message send by the advising bank to the issuing bank.

Case Study : Can the Issuing Bank Cancel the L/C by Himself on the Grounds That Bad Quality of Goods?

Summary: The letter of credit was issued by National Import Bank in Saudi Arabia for USD 5,500,000 allowing partial shipments.

It was planned under the sales contract that the goods will be loaded via 5 partial shipments of each equals to USD 1,100,000.

Letter of credit was available with a nominated bank located in Germany by payment. The nominated bank in Germany just advised the credit without adding its confirmation.

Additionally the nominated bank did not make any payments to the beneficiary. Its role was rather an advising bank’s role under this transaction.

The beneficiary made the 1st shipment and received the payment from the issuing bank.

On the 2nd shipment beneficiary did not get any payment from the issuing bank, although there was no advice of refusal received.

Later on the beneficiary received following message from the issuing bank via the nominated bank ‘Goods are defective, as stated by the buyer, the said L/C is cancelled.’

————————————-Message Header——————————————
Swift OUTPUT FIN 700 Issue of a Documentary Credit
Sender : NATIONALXXX
NATIONAL IMPORT BANK, THE (HEAD OFFICE) JEDDAH SAUDI ARABIA
Receiver : EXPORTXXX EXPORT BANK OF GERMANY (ALL GERMANY OFFICES) MUNICH GERMANY
————————————–Message Text ———————————————-
27 : Sequence of Total
1/1

40A : Form of Documentary Credit
IRREVOCABLE

20 : Documentary Credit Number
NATIONAL01022015

31C : Date of Issue
150102

40E : Applicable Rules
UCPURR LATEST VERSION

31D : Date and Place of Expiry
150622 GERMANY

50 : Applicant
THE NATIONAL IMPORT BANK A/C OF AL-TAJ SOAP FACTORY CO. P.O.BOX 2037 JEDDAH 21451 K.S.A

59 : Beneficiary – Name & Address
WIND TURBINES EXPORTER OF GERMANY D-28199 BREMEN, GERMANY

32B : Currency Code, Amount
Currency : USD (US DOLLAR)
Amount : #5.500.000,#

41A : Available With…By… – BIC
EXPORTXXX BY PAYMENT

43P : Partial Shipments
PARTIAL SHIPMENTS ARE ALLOWED

43T : Transhipment
TRANSSHIPMENTS ARE ALLOWED

45A : Description of Goods &/or Services
5 SETS OF WIND TURBINES

Answer: The letter of credit cannot be cancelled by the issuing bank by himself on the grounds that bad quality of goods. Only a court order could stop issuing bank to pay for the complying documents.

What happens if court stops payment of an irrevocable, confirmed letter of credit which is payable 90 days after sight due to low quality of goods?

How Much Does It Cost to Open a Letter of Credit?

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letter of credit issuance fees

On this page, I will try to explain the letter of credit issuance costs, and the main factors that are effecting them.

Letter of credit is a secure payment method comparing to other payment options in international trade.

However, letter of credit has one clear disadvantage. It is expensive.

There are multiple banks in action in a letter of credit transaction, and each bank demands a fee for its each action.

Typical letter of credit fees demanded by banks are as follows:

  • Letter of Credit Issuance Fee: This is the amount demanded by the issuing bank to open a letter of credit.
  • Advising Fee: A type of letter of credit fee, which is demanded by the advising bank to advise the credit to the beneficiary.
  • Discrepancy Fee: The issuing bank discount a certain sum of money from the proceeds of the letter of credit, if the beneficiary has presented discrepant documents.
  • Confirmation Fee: This is the fee, that is taken by the confirming bank to adding its confirmation to the credit.
  • Amendment Fee: If the letter of credit is amended, the issuing bank and/or the confirming bank may demand amendment fees.
  • Handling Fee: Handling fees are collected by banks for a variety of reasons, such as sending swift messages, holding documents, set of photocopy documents not presented etc.
  • Reimbursement Fee: Reimbursement bank’s fee to settle the credit amount between issuing bank and the confirming bank or the nominated bank.

Letter of credit opening cost change case per case, as the costs associated with the letter of credit issuance are effected from various factors.

What are the Main Factors Effecting Letter of Credit Issuance Costs?

  • Issuing Bank Charges: Issuing a letter of credit is a commercial act and banks open L/Cs in order to make profit.
  • Letter of Credit Amount: Banks determine letter of credit issuance charges in percentage of the letter of credit amount. Higher the L/C amounts, higher the charges.
  • How Letter of Credit is Financed? Importers can finance the letter of credit amount either via cash or trade finance loans. Cash backed letter of credit is expected to be cheaper than the loan backed letter of credit.
  • Payment Term: As the payment period is getting longer, the letter of credit issuance fees are getting higher. The longer the payment due, higher the fees.
  • How Letter of Credit Charges are Shared Between the Importer and the Exporter: How total letter of credit cost is shared between the importer and exporter may differ from one letter of credit to another.

How Letter of Credit Charges are Shared Between the Importer and the Exporter

How Much Does It Cost to Open a Letter of Credit?

Example: A German food importer wants to import cacao from Ivory Coast via an at sight letter of credit.

The German importer applies his bank, which is Deutsche Bank, to open a letter of credit in favor of the exporter.

Deutsche Bank’s import letter of credit issuance cost can be found on this document.

Letter of credit amount is 100.000 Euro and the time between the issuance of the letter of credit and the payment to the exporter is 3 months.

The letter of credit is issued in irrevocable format and all fees outside of the Germany will be paid by the exporter.

Minimum letter of credit issuance cost to the importer for this example is 625 Euro. (Irrevocability fee 200 Euro + Issuance of a letter of credit fee 125 Euro + Acceptance of documents fee 300 Euro)

How to Deal with High Banking Commissions under Letters of Credit?

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high letter of credit fees and commissions

No matter how many advantages letters of credit have, they have one big disadvantage. They are expensive.

As a result, you should understand your costs before finalizing a letter of credit deal.

Letter of credit is a secure payment method in foreign trade. But this comfort of security comes with a price.

Letters of credit are one of the most expensive international payment methods available on the market.

As a result, exporters find themselves in a dilemma, when negotiating the terms of the business conditions.

Question is simple but not easy to answer; either choosing an expensive but relatively secure payment method or choosing a risky but less expensive payment method.

What are the Main Letter of Credit Fees That Exporters Have to Pay?

It is really hard to answer this question. Because what rules say is different than what the daily practice dictates.

  • According to the Rules: The issuing bank must pay all banking commissions as per UCP 600, which is the latest ICC rules of documentary credits.
  • Real Life Situations: The applicant pays the letter of credit issuance charges, but all other l/c costs will be collected from the beneficiary.

Bank Commissions That Exporters Normally Have to Pay:

  • Courier Fee / Postage Fee
  • Advising Fee
  • Discrepancy Fee
  • Handling Fee / Negotiation Fee
  • Amendment Commission
  • Confirmation Fee
  • Reimbursing Bank Charges

Real Life Example :

I would like to share a real life bank commissions example below.

These bank fees were collected from a British exporter under a letter of credit transaction. As you can see, the exporter had to pay 487 GBP to the banks as letter of credit fees.

Total transaction amount was only 1890 GBP. Letter of credit fees comprised 25% of all transaction amount, and this is unacceptable.

letter of credit bank commissions
Figure 1 : Real life example of bank commissions under a letter of credit transaction.

Suggestions to Eliminate High Banking Commissions Under Letters of Credit Transactions for Exporters:

  • Suggestion 1: Do not use letters of credit in low value transactions. As a general rule of thumb, transaction amounts below 10.000 USD to 15.000 USD can be considered as a low value businesses. Try to use alternative payment methods, instead of letters of credit on these occasions.
  • Suggestion 2: Try to convince your customer, so that the letter of credit fees will be paid by the applicant. Remember, letter of credit rules are on your side.
  • Suggestion 3: The worst case scenario may be is that, you can not find an alternative payment option and your customer does not want to pay letter of credit charges, except for the l/c issuance costs. If this is the situation, then try to learn approximate bank commissions and make sure that you have included at least some of them on your price offer.

Discrepancy Fee

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discrepancy fee

Discrepancy can be defined as an error or defect, according to the issuing bank, in the presented documents compared with the documentary credit, the UCP 600 rules or other documents that have been presented under the same letter of credit.

Discrepancy fee occurs, only when the issuing bank determines that the presentation is not complying.

Issuing banks try to justify discrepancy fee, based on their claim that discrepant documents increase handling costs of issuing banks.

Many trade professionals find these claims unjustified.

Later on this post, you can find the history of the discrepancy fee and how it evolved since its introduction to trade finance word.

But, first of all, I need to explain the usage of the discrepancy fee in letters of credit.

How to Determine, How Much You Have to Pay Due to a Discrepancy Fee, If You Make a Non-Complying Presentation:

Issuing banks must insert discrepancy fee clauses to letters of credit, otherwise they can not demand such fees from beneficiaries.

For this reason, at the first stage, you have to determine, whether or not the letter of credit contains a discrepancy fee clause.

In order to that, you must look at Field 47-A : Additional Conditions.

Discrepancy fee clauses vary from one letter of credit to another in terms of wording. But their structure remains similar. After reading couple of examples, you will be familiarized with them.

Examples of Discrepancy Fees:

  • Discrepancy Fee Format 1: Any set of documents containing discrepancies and presented to us under this documentary credit, will be charged with a fee of USD 50.00 plus telex charge (if any) at final payment. This charge is for account of beneficiary and will be deducted from any proceeds to be paid.
  • Discrepancy Fee Format 2: Discrepancy fee for USD 75.- (or equivalent in l/c currency) plus all relative swift/tlx charges will be deducted from documents value for each presentation of discrepant documents under this credit, notwithstanding any instructions to the contrary.
  • Discrepancy Fee Format 3: If documents are presented with discrepancies and accepted by applicant a fee at the rate of USD 225.

History of the Discrepancy Fees

“As I recall, it all began sometime in the mid-1980s, when banks in US began charging a discrepancy fee – usually about US$25. Over the last decade, this practice spread through the documentary credit world so much that now practically most banks, including some large international banks, engage in this practice. A senior trade finance department manager says: “Now more than 60% of the credits impose discrepancy fees and these credits come from all over the world.” writes Abdul Latiff Abdul Rahim in his article which was published in year 1997 at DCInsight. We have reached 2014 and now almost every letter of credit issued with very little exception contains a discrepancy fee.

Discrepancy fees applied to vast majority of the letters of credit because banks can increase their letter of credit commissions significantly with these kinds of charges.

“Nonetheless, there is a worrying trend whereby more and more items and with higher rates of banking charges are being deducted by banks in the course of L/C transactions. Some of these charges include: opening charges, amendment fees, advising fees, negotiation fees, confirmation fees, transferring fees, reimbursing fees, payment commissions, telex/SWIFT commissions, courier charges, document checking fees, handling charges, discrepancy fees, and commission in lieu of exchange and so on.” Wang Shanlun states in his article published in 2010 at DCInsight.

Unless exporters and importers object these high banking charges in letter of credit transactions, we should expect to see the trend keep going which results higher and higher L/C fees that will be imposing by the banks.

Who Should Pay Discrepancy Fees?

Discrepancy fees are collected from the beneficiaries.

Confirmation Fee

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confirmation fee

Confirmation fee can be defined as charges collected by the confirming banks, against the risks they will be having to posses by confirming the letters of credit.

As I will be explaining below a confirming bank undertakes two main risk factors by adding its confirmation to the letter of credit: default risk of the issuing bank and political risk of the issuing bank’s country.

Basically, the confirmation fee is the ‘risk fee’ taken by the confirming bank.

Understanding the Confirmation Process and Confirmation Fee Reasoning:

Confirmation, is defined as an undertaking from a bank, in addition to the undertaking provided to the beneficiary by the issuing bank.

Beneficiary, by having the letter of credit confirmed to a bank which is located within the same country of himself, would like to eliminate the default risk of the issuing bank as well as political risks of the issuing bank’s country of domicile.

A confirming bank takes the default risk of the issuing bank; as well as non-payment risk of the letter of credit originated from the political risks of the issuing bank’s country.

The confirming bank, irrevocably bound himself to make a payment to the beneficiary against a complying presentation from the moment it has added its confirmation to the letter of credit.

Even if the confirming bank could not receive any reimbursement from the issuing bank, he has to make payment to the beneficiary against a complying presentation under the letter of credit which he has confirmed.

By the way, it is beneficial to remind my readers that a confirming bank could only honour or negotiate a complying presentation.

As a result, the beneficiary has to present complying documents in order to obtain funds under the letter of credit, either from the issuing bank or the confirming bank.

For this reason, the complying presentation is the key for reaching out the payment under both confirmed and unconfirmed letters of credit.

You might be wondering, why a confirming bank would take such risks to confirm a letter of credit.

The correct answer is very simple and straight forward; to make more profit.

Determinants of a Confirmation Fee:

The confirmation fee is subject to arrangement and based on the following:

  1. Issuing bank isk
  2. Country risk
  3. Value of the letter of credit
  4. Validity period of the letter of credit

The confirmation fee is usually difficult to quantify in advance, unless you have managed to establish which bank is to confirm and they have provided the information to you in advance. (1)

Examples of Confirmation Fees:

Confirmation Fee Format 1:

Exporters First Help Bank of New York confirms this credit and hereby undertakes to honor all drafts and documents presented in strict compliance with the credit terms.

Our confirmation charges USD3.120,48.

Confirmation Fee Format 2:

We shall charge our confirmation commission of 4,000000 PCT p.a., min. EUR 200.00 p.q.

p.a. : per annum (12 months or 360 days)
p.q. : per quarter (3 months)

Who should pay confirmation fees?

According to letter of credit rules all fees and charges related to credits should be paid by the applicants.

But we have learned long ago that this perfect world indication is not valid under real life situations.

In most cases applicants pay only letter of credit issuance charges and let the banks collect all the remaining fees from the beneficiaries.

As a result confirmation fees will be paid by the beneficiaries in most cases.

Sources: 1: A Guide to Letter of Credit Charges,  the Institute of Export & International Trade, Reached : 24.Jan.2018

Advising Fee

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advising fee

The act of informing the details of a credit or an amendment to the beneficiary is known as advising under documentary credit transactions.

By advising the credit to the beneficiary, an advising bank certifies that it has satisfied itself as to the apparent authenticity of the credit or amendment and that the advice accurately reflects the terms and conditions of the credit or amendment received.

Charges, that the advising bank demands in exchange for its advising services, is defined as an advising fee. Advising fee is a part of letter of credit fees.

On this post I would like to write about the advising fee.

Why Banks Apply Advising Fees?

Letter of credit is a payment method, which is mainly used in international trade.

As a result of its international character, letter of credit parties, in particular the issuing bank and the beneficiary, are mostly located in different countries.

For this reason, the issuing bank has to use another bank’s services to transmit the credit to the beneficiary.

An advising bank, that advises the credit to the beneficiary, is located in the same country as beneficiary.

The advising bank receives the documentary credit from the issuing bank via swift platform and sends it to the the beneficiary mostly other means of communication.

According to the letter of credit rules, advising bank’s role is simple and its responsibilities are very limited.

By advising the credit to the beneficiary, an advising bank certifies that it has satisfied itself as to the apparent authenticity of the credit or amendment and that the advice accurately reflects the terms and conditions of the credit or amendment received.

Advising fees are originated from above mentioned services, that advising banks perform under the letters of credit transactions.

Who Should Pay the Advising Fee?

According to the letter of credit rules, the issuing bank has to pay the advising fee, but in practice, most of the time, advising fees are being paid by the beneficiaries.

Amendment Advising Fee:

It must be stressed here that not only actual letters of credit, but also any subsequent amendments are subject to advising fees.

Many advising banks charge relatively smaller fees for advising amendments comparing to advising fees related to advise of actual letters of credit.

L/C Advising Commission Samples:

  • Bank of China Singapore : USD 40,00
  • Citibank UAE : AED 150,00
  • Commerzbank Germany : Around EUR 100,00

Letter of Credit Fees

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Letter of credit fees

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Letters of credit have certain advantages as an international payment method.

If you have enough knowledge and expertise on letters of credit field, then you can use them wisely to get paid where no other payment method works.

No matter how many advantages letters of credit have, they have one big disadvantage.

They are expensive.

As a result, you should understand your costs, before finalizing a letter of credit deal.

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