CHAPTER EIGHT
THE BASIC LETTER OF CREDIT
• With a letter of credit banks become directly involved by
committing themselves to pay the seller, which enables trade to
take place. In collection the bank’s role is basically only to transfer
funds. A letter of credit is an instrument issued by a bank by which
the bank furnishes its credit, in place of the buyer’s credit.
• The letter of credit is widely used and is regarded as a key bank
product that enables an important amount of international trade to
take place.
• Letters of credit can be either revocable (cayılabilir) or
irrevocable (cayılamaz).
• Irrevocable L/C means it cannot be canceled or changed without
the consent of all parties.
• Beneficiary (exporter, seller)
• The account party (importer, buyer)
• The exporter has to fulfill all the conditions of the L/C before
payment to him can be made (CY 1- C41 forms).
MERCHANDISE CONTRACT
• A letter of credit transaction usually begins after a merchandise
contract, between the buyer and seller has been made. The bank is
not a party of the contract. It only deals with the documents and not
the merchandise. However the L/C should be drawn in strict
compliance with the provisions of that contract. The amount of credit,
the expiration date, the shipping date, the documents to be
presented etc. must be included.
See figure 8.1
• Certain protections for both buyer and seller are inherent in all letters
of credit. The seller knows that it will be paid as soon as it complies
with the terms of the L/C; the buyer knows that no payment will be
made until documents are presented, showing that the shipment has
been made as specified.
APPLICATION FOR AN IMPORTER LETTER OF
CREDIT
• A request for a commercial L/C is similar to an application for a
loan. The bank usually insists that the documents be in negotiable
form so that it obtains title to the documents between the time it
makes payments and the time it is reimbursed.
• A letter of credit is considered a self-liquidating loan.
• Although the bank have control over the title of documents, after
making payment, the banker should not consider this to be
sufficient security since merchandise may have limited market. The
price may change, etc. The banker usually asks for the evidence
that the merchandise is insured as an added protection.
• See figure 8.2
• Part shipments and transshipments must be clarified.
THE EXPORTER’S RESPONSIBILITIES
• A L/C is sent either directly to the beneficiary or indirectly through a
correspondent bank. The beneficiary examines the terms and the
conditions of the L/C and if an amendment is needed the beneficiary
contact the buyer and asks for an amendment covering the changes.
• “To order of shipper, blank endorsed”
• Expiration Date
• Documents must be presented to the bank as soon as they are
prepared and not later than 21 days after issuance of bills of lading. If
the bill of lading reaches the importer after the ship has arrived, the
merchandise can only be released with a bank guarantee.
NEGOTIATION
• The bank examines the documents to see whether they comply with the
conditions of the L/C. This is known as negotiation. If there is a
discrepancy, the bank does not pay and contacts the seller -who
requested the opening of the L/C. The customer however can accept to
receive the goods in spite of the discrepancy. But if the customer
refuses to accept any deviation from the original requirements, the bank
will refuse to pay the draft. In this circumstance the seller has to correct
the discrepancy before payment can be made to him.
• Each party in the L/C process examines the documents. If banks have
been careless and overlooked discrepancies, the buyer may refuse to
pay.
• In letters of credit, the bank remains responsible even if the buyer is no
longer able to repay the bank. The bank carries the risk.
• If the importer is unable to pay the bank, the bank has the bill of
lading in negotiable form. The bank can take possession of the
merchandise. This is why the bank requires that bills of lading be in
negotiable form and goods should not be consigned directly to the
buyer.
• The banks collect fees for the opening letters of credit, for advising
and confirming it and for negotiating the documents when presented.
FRAUD
• All parties concerned deal in documents and not in goods (the Uniform
Customs and Practice for Documentary Credits). The problem arises
when the bank knows or strongly suspects that the documents, when
presented, do not describe the merchandise or fraudulently
misrepresents the facts. The bank has to act with caution. But some
people argue that the best way to get out of this situation is that, the
“account party-the buyer” should apply for a court order rather than
putting pressure on the bank not to pay.
COLLECTIONS VERSUS LETTERS OF CREDIT
• An irrevocable letter of credit is an obligation of the bank to pay if all
conditions are met.
• In collection the bank has no obligation and the buyer (importer) is
responsible for the payment. An importer might not pay an exporter for
many reasons (importers may change their minds or go out of
business or price of goods go down etc).
• In letters of credit, drafts are drawn on banks that mean the payment
is certain, and therefore allows exporters to easily discount the
document for cash (transferability of drafts). But in collection, a draft
payable at a future date is drawn on the buyer, not on a bank and
there is always the chance that the buyer can go into bankruptcy etc.
before maturity.
• The cost of letters of credit is much more than the cost of collections.
ACCOUNT
• The amount of the letter of credit appears as a contingent account as
soon as it is issued. Usually 20% risk is calculated for letters of credit.
When the letter of credit is paid this amount is taken out of contingent
account.
