Top Stories: InternationalKnow Your Basics:A SIMSREE Finance Forum Initiative | Issue 30FIN-O-PEDIA Let’s Talk FI NANCE!!SYDENHAM INSTITUTE OF MANAGEMENT STUDIES, RESEARCH &ENTREPRENEURSHI P EDUCATION2012 Know Your Basics: Overnight Index Swaps Letter Of Credit
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Banks issue letters of credit to ensure sellers that they will get paid as long as they fulfilconditions agreed upon.
Letters of credit are commonly used in international transactions because the bank acts as
a link between buyer and seller i.e. importers and exporters use letters of credit as a way
to protect themselves. It acts as a mode of communication between two parties. Issuing
bank may have a funding bank in country of exporter.
The bank will only issue a letter of credit after ensuring credibility of Importer from its
end. Some buyers have deposit enough to cover the letter of credit, and some customersuse a line of credit with the bank. Sellers must trust that the bank issuing the letter of
credit is legitimate.
Documentary Terms
Following terms are commonly used in L/C:
Applicant - the buyer in a transaction(Importer)
Beneficiary - the seller or ultimate recipient of funds(Exporter)
Issuing bank - the bank that promises to pay (Importer’s Bank)
Advising bank - helps the beneficiary use the letter of credit( Bank in exporter’s
country)
Payment Process
A seller only gets paid after performing specific actions that the buyer and seller agree to.
For example, the seller needs to deliver product or service to buyer in order to satisfy
requirements for the letter of credit. Once the merchandise/service is delivered, the seller
receives documentation proving about delivery. The letter of credit now must be paid
even if something happens to the merchandise. Seller will submit documents with Issuing
bank through advising bank. Documents represent ownership of goods.
To pay on a letter of credit, banks simply review documents proving that a seller
performed his required actions. They do not worry about the quality of goods or other
items that may be important to the buyer and seller.