Letter of Credit​

A Letter of Credit (LC) is an irrevocable undertaking issued by the buyer’s/importer’s bank (Issuing Bank), at the request of the buyer/importer (Applicant), in favour of the seller/exporter (Beneficiary). Under this undertaking, the issuing bank agrees to honour payment of a specified amount in a specified currency, provided the beneficiary presents documents complying with all LC terms and conditions, within the stipulated time.

 

A Letter of Credit provides payment assurance to the seller in both international and domestic trade transactions. The issuing bank will require a security from the applicant, such as a collateral, margin or fixed deposit, as per the underlying the credit arrangement.

About Letter of Credit​

Parties Involved in a Letter of Credit

  • Applicant (Buyer/Importer): The Applicant is the party on whose request and on whose behalf the LC is issued. Applicant undertakes to reimburse the issuing bank for any payment made under the LC.

  • Issuing Bank (Applicant’s Bank): The Issuing Bank is the bank that, acting on the applicant’s instructions, issues the LC and undertakes an irrevocable and independent obligation to honour or negotiate, provided the beneficiary presents documents that comply with the LC terms and conditions.

  • Beneficiary (Seller/Exporter): The Beneficiary is the party in whose favour the LC is issued, usually the seller/exporter. The beneficiary is entitled to payment upon presentation of documents strictly complying with the LC terms and conditions.

  • Advising Bank : The Advising Bank is a bank that verifies the apparent authenticity of the LC and transmits it to the beneficiary’s bank, without adding any obligation to honour or negotiate.

  • Nominated Bank/Negotiating Bank: A nominated bank is the bank authorized by the issuing bank to honour, negotiate, accept, or incur a deferred payment undertaking under a letter of credit. Nominated bank is not obliged to act on its nomination, except where it has expressly agreed. Nominated bank agreeing to act on its nomination will drafts and/or documents by paying/advancing or agreeing to pay/advance funds to the beneficiary against a compliant presentation.

  • Confirming Bank: A Confirming Bank is the bank that, upon the issuing bank’s authorization, adds its own independent and irrevocable undertaking to honour or negotiate a complying presentation. Confirming assumes the same liability as the issuing bank toward the beneficiary.

Types of Letters of Credit

Confirmed LC: A confirmed LC is an LC to which a another bank or advising bank, usually in the beneficiary’s country, adds its own independent undertaking of payment. The confirming bank undertakes to pay even if the issuing bank fails to do so. Common in cross-border trade involving new counterparties, higher-risk countries, or longer usance periods.

Transferable LC: A transferable LC allows the original beneficiary to transfer all or a portion of the LC value to another party, typically the actual supplier. It is commonly used by traders or intermediaries who do not manufacture or produce goods directly but arrange procurement through another supplier.

Back-to-Back LC: A back-to-back LC is issued when a trader uses an LC received from the buyer to request a second LC in favour of their supplier. Both LCs are separate instruments but linked to the same underlying trade. It is used when the intermediary cannot transfer the original LC.

Revolving LC: A revolving LC ideal for long-term supply arrangements involving repetitive shipments, eliminating the need to issue multiple LCs for recurring transactions.

Benefits to Importer

An LC offers assurance that the payment will only be made when the exporter meets the specified terms and conditions. This mitigates the risk of non-performance or delivery issues, ensuring the importer receives the goods as agreed and protects their financial interests.

Benefits to Exporter

An LC ensures that the exporter will receive payment for goods or services once they comply with the terms and conditions of the LC. This reduces payment default risks, enhances trust and facilitates smooth international trade transactions.

FAQs

What is a Letter of Credit? 

A Letter of Credit is a mode of payment under which a written undertaking issued by the importer’s bank, guaranteeing payment to the seller, provided that the seller complies with all the specified terms and conditions and submits the required documents within a stipulated timeframe. Letters of credit facility can be availed against sanctioned credit lines or against Fixed Deposits. 

What is the importance of a Letter of Credit? 

The nature of international trade includes factors such as distance, different laws in each country and the lack of personal contact. Letters of Credit make a reliable payment mechanism. The ‘International Chamber of Commerce’ has issued Uniform Customs and Practice for Documentary Credits’ to govern issuance and handling of Letters of Credit used in international and domestic transactions. 

How does a Letter of Credit work? 

  • Step 1 - You (the buyer) and the supplier sign a contract stating that the payment will be made based on the Letter of Credit 

  • Step 2 - You approach ICICI Bank to issue a Letter of Credit in the supplier’s favour 

  • Step 3 - ICICI Bank issues the Letter of Credit, advised by its own branch or correspondent bank in the supplier’s country 

  • Step 4 - Advising Bank advises a Letter of Credit to the supplier 

  • Step 5 - The supplier receives the Letter of Credit, sends the shipment of goods and delivers documents to its own bank 

  • Step 6 – The supplier’s bank sends the documents to ICICI Bank for payment 

  • Step 7 - You now pay the amount due to ICICI Bank and get the documents in turn. 

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