Confirmation Fee

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24 January 2018

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:

Issuing bank isk
Country risk
Value of the letter of credit
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

By

Ozgur Eker (CDCS)

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23 January 2018

0

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

By

Ozgur Eker (CDCS)

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23 January 2018

0

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.

Why Letters of Credit are Expensive Comparing to Other Payment Methods?

Banks play a key role in letters of credit transactions.

This is the main reason, why letters of credit are so expensive comparing to other payment methods.

Issuing banks open letters of credit for the account of applicants and in favor of the beneficiaries.

Issuing banks have to bear certain amount of risks, when they open letters of credit. They also let the applicants are benefited from their credit worthiness.

As a commercial institution, issuing banks provide these services only for one reason. To earn more money, to make more profit.

Similarly, confirming banks collect fees from the letter of credit parties for the same reason.

When confirming a letter of credit, confirming banks may have to bear substantial amount of non-payment risk.

As a result, confirmation fees can sometimes be climbing to high values.

As I have indicated on my previous posts, in a typical letter of credit transaction an advising bank, a nominated bank, a reimbursing bank may exist in addition to that an issuing bank and a confirming bank.

Every additional bank means additional fees and additional costs for either applicants or beneficiaries.

Who Should Pay Bank Charges in a Letter of Credit Transaction?

This question can be answered either by looking at the rules or by looking at the real life situations, because what rules say is not what is really happening on practice.

UCP 600’s article related to charges of letters of credit is article 37 c: “A bank instructing another bank to perform services is liable for any commissions, fees, costs or expenses (“charges”) incurred by that bank in connection with its instructions. If a credit states that charges are for the account of the beneficiary and charges cannot be collected or deducted from proceeds, the issuing bank remains liable for payment of charges.”
In real life situations, the applicant pay only the issuing bank’s charges and remaining bank charges will be paid by the beneficiary unless the beneficiary is in a very strong position against the applicant. One must look at field “71B: Charges” in a letter of credit text, which is issued in swift format, to understand how bank charges are allocated to the letter of credit parties.

Examples :

Issuing bank charges will be paid by the applicant and all other charges will be paid by the beneficiary:

Field “71B: Charges: “ALL BANKING CHARGES OUTSIDE BRAZIL ARE FOR BENEFICIARY’S ACCOUNT.” This letter of credit issued by a Brazilian bank.
Field “71B : Charges and Fees: “OTHER THAN THE ISSUING BANKS ARE FOR THE ACCOUNT OF THE BENEFICIARY. ISSUING BANK’S CHARGES ARE FOR THE ACCOUNT OF THE APPLICANT.”

What are the Major Types of Letter of Credit Fees?

L/C 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.

Confirmation and Confirmed Letter of Credit

By

Ozgur Eker (CDCS)

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22 January 2018

0

When an irrevocable letter of credit is issued, the risk of payment rests with the issuing bank. This type of letter of credit is defined as an unconfirmed letter of credit.

However, in certain circumstances, the exporter may find the issuing bank not fully trustworthy and/or the country where it is located has high political or economic uncertainty.

In this situation, the exporter should consider requesting a confirmed letter of credit.

Confirmation is a security tool for the exporters. Confirmation eliminates country risks and insolvency risk of the issuing bank.

With a confirmed letter of credit, another bank, the confirming bank, usually located in the same country that the exporter is located, will add its confirmation to the letter of credit.

By adding its confirmation, the confirming bank undertakes to honour the exporter’s claim under the letter of credit, provided all terms and conditions of the letter of credit are met. (1)

What are the benefits of a confirmed letter of credit?

As I have discussed earlier, there are some risk factors exist for each party in a letter of credit transaction.

When we look at the risk issue from the beneficiary’s perspective, we will observe two main risk factors that beneficiaries must bear; the country risk and the insolvency risk of the issuing bank.

Confirmation can be seen as a security mechanism, which works in favor of the beneficiary to eliminate these two risk factors.

What is a confirmation?

Let us look at the definitions of confirmation and confirming bank from the UCP 600;

“Confirmation means a definite undertaking of the confirming bank , in addition to that of the issuing bank, to honour or negotiate a complying presentation.”

“Confirming bank means the bank that adds its confirmation to a credit upon the issuing bank’s authorization or request.”

As can be seen on the above definitions, confirming bank adds its undertaking to the letter of credit in addition to that of the issuing bank.

In this way, the beneficiary receive a second payment guarantee from another bank.

Insolvency risk of the issuing bank is eliminated by addition of this second payment guarantee to the letter of credit.

Mostly, the confirming bank and the beneficiary are located in the same country.

If this is the case, the country risk of the issuing bank is eliminated, because a bank which locates in the same country with the beneficiary adds its payment undertaking to the letter of credit in addition to that of the issuing bank.

Key Points of a Confirmed Letter of Credit

After discussing the benefits of the confirmation in a letter of credit transaction, let us examine the key points that need to be taken into consideration regarding the confirmed letter of credit.

Only irrevocable letters of credit can be confirmed.
During the issuance phase of a letter of credit, the issuing bank should “authorize or request” the potential confirming bank to add its confirmation to the letter of credit.
No bank can be forced to add its confirmation to any letter of credit.
If a bank is authorized or requested by the issuing bank to confirm a credit but is not prepared to do so, it must inform the issuing bank without delay and may advise the credit without confirmation. (UCP 600 article 8 ii-d)
Confirming a letter of credit does not mean that confirming bank is obligated to confirm any subsequent amendment or amendments.
A confirming bank is irrevocably bound to honour or negotiate as of the time it adds its confirmation to the letter of credit. (UCP 600 article 8 ii-b)

Sources:

A Guide to Letters of Credit, TD Securities, page: 24

Availability of Letters of Credit

By

Ozgur Eker (CDCS)

-

22 January 2018

0

According to letter of credit rules, a credit must state whether it is available by sight payment, deferred payment, acceptance or negotiation. (UCP 600 – Article 6- b)

What does availability mean in a letter of credit transaction?

In documentary credit terminology, availability refers to the availability of the documents in exchange for the payment of the amount stated in the letter of credit.

UCP 600 defines four availability options;

Sight payment
Deferred payment
Acceptance
Negotiation

Sight Payment:

Sight payment refers to the payment which is made as soon as the complying presentation is acknowledged by the issuing bank or the bank nominated in the letter of credit.

The nominated bank fulfills its payment obligation with recourse basis.

Which means that the nominated bank can demand the amount paid to the beneficiary back, in case of documents are found non-complying by the issuing bank.

Nominated bank’s payment obligation is not strict; as oppose to the issuing bank’s payment obligation or the confirming bank’s payment obligation.

UCP 600 states that a nominated bank is not obligated to accept the nomination directed to itself, unless the nominated bank informs its acceptance of nomination expressly to the beneficiary.

Even in this situation, UCP 600 assumes non-payment by the nominated bank and describe the roles of the issuing bank and the confirming bank, when nominated bank refuses to make payment to the beneficiary.

Example: The nominated bank receives the documents Monday, May 2. On May 5 the bank decides, after examining the documents, that they comply with the terms and conditions of the LC and makes the payment value date Monday, May 9. (Source: Documentary credits, collections and bank guarantees, page: 15)

Deferred Payment:

Deferred payment refers to the payment which is made after a period of time that is specified also in the letter of credit.

The payment period is usually determined as specific number of days after the date of presentation or the date of the transport document.

Bill of exchange or draft is not required under deferred payment.

Example: The LC is payable 60 days after loading the goods on board the ship. The nominated bank receives the documents on May 2. On May 5 the bank decides, after examining the documents, that they comply with the terms and conditions of the LC. According to the bill of lading the goods were loaded on board April 12. The bank is obligated to pay the beneficiary on June 11. (Source: Documentary credits, collections and bank guarantees, page: 15)

Acceptance:

Acceptance refers to acceptance of a bill of exchange, which is drawn on the bank mentioned in the letter of credit, to be presented along with the other required documents and payment at the maturity.

Negotiation:

Let us check the definition of the negotiation from the UCP 600 in order to understand the term more clearly.

Negotiation means the purchase by the nominated bank of drafts (drawn on a bank other than the nominated bank) and/or documents under a complying presentation, by advancing or agreeing to advance funds to the beneficiary on or before the banking day on which reimbursement is due to the nominated bank. (UCP 600 – Article 2)

As can be seen from the above definition, any letter of credit which is available by negotiation could be issued in a way so that a draft may or may not be required.

Also, the payment of the letter of credit may or may not be at sight.

If the nominated bank advance or agreeing to advance funds to the beneficiary, before it receives reimbursement from the issuing bank the negotiation condition is fulfilled.

This can be happened in two different ways.

How does a negotiable letter of credit work?

First option is possible under a letter of credit which is available by sight payment, when the nominated bank reimburse the beneficiary before it receives funds from the issuing bank.

Second possibility occurs when a letter of credit is available by negotiation requesting presentation of a time draft, while the nominated bank reimburses the beneficiary before the maturity date of the bill of exchange.

Letter of Credit Transaction

By

Ozgur Eker (CDCS)

-

20 January 2018

0

On my previous posts, I have not only made a definition of a letter of credit, but also clarified its types and parties that involved in it.

You can also check the risks associated with letters of credit and sample letters of credit from my past posts.

On this post, I will try to explain letter of credit process in a very simple way.

After reading this article, you should understand the working mechanism of letter of credit payment in general terms.

How do documentary letters of credit work?

Documentary letters of credit cover the shipment of commercial goods, they can also cover business services.

On receipt of an acceptable documentary letter of credit the exporter will ship the goods, then send the trade documents to the importer’s bank.

Assuming they are in order, the importer’s bank affects payment, regardless of whether or
not the importer is able to or wishes to make payment. (1)

Letter of Credit Transaction

The starting point of the letter of credit process is the agreement upon the sales terms between the exporter and the importer. Afterwards, they sign a sales contract. It is important to stress here that a letter of credit is not a sales contract. Actually, letters of credit are independent structures from the sale or any other contract on which they may be based. Therefore, it should be kept in mind that a well-structured sales contract protects the party, which behaves in goodwill against various kinds of risks.
After the sales contract has been signed, the importer (applicant) applies for its bank having the letter of credit issued. The letter of credit application must be in accordance with the terms of the sales agreement.
As soon as the importer and its bank reach an agreement together, the importer’s bank (issuing bank) issues the letter of credit. In case the issuing bank and the exporter (beneficiary) are located in different countries, the issuing bank may use another bank’s services (advising bank) to advise the credit to the exporter (beneficiary).
The advising bank advises the letter of credit to the beneficiary without any undertaking to honor or negotiate. The advising bank has two responsibilities against to the beneficiary. Advising bank’s first responsibility is satisfy itself as to the apparent authenticity of the credit and its second responsibility is to make sure that the advice accurately reflects the terms and conditions of the credit.
The beneficiary should check the conditions of the letter of credit, as soon as it is received from the advising bank. If some disparities have been detected, the beneficiary should inform the applicant about these points and demand an amendment. If letter of credit conditions seem reasonable to the beneficiary, then beneficiary starts producing the goods in order to make the shipment on or before the latest shipment date stated in the L/C. The beneficiary ships the order according to the terms and conditions stated in the credit.
When the goods are loaded, the exporter collects the documents, which are requested by the credit and forwards them to the advising bank.
The advising bank posts the documents to the issuing bank on behalf of the beneficiary.
The issuing bank checks the documents according to the terms and conditions of the credit and the governing rules, which are mostly latest version of the UCP. If the documents are found complying after the examination, then the issuing bank must honor the payment claim. The issuing bank transmits the documents to the applicant, after securing its funds. (Letter of credit amount, expenses and profits)
The applicant uses these documents to clear the goods from the customs.

Sources: A guide to documentary letters of credit, Lloyds TSB Commercial, dlcguide/0109, page :1

Risks in Letters of Credit

By

Ozgur Eker (CDCS)

-

17 January 2018

0

Documentary credit is an essential part of the export process.

The documentary credit system has been used for over a hundred and fifty years, and still
plays a major role in international trade.

Letters of credit have been estimated to represent more than US$100 billion in banking obligations annually.

At least 60 per cent of commodity trading is conducted through letters of credit.(Source: Documentary Risk in Commodity Trade, UNCTAD/ITCD/COM/Misc.31, Page:1)

Although letter of credit is a balanced payment method in terms of risk issues for both exporters and importers, each letters of credit party bears some amount of risk; higher or lower.

As I have explained on my previous post, letters of credit transactions are handled by banks, which make banks one of the parties that bears risks in l/c transactions in addition to exporters and importers.

Risks in letters of credit can be discussed under four groups; general risks, risks to the applicant, risks to the beneficiary and risks to the banks.

On this post each risk group will be examined in detail with in real life examples.

General Risks in Letters of Credit:

Country Risk: (Political Risk)

The first risk factor that can be mentioned in the general risks group is the country risk or the political risk.

Let us assume that we are an exporter located in a country X and we have a customer from the country Y.

Our customer, which is from the country Y, opened a L/C in favor of us. We have checked the L/C conditions and they seem workable.

We have produced and shipped the order as per the L/C and transmit the required documents to the issuing bank before the expiry date.

The issuing bank found our presentation complying and informed us that they will be honoring our payment claim at the maturity date.

However, before the maturity date due Country Y has changed its export regime, which makes it impossible for the issuing bank to honor our presentation.

This illustrative is a good example of a country risks.

Other examples of country risks are mass riots, civil war, boycott, sovereign risk and transfer risk.

Country Risk Example: During Libyan Civil War in year 2011, hundreds of exporters could not receive their payments as international community blocked Libyan Government’s funds in major currencies such as US Dollars and Euros.

Fraud Risk:

As we have described before all conditions stated in a letter of credit must be connected to a document, otherwise banks will disregard such a condition.

In addition, banks deal with only documents but not goods, services or performance to which the documents may relate.

This feature of the letters of credit is the source of the fraud risk at the same time.

As an example, a beneficiary of a certain letter of credit transaction can prepare fake documents, which looks complying on their face, to make the presentation to the issuing bank.

As the documents are complying on their face, the issuing bank may honor the presentation and in this case, the applicant must pay to the issuing bank for the goods it will never be receiving.

Beneficiaries of L/Cs are also open to significant amount of fraud risks.

This happens if an applicant issues a counterfeit letter of credit. In this case, the beneficiary never receives its payment for the goods it has shipped.

Fraud Risks Example: UK steel giant, which was very close to bankruptcy at the time when the business occurs, has received funds under a letter of credit issued from Algeria via fake documents.

Risks to the Applicant:

In a letter of credit transaction, main risk factors for the applicants are non-delivery, goods received with inferior quality, exchange rate risk and the issuing bank’s bankruptcy risk.

Risks to the Beneficiary:

In a letter of credit transaction, main risk factors for the beneficiaries are unable to comply with letter of credit conditions, counterfeit L/C, issuing bank’s failure risk and issuing bank’s country risk.

Risks to the Banks:

Every bank in a L/C transaction bears risks more or less. The risk amount increases as responsibility of the bank increases.

Parties to Letters of Credit

By

Ozgur Eker (CDCS)

-

16 January 2018

0

This page deals with the parties of the letter of credit.

Main parties of a typical letter of credit transaction are applicant, beneficiary, issuing bank, confirming bank, nominated bank, advising bank and reimbursing bank will be discussed in this article.

Each L/C party will be presented briefly and its roles and responsibilities will be explained with the help of the graphic illustrations.

Applicant

Applicant is the buyer of the goods or services supplied by the seller.

Letter of credit is opened by the issuing bank as per applicant’s request. However, applicant does not belong one of the parties to a letter of credit transaction.

This is because of the fact that letters of credit are separate transactions from the sale or other contract on which they may be based.

Beneficiary

Beneficiary is the seller of the goods or the provider of the services in a standard commercial letter of credit transaction.

Letter of credit is opened by the issuing bank in favor of the beneficiary.

Beneficiaries will be eligible to receive payment under both commercial and standby letters of credit, as long as they make complying presentations.

Issuing Bank

Issuing Bank is the bank that issues a letter of credit at the request of an applicant or its own behalf.

Issuing bank undertakes to honor a complying presentation of the beneficiary without recourse.

Which means that issuing banks must pay the letter of credit amount to the beneficiaries, if complying presentation has been made.

Nominated Bank

Nominated bank is the bank with which the credit is available or any bank in the case of a credit available with any bank.

Nominated banks play a key role determining whether or not the documents are presented within the allowed period or not.

nominated bak — Figure 4 : Nominated Bank. Definition, roles and responsibilities in a letter of credit transaction.

Advising Bank

Advising bank is the bank that advises the credit at the request of the issuing bank.

An advising bank that is not a confirming bank advises the credit and any amendment without any obligation to honor.

By advising the credit or amendment, the advising bank signifies 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.

Confirming Bank

Confirming bank is the bank that adds its confirmation to a credit upon the issuing bank’s authorization or request.

Confirming bank may or may not add its confirmation to a letter of credit. This decision is up to confirming bank only.

However, once it adds its confirmation to the credit confirming is irrevocably bound to honor or negotiate as of the time it adds its confirmation to the credit.

Even if the issuing bank fails to honor, confirming bank must pay to the beneficiary.

Reimbursing Bank

Reimbursing Bank shall mean the bank instructed and/or authorized to provide reimbursement pursuant to a reimbursement authorization issued by the issuing bank.

Reimbursing Bank is the settlement bank between the issuing bank and the nominated bank or the confirming bank.

If letter of credit currency is USD, reimbursing bank is usually located in US. If letter of credit currency is EUR, reimbursing bank is generally located in Germany.

Types of Letters of Credit

By

Ozgur Eker (CDCS)

-

15 January 2018

0

Have you ever heard any of the following trade finance terms and wonder their meanings: red clause, confirmed, standby, irrevocable.

These are the terms that are used to describe different types of letters of credit.

On this post, I will discuss the types of letters of credit.

Types of Letters of Credit

Traveler’s letters of credit, which were commonly used in eighteenth and nineteenth century, were the first financial instruments that contain very similar characteristics with the contemporary letters of credit.

From traveler’s letters of credit days to today’s complex global economy, the letters of credit have been performing their duties as a secure and reliable payment method.

Furthermore, in all of these years, the letters of credit provide a very flexible structure that has proven itself to meet the needs of different parties in international trade.

Letters of credit can be classified under two main categories: Commercial letters of credit and standby letters of credit.

Commercial Letters of Credit

Commercial letters of credit are mainly used as a primary payment tool in international trade.

Commercial letter of credit is the correct type of credit that should be used when an importer pays transaction amount directly to an exporter via letter of credit.

Majority of commercial letters of credit are issued subject to the latest version of UCP (Uniform Customs and Practice for Documentary Credits).

Letter of credit rules are published by a non-governmental international institution called ICC (International Chamber of Commerce).

Standby Letters of Credit

Commercial letters of credit are primary payment tools that need to be utilized when the beneficiary performs its duties and makes a complying presentation.

As an example, let us consider an exporter who ships the goods according to the sales contract and applies to the nominated bank for the payment.

If the nominated bank decides that the presentation is conforming to the terms and conditions of the credit and the UCP rules, then the exporter will be paid.

In standby letters of credit, the opposite scenario is valid.

A payment is made to the beneficiary of a standby letter of credit when the principal can’t fulfill his obligations.

As an example, let us consider a construction company which has been awarded with a tender.

If the construction company can’t fulfill its obligations under the project contract, the beneficiary of the standby letter of credit can apply to the nominated bank for the compensation.

The nominated bank considers only the terms and the conditions of the standby letter of credit and the rules governing the credit when deciding a complying presentation.

One point that needs to be stressed is that standby letters of credit have their own rules, which are called The International Standby Practices 1998 (ISP 98).

These rules are also published by ICC. However, a standby letter of credit can be issued subject to either the UCP or the ISP.

Revocable Letters of Credit

Under a revocable letter of credit, the issuer can either amend or cancel the letter of credit any time without prior notice to the beneficiary.

Since revocable letters of credit do not provide any protection to the beneficiary, they are not used frequently. In addition, UCP 600 has no reference to revocable letters of credit.

All credits issued subject to UCP 600 are irrevocable unless otherwise agreed between the parties.

Irrevocable Letters of Credit

Irrevocable Letters of Credit cannot be amended or cancelled without the agreement of the credit parties.

Unconfirmed irrevocable letters of credit cannot be modified without the written consent of both the issuing bank and the beneficiary.

Confirmed irrevocable letters of credit need also confirming bank’s written consent in order any modification or cancellation to be effective.

Unconfirmed Letters of Credit

Unconfirmed Letters of Credit can be described as a letter of credit, which has not been guaranteed or confirmed by any bank other than the bank that opened it.

In these types of credits, the only bank that undertakes to honor a complying presentation is the issuing bank.

Confirmed Letters of Credit

It would be easier to understand the confirmed letter of credit, if we start from the definition of the confirmation.

Confirmation means a definite undertaking of the confirming bank, in addition to that of the issuing bank, to honor or negotiate a complying presentation.

If a letter of credit’s payment undertaking is guaranteed by a second bank, in addition to the bank originally issuing the credit this kind of credit is called confirmed letter of credit.

The confirming bank agrees to pay or accept drafts against the credit even if the issuer refuses to do so. Only irrevocable credits can be confirmed.

Clean Letters of Credit :

Below, you can find two different definitions of a clean letter of credit.

A letter of credit payable upon presentation of the draft, without any supporting document being required.(www.businessdictionary.com)

L/C that does not require any document other than a written demand for payment by its beneficiary. In effect, a draft. (www.intracen.org)

Clean letters of credit are issued only by the request of the highest credit standing companies.

It is suitable for variety of commercial situations where no movement of goods is expected. Historically these types of credits have been used in traveler’s letters of credit.

Today direct pay standby letter of credit can be given as an example of clean letters of credit.

There are also some other form of letters of credits which deserve special attention.

We will discuss them by one by more in detail, however; you can find short description of each of them below.

Transferable Letters of Credit

Transferable letter of credit is a documentary credit that is issued with the option to allow a trader to transfer its rights and obligations to a new supplier.

Back-to-Back Letters of Credit

Arrangement in which one irrevocable letter of credit serves as the collateral for another; the advising bank of the first letter of credit becomes the issuing bank of the second L/C.

Unlike transferable letters of credit, there are two separate letter of credits exist in back-to-back letter of credit transactions.

Advance Payment (Red Clause) Letters of Credit

Letter of credit that carries a provision (traditionally written or typed in red ink) which allows a seller to draw up to a fixed sum from the advising or paying-bank, in advance of the shipment or before presenting the prescribed documents.

What is Letter of Credit

By

Ozgur Eker (CDCS)

-

15 January 2018

0

Letter of credit, in a broad perspective, is one of the payment methods in international trade.

The letter of credit is distinguished itself from other payment methods in international trade by its complex structure and detailed rules.

Some of the other payment methods in international trade are Cash-in-Advance, Documentary Collections and Open Account.

All of these payment methods inherit different risk levels for exporters and importers.

For example, if you choose Open Account payment method as an exporter, you will have to burden almost all of the non-payment risk by yourself, unless you secure the payment with another guarantee such as export credit insurance.

Perhaps, letter of credit is the only payment method, which has a balanced risk structure for both parties, namely exporters and importers.

Important Note: Bank Payment Obligation (BPO) has similar functions like letter of credit, but not used widely.

Figure 1: Payment Risk Diagram

international payment methods and risk levels — Source: https://www.trade.gov/media/publications/pdf/tfg2008ch1.pdf

As I have explained above, letters of credit can limit the risks of both importers and exporters.

However, how can letters of credit achieve a balanced payment status?

Letters of credit can balance the risks of both exporters and importers, because responsibility of L/C operations is given to a third party, to the banks.

I will explain this later on in detail. But now it is time to make a definition of a letter of credit.

Definition of a Letter of Credit:

“Credit means any arrangement, however named or described, that is irrevocable and thereby constitutes a definite undertaking of the issuing bank to honour a complying presentation.” (UCP 600, article 2)

Above letter of credit definition is taken from the UCP 600 (Uniform Customs and Practice for Documentary Credits) which is the latest version of the rules published by ICC (International Chamber of Commerce ) regulating the letters of credit operations all around the world.

Role of the ICC and UCP in Letters of Credit

International trade is exchange of capital, goods, and services across international borders between people whom belong to different languages, cultures and laws.

As letters of credit are a payment method of international trade it is obvious that standardized rules are needed to govern letters of credit in a global scale to make sure that letters of credit transactions run smoothly.

ICC, International Chamber of Commerce, is the organization that publishes the standardized rules. The rules, which are called UCP, Uniform Customs and Practice for Documentary Credits, are revised regularly.

At the time of this text is written sixth version of the UCP rules is in force.

Videos Explaining Letters of Credit:

HSBC Trade Academy | Export Letter of Credit

In this first article, we have understood what letter of credit is, its definition, the rules that apply to them and the organization that publishes these rules.

In the next article, I will examine types of letters of credit.

NewsPaper

Understanding the Confirmation Process and Confirmation Fee Reasoning:

Determinants of a Confirmation Fee:

Examples of Confirmation Fees:

Who should pay confirmation fees?

Why Banks Apply Advising Fees?

Who Should Pay the Advising Fee?

Amendment Advising Fee:

L/C Advising Commission Samples:

Why Letters of Credit are Expensive Comparing to Other Payment Methods?

Who Should Pay Bank Charges in a Letter of Credit Transaction?

Examples :

What are the Major Types of Letter of Credit Fees?

What are the benefits of a confirmed letter of credit?

What is a confirmation?

Key Points of a Confirmed Letter of Credit

Sources:

Sight Payment:

Deferred Payment:

Acceptance:

Negotiation:

Letter of Credit Transaction

General Risks in Letters of Credit:

Risks to the Applicant:

Risks to the Beneficiary:

Risks to the Banks:

Applicant

Beneficiary

Issuing Bank

Nominated Bank

Advising Bank

Confirming Bank

Reimbursing Bank

Types of Letters of Credit

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