Q:What are the documents required under letter of credit. Discuss various kinds of letter of credit
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A Letter of Credit (LC) is a crucial financial instrument used in international trade to ensure that payments are made securely and efficiently. It involves various documents that must be presented by the seller to the bank in order to receive payment. Below is an outline of the documents typically required under a Letter of Credit and a discussion of the various kinds of letters of credit.
Documents Required Under a Letter of Credit
The specific documents required can vary depending on the terms stipulated in the letter of credit. However, the following documents are commonly required:
- Commercial Invoice:
- This document provides details of the transaction, including the description of goods, quantities, prices, and total amount due. It serves as the primary request for payment.
- Bill of Lading:
- A key shipping document issued by the carrier that serves as proof of shipment and ownership of goods. It outlines the terms and conditions of transport.
- Insurance Certificate:
- This document certifies that insurance coverage has been obtained for the shipment. It typically includes details about the policy, coverage amount, and types of risks covered.
- Packing List:
- A detailed list of the contents of the shipment, including the packaging details, weights, and dimensions. It helps in verifying the goods upon receipt.
- Certificate of Origin:
- This document certifies the country in which the goods were manufactured or produced. It may be required by customs authorities for tariff purposes.
- Export License:
- If applicable, an export license permits the seller to export the goods. It is especially important for regulated or controlled items.
- Inspection Certificate:
- This document may be required to prove that the goods meet the quality standards or specifications set forth in the letter of credit. It is often issued by an independent inspection agency.
- Transport Documents:
- Any other relevant transport documents, such as an airway bill for air freight, may be required, depending on the mode of shipment.
Various Kinds of Letters of Credit
Letters of credit can be classified into several types based on their features and the nature of the transaction. Here are the most common types:
- Revocable and Irrevocable Letters of Credit:
- Revocable Letter of Credit: Can be amended or canceled by the buyer without the seller’s consent. It offers less security to the seller.
- Irrevocable Letter of Credit: Cannot be changed or canceled without the agreement of all parties involved. This type provides greater security for the seller.
- Confirmed and Unconfirmed Letters of Credit:
- Confirmed Letter of Credit: Involves a second bank (usually in the seller’s country) that adds its guarantee to the LC issued by the buyer’s bank. This provides additional security to the seller.
- Unconfirmed Letter of Credit: Only the buyer’s bank is responsible for the payment, which may pose a higher risk for the seller, especially if the buyer’s bank is less reputable.
- Sight and Usance Letters of Credit:
- Sight Letter of Credit: Payment is made immediately upon presentation of the required documents. This type is typically used when immediate payment is preferred.
- Usance Letter of Credit: Allows for deferred payment, where the seller receives payment after a specified period (e.g., 30, 60, or 90 days) following the presentation of documents.
- Standby Letter of Credit:
- A backup payment mechanism used primarily for securing a loan or guaranteeing performance. It is often used in cases where the primary contract fails, and the standby LC ensures payment to the beneficiary.
- Red Clause and Green Clause Letters of Credit:
- Red Clause Letter of Credit: Allows the seller to receive an advance payment before shipping the goods, based on a specified amount or percentage.
- Green Clause Letter of Credit: Similar to the red clause but requires the seller to provide proof of shipment before receiving the advance.
- Transferable Letter of Credit:
- This type allows the seller (beneficiary) to transfer some or all of the credit to another party (second beneficiary). It is useful in cases where the original seller acts as an intermediary.
- Back-to-Back Letter of Credit:
- Involves two letters of credit: one issued to the seller by the buyer and another issued to the final supplier by the seller. It is typically used in trade financing when the intermediary does not want to use their funds to pay suppliers.
Conclusion
A Letter of Credit is a vital financial tool that provides security and facilitates international trade transactions. The various documents required under an LC ensure that both parties meet their contractual obligations, while the different kinds of letters of credit cater to specific needs and risks associated with international trade. Understanding the types of letters of credit and their respective features can help businesses choose the most appropriate method for securing transactions and mitigating risks.