Import Letters of Credit Overview
Import Letters of Credit are the most common method of import financing. They are versatile, secure and can be used to finance any import transaction. An Import Letter of Credit is a financial instrument issued by a bank that represents the commitment of the bank, on behalf of an importer, that guarantees payment will be made to the exporter provided the terms and conditions specified in the Letter of Credit have been met. Conditions specified in Import Letters of Credit are typically evidenced by the presentation of documents. Since they are credit instruments, issuing banks rely on the credit-worthiness of importers when issuing Import Letters of Credit.
The importer pays the issuing bank a fee to render this service. Import Letters of Credit are useful when there is insufficient credit information about a foreign buyer or the foreign buyer’s credit is unacceptable to the exporter, but the exporter is comfortable with the creditworthiness of the issuing financial institution. Import Letters of Credit are the most common method of trade finance because they also provide protection for the importer since the documents required to trigger payment provide evidence that the goods being purchased have been shipped as agreed.
Letters of Credit In Trade Finance
Import Letters of Credit Key Features
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An Import Letter of Credit, which is also referred to as a documentary credit, is a financial instrument where the issuing bank, acting on behalf of the importer, contractually agrees to pay the beneficiary or exporter the amount stipulated, provided conditions specified in the Letter of Credit have been satisfied.
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The bank that issues an Import Letter of Credit will typically use intermediary banks to facilitate the transaction and make payment to the exporter.
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The Letter of Credit is a separate contract from the contract for the transaction on which it is based. Thus, the banks who are involved in financing the transaction are not concerned with the quality of the underlying merchandise or even whether either party fulfills the terms of the sales contract.
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The issuing bank’s obligation to pay pursuant to Import Letters of Credit are solely conditioned upon the seller’s compliance with the terms and conditions specified in the Import Letter of Credit.
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In transactions involving Import Letters of Credit, banks are only concerned with documents, not goods.
Letters of Credit are effective payment instruments that facilitate international trade by providing sellers with an assurance of payment and buyers with cross-border documentary protection.
Using Import Letters of Credit
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Letters of credit are a highly recommended method of funding international trade, and are especially beneficial for high-risk situations, for transactions with new or less-established trade relationships and for transactions where the exporter is satisfied with the creditworthiness of the issuing bank.
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When Letters of Credit are used to finance trade, the transaction risk is fairly balanced between exporter and importer, assuming that all terms and conditions specified in the Letter of Credit are performed.
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Payment in Letter of Credit transactions is only made after the goods are shipped by the exporter. A variety of payment, financing and risk mitigation options are available to both the importer and exporter with Letters of Credit.
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Letters of Credit are a tremendously popular and effective method of financing international trade. They are, however, labor-intensive and are a relatively expensive method of financing international transactions.
Import Letters of Credit Process
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The importer arranges for the issuing bank to open a Letter of Credit in favor of the exporter.
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The issuing bank transmits the Letter of Credit to the nominated bank, which forwards it to the exporter.
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The exporter forwards the goods and documents to a freight forwarder.
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The freight forwarder dispatches the goods and either the dispatcher or the exporter submits documents to the nominated bank.
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The nominated bank checks documents for compliance with the Letter of Credit and collects payment from the issuing bank for the exporter.
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The importer’s account at the issuing bank is debited.
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The issuing bank releases documents to the importer to claim the goods from the carrier and to clear them at customs.