LETTER OF CREDIT CITD SEMINAR Tuesday, June 22nd, 2004.

LETTER OF CREDIT LETTER OF CREDIT CITD SEMINARCITD SEMINAR

Tuesday, June 22nd, 2004Tuesday, June 22nd, 2004

MethodsMethods of of PaymentPayment

Methods of Methods of PaymentPayment

Cash in AdvanceCash in Advance

Letters of CreditLetters of Credit

Documentary Documentary CollectionCollection– Sight/Time DraftsSight/Time Drafts– aka D/P, D/Aaka D/P, D/A

Open AccountOpen Account– Risk mitigation:Risk mitigation:

» Export Credit InsuranceExport Credit Insurance» Standby L/C’sStandby L/C’s

L /C

Cash in AdvanceCash in Advance Importer pays Exporter Importer pays Exporter

prior to shipmentprior to shipment

Exporter has no risk of non-Exporter has no risk of non-payment or non-acceptancepayment or non-acceptance

Importer has risk that Importer has risk that exporter will not ship the exporter will not ship the goods as orderedgoods as ordered

Used occasionally for small Used occasionally for small amounts, new customers, amounts, new customers, one-time salesone-time sales

ImporterExporter

Goods

Letters of CreditLetters of CreditProtects the interests of both Protects the interests of both the Importer and the Exporterthe Importer and the Exporter

Exporter is assured payment Exporter is assured payment provided terms of L/C are metprovided terms of L/C are met

Importer is assured terms of L/C Importer is assured terms of L/C have been met before she is have been met before she is required to payrequired to pay

Used for larger amounts, higher Used for larger amounts, higher credit risks, sometimes credit risks, sometimes mandatedmandated

L / C

Documentary Documentary CollectionsCollections

Exporter routes documents through Exporter routes documents through banking channels, where they are banking channels, where they are held for payment or acceptanceheld for payment or acceptance

Exporter Exporter’s Importer’s Exporter Exporter’s Importer’s ImporterImporter

Bank Bank BankBank

Less costly than a L/C and Less costly than a L/C and avoids tying up Importer’s line avoids tying up Importer’s line of creditof credit

Average of 2 - 4 weeks for Average of 2 - 4 weeks for exporter to collect on a sight exporter to collect on a sight draftdraft

Consignment IssuesConsignment Issues Used for lower risk customersUsed for lower risk customers

Goods

Open AccountOpen AccountExporter ships goods and Exporter ships goods and

bills the bills the importer for payment at importer for payment at sight or at a future datesight or at a future date

Importer has use of funds, no Importer has use of funds, no product risk product risk

Exporter has risk of non-Exporter has risk of non-paymentpayment

Risk can be shifted through Risk can be shifted through credit insurance, standby L/C’s credit insurance, standby L/C’s

Used for well-established Used for well-established customers with good creditcustomers with good credit

Goods

Invoice

net 30

Letters of Letters of Credit Credit

Types of Letters of Types of Letters of CreditCredit

TradeTrade– ImportImport– ExportExport

StandbyStandby

Definition of a Definition of a Trade Trade

Letter of CreditLetter of Credit A letter addressed to a A letter addressed to a

beneficiary (exporter) by a bank beneficiary (exporter) by a bank (issuing bank)(issuing bank)

wherein the bank undertakes, on wherein the bank undertakes, on behalf of an applicant (importer)behalf of an applicant (importer)

to effect payment to the to effect payment to the beneficiary for merchandise beneficiary for merchandise shipped or services performedshipped or services performed

provided that the beneficiary provided that the beneficiary presents the required presents the required documents in compliance with documents in compliance with the terms of the letter of creditthe terms of the letter of credit

Documents Documents Common to an Common to an

Export L/CExport L/C

Commercial InvoiceCommercial Invoice Packing ListPacking List Bills of LadingBills of Lading Certificate of OriginCertificate of Origin Other Certificates: Quality, Other Certificates: Quality,

InspectionInspection Beneficiary StatementsBeneficiary Statements

1.1. Importer and Importer and Exporter Exporter enter into a enter into a sales sales agreementagreement

AgreementExporter Importer

2.2. Importer applies Importer applies for a for a letter of credit letter of credit with the with the Issuing Issuing BankBank

Application

Issuing Bank

Importer

3.3. Issuing Bank Issuing Bank advises advises the letter of the letter of credit to credit to U.S. Bank, U.S. Bank, usually via usually via SWIFTSWIFT

Letter of

Credit Issuing BankU.S.

Bank

L / C

SWIFT

4.4. U.S. Bank U.S. Bank authenticates authenticates the the

L/C and advises L/C and advises L/C L/C to Beneficiary to Beneficiary

U.S. Bank

Letter of Credit

Beneficiary

5.5. Exporter prepares Exporter prepares thethedocuments and documents and ships ships the goodsthe goods

Goods

Exporter

Goods

Importer

6.6. Exporter sends Exporter sends shipping shipping documents to documents to U.S. Bank U.S. Bank for for examinationexamination

Documents

Exporter

FBM

U.S. Bank

7.7. Assuming cleanAssuming clean documents,documents, U.S. U.S.

Bank pays Bank pays exporter by exporter by debiting debiting Issuing Issuing Bank’s account or Bank’s account or upon upon receipt of funds from receipt of funds from a a separate reimbursing separate reimbursing bank. Documents sent to bank. Documents sent to

Issuing Bank.Issuing Bank.

Exporter

U.S. Bank

Documents

Issuing Bank

8.8. Issuing Bank examines Issuing Bank examines documents and documents and

delivers delivers to to importer importer against against payment. payment. Importer Importer takes takes possession of possession of goods goods by presenting by presenting documents.documents.

Documents

Issuing Bank

Importer

Goods

Docs

9.9. The exporter has been The exporter has been paid, the importer has paid, the importer has their goods, the banks their goods, the banks have been reimbursed, have been reimbursed,

and and the cycle is the cycle is complete!complete!

Agreement

Application

Letter of

CreditDocuments

Letter of

Credit

Documents

Documents

Exporter

Issuing Bank

U.S. Bank

Goods

Importer

Special Uses ofSpecial Uses ofLetters of CreditLetters of Credit

Bankers’ Bankers’ AcceptancesAcceptances

On a time draft, the bank on On a time draft, the bank on whom the draft is drawn whom the draft is drawn commits to pay the face commits to pay the face amount at maturity by amount at maturity by stamping “Accepted” stamping “Accepted” across the draft . across the draft .

If the exporter wishes If the exporter wishes early early

payment, the accepting payment, the accepting bank may discount the bank may discount the draft and pay the exporter draft and pay the exporter at sight. at sight.

U.S. Bank can offer you very U.S. Bank can offer you very

competitive rates for BA’s if competitive rates for BA’s if the draft is drawn on us!the draft is drawn on us!

Standby Letter of Standby Letter of CreditCredit

Standby L/C’s are an Standby L/C’s are an irrevocable commitment irrevocable commitment issued by a bank for a issued by a bank for a stated time period stated time period

to pay a beneficiary a to pay a beneficiary a stated amount of money stated amount of money

upon presentation of upon presentation of specified documents specified documents stating that the applicant stating that the applicant did not fulfill their did not fulfill their contractual obligations.contractual obligations.

Transferable Letters of Transferable Letters of CreditCredit

– Often used by an export Often used by an export intermediary to pay a intermediary to pay a vendor or producer vendor or producer

– The L/C may be transferred The L/C may be transferred only once, but there may only once, but there may be several partial be several partial ‘transferees’‘transferees’

– VendorVendor controls controls presentation of presentation of documents to bankdocuments to bank

– Intermediary may Intermediary may substitute his own invoice substitute his own invoice and draft, but it still may and draft, but it still may be difficult for the vendor be difficult for the vendor and buyer to remain and buyer to remain unknown to each otherunknown to each other

Assignment of ProceedsAssignment of Proceeds

– Similar to Transferable L/C in Similar to Transferable L/C in that it is commonly used by that it is commonly used by an export intermediary to an export intermediary to pay a producer or vendorpay a producer or vendor

– IntermediaryIntermediary (beneficiary) (beneficiary) controls document controls document presentation, not the presentation, not the vendor, allowing him/her to vendor, allowing him/her to keep information on the keep information on the vendor out of the paperworkvendor out of the paperwork

– Vendor relies on Vendor relies on intermediary for proper intermediary for proper presentation / performance presentation / performance under the terms of the L/C under the terms of the L/C before funds will be remitted before funds will be remitted to themto them

Confirmations ofConfirmations ofExport Letters of Export Letters of

CreditCredit

ConfirmedConfirmed - A second - A second bank, usually in the bank, usually in the exporter’s country, exporter’s country, guarantees the guarantees the obligation of the issuing obligation of the issuing bank, providing an extra bank, providing an extra layer of protection - layer of protection - especially important if especially important if the country or the the country or the issuing bank is issuing bank is considered risky.considered risky.

More on More on Confirmations ...Confirmations ...

Gives the greatest degree of Gives the greatest degree of payment payment protection and an protection and an immediate payment source, immediate payment source, provided the documents are clean.provided the documents are clean.

Added cost, normally to the Added cost, normally to the exporter.exporter.

Exporter must instruct the importer Exporter must instruct the importer to have the L/C issued with a request to have the L/C issued with a request for confirmation.for confirmation.

The confirming bank makes a credit The confirming bank makes a credit decision based on the credit of the decision based on the credit of the issuing bank and the country risk. issuing bank and the country risk. Approval will depend also on Approval will depend also on availability under an established line availability under an established line of credit.of credit.

Adding a Adding a confirmation or confirmation or engagement to engagement to

purchase purchase documents:documents:

Agreement

Application

Letter of

Credit

Letter of

Credit

Documents

Documents

Exporter

Issuing Bank

Advising Bank

Documents

Goods

Importer

Faxpor

t

Confirm. Bank

Benefits of Letters of Benefits of Letters of CreditCredit

To the To the Exporter:Exporter:

Payment Payment protection protection

Reliance on Reliance on issuing bank’s issuing bank’s credit rather credit rather than buyer’sthan buyer’s

Rapid, local Rapid, local source of source of repayment, if repayment, if payable at a payable at a U.S. bankU.S. bank

To the To the Importer:Importer:

Documentary Documentary evidence that the evidence that the ordered goods ordered goods have been have been shipped on timeshipped on time

Assurance that Assurance that necessary necessary clearance clearance documents will be documents will be providedprovided

Payment deferred Payment deferred until goods are until goods are shipped and shipped and documents documents presented (use of presented (use of funds)funds)