Home Knowledge Base International Trade Importance of Letter of Credit-LC

Importance of Letter of Credit-LC

The letter of credit considers the most secure payment method for both consignees and consignors in international trade. Importance of Letter of Credit-LC is highly recognized due to factors like unknown business partners, different law governing in different countries, and the distance between business partners are major reasons for the letter of credit to pays a crucial role in trade.

The LC has its own terms to name parties involved in the letter of credit. The consignee becomes the client and the consignor is the beneficiary. The client’s bank is the issuing bank and the beneficiary’s bank is the advising bank.

LCThe consignee of the business has the utmost power to open the bank through his/her bank. Consignee’s bank defines as the issuing bank as they are responsible to issue the LC. The opener should have the money in the bank account adequate for the payment amount mentioned in the letter of credit. Most of the banks tend to provide loans to open the LC if the opener is trustworthy and has a good banking history.

The consignee can prepare the LC draft and send it to the consignor’s bank or the advising bank for their confirmation on the details in it. The advising bank shares the draft with the consignor to get the approval. If they have no issue, same will communicate to the issuing bank to issue the final Letter of Credit. If consignor needs to change anything in the draft, advising bank communicates same to issuing bank until both parties agree on the details in the letter of credit. By opening the Letter of Credit, issuing bank guarantee the funds availability of consignee to the consignor.

Once the draft is approved by both parties, one party cannot change the terms and conditions, or any data related to the shipment without the concession of the other party. This is well known as the “irrevocability”. So, with the LC shipper or the consignor has a bond with the advising bank and consigner create a bond with his/her issuing bank. With this, both parties get the protection from their respective bank for the transaction.

Importance of Letter of Credit

Sometimes issuing bank and advising bank use an intermediary bank calls negotiating bank to coordinate the activities between issuing and advising bank. The service of the negotiation bank uses when there are communication barriers between issuing and advising banks.

The confirming bank supports to evaluate and confirm the letter of credit. If parties in the LC decide to use another bank as issuing bank, they can use another bank too. In the absence of the confirming bank, issuing bank act as the confirming bank.

The consignor is bound to ship the cargo before the latest shipment date and courier the clearance documents to the consignee prior to the agreed date. By failing to do so can cause penalties. The LC can open under at sight or as deferred payment. The issuing bank is responsible to transmit the invoice value mentioned in the LC to the consignor’s account upon the maturity date. The advising bank is responsible to share all agreed documents with the issuing bank.

According to the Uniform Customs and Practices or UCP, the letter of credit has a standard format. Its rules and regulations are fixed despite the bank you open the LC. The article 3 in UPS also explain on the “Irrevocability”.

The letter of credit is legal in nature and UCP backup the security involved with the LC. Its legal protection encourages business partners to use LC as well as give the confidence to engage in new businesses with new business partners.

Having a good payment history is a plus for the consignee when need a credit facility from a bank.

You have to remember, the letter of credit is an international payment method. It only speaks on the payment and documents related to the payment. If there is an issue with cargo, the consignee has to deal it under the breach of sales of goods contract. Or any contract between the consignee and consignor.

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