Letter of credits (LC)

Letter of credits

A letter of credit assures that payment will be made to the seller as they meet the specified conditions. 

Letters of credit are frequently given within two business days, ensuring payment by the Citibank office providing confirmation. This advantage is especially useful for clients who are situated in areas with uncertain economic conditions. 

What is a letter of credit? 

A Letter of Credit (LC) is a document that financial institutions issue to guarantee payment to a seller for goods or services a buyer has contracted to purchase.  

The LC protects the seller from the buyer defaulting on payment and can be used as a form of financing for the seller. The buyer is typically responsible for paying any fees associated with the LC, such as issuance and confirmation fees. The seller presents the LC to the bank. The buyer’s bank reimburses the seller’s bank. 

Letter of credits (LC)

Understanding letter of credits 

There are typically three parties in a letter of credit. The beneficiary is the first, who is the individual or business that will receive payment. The purchaser of the product or application for the services comes next. This party requires a letter of credit. The organisation that issues the letter of credit, the issuing bank, is the last party. 

Additionally, the beneficiary can request payment be made to an advising bank or a bank that already has the beneficiary as a customer, as opposed to the beneficiary directly. This may be carried out, for instance, if the advising bank funded the transaction on behalf of the recipient until payment was made. 

Most frequently used in international commerce, letters of credit are controlled by the UCP which stands for Uniform Customs and Practise for Documentary Credits, a set of guidelines established by the International Chamber of Commerce. But as we’ll see, they may also be applied in other circumstances. 

Types of letters of credit 

There are four main types of letters of credit: commercial, standby, travel rules, and irrevocable.  

  • Commercial letter of credit 

Commercial letters of credit are the most common type of letter of credit. They are typically used in international trade transactions to provide payment assurance between buyers and sellers.  

  • Standby letters of credit 

They are similar to commercial letters of credit but are typically used to provide payment assurance for contractual obligations, such as construction contracts.  

  • Traveller’s letter of credit 

Travel rules letters of credit are used to provide payment assurance for travel-related expenses, such as hotel reservations and airfare.  

  • Irrevocable letters of credit 

They are the most secure letter of credit, as they cannot be cancelled or modified without all parties’ agreement.

Importance of letters of credit 

In international commerce transactions, when the buyer and seller are not acquainted, credit letters are applied to reduce risk. If you’re an importer, having a letter of credit will help you make sure that your business will only make payments for purchases once the supplier has supplied proof that the products have been transported. 

The letter may indicate that you are prepared to expand your commercial dealings with foreign suppliers. When doing international trade and business, this is essential. 

In contrast, a letter of credit might provide reassurance to the seller if the buyer defaults on the payment. Additionally, this letter might shield the seller from any liabilities if the criteria are satisfied. 

A letter of credit can assist people and businesses in getting adequate money for significant undertakings in addition to international trade. You may use this letter to check someone’s or a company’s credit standing. The financial firm will bear the costs if the buyer cannot pay for their purchases. 

How a letter of credit works 

A letter of credit is a contract that allows the issuing bank to operate independently or at the request and direction of the applicant (importer). The issuing bank may pay the beneficiary (or on their behalf) under an LC agreement (the exporter).  

Alternatively, the issuing bank may accept the exporter’s draft or bills of exchange. Bills of exchange may also be paid or accepted by advised or nominated banks with permission from the issuing bank. 

Frequently Asked Questions

To get funding for a single transaction, back-to-back letters of credit need two letters of credit. These are typically employed in trades with a middleman between the purchaser and the seller.  

Back-to-back letters of credit typically consist of two LoCs, one issued to the intermediary by the buyer’s bank and the other to the seller by the intermediary’s bank.  

 

When a bank client (the principal) fails on a payment or other obligation to a beneficiary, the bank (the guarantor) agrees to pay the beneficiary a certain sum of money. 

A letter of guarantee aids in the efficient operation of international commerce, as investors are more prepared to invest in riskier bonds due to the bond market’s increased security, thanks to a letter of guarantee. In this case, the bank will reimburse the person that received the guarantee for that amount. 

 

To apply for a letter of credit (LOC), the buyer must first contact a bank or financial institution and provide the necessary documentation, including the commercial invoice and the contract between the buyer and seller. The bank will then issue the LOC to the seller. 

 

Citibank provides letters of credit for purchasers in Africa,  Latin America, Asia, the Middle East, and Eastern Europe who would struggle to secure foreign credit on their own. Exporters can reduce the importer’s country risk and the issuing bank’s commercial credit risk by using letters of credit from Citibank. 

 

A commercial letter of credit can be used to facilitate international trade transactions. A bank often issues a commercial letter of credit in place of a buyer to pay the vendor of goods or services. The key difference between a commercial letter of credit and a revolving letter of credit is that a commercial letter of credit is a one-time transaction. In contrast, a revolving letter of credit can be used multiple times.  

When the buyer and seller are in separate nations, a commercial letter of credit is commonly employed. The commercial letter of credit provides the seller with a guarantee of payment from a reputable financial institution, which can reduce the risk associated with doing business with a new buyer. In contrast, a revolving letter of credit is typically used in situations where the buyer and seller are located in the same country. 

    Read the Latest Market Journal

    Weekly Updates 4/3/24 – 8/3/24

    Published on Mar 4, 2024 18 

    This weekly update is designed to help you stay informed and relate economic and company...

    Weekly Updates 26/2/24 – 1/3/24

    Published on Feb 28, 2024 61 

    This weekly update is designed to help you stay informed and relate economic and company...

    All-in-One Guide to Investing in China via ETFs

    Published on Feb 27, 2024 407 

    Start trading on POEMS! Open a free account here! Why China? In the vast landscape...

    Navigating the Post-Inflation Landscape in 2024: Top 10 US Markets Key Events to Look out for

    Published on Feb 23, 2024 423 

    Start trading on POEMS! Open a free account here! In 2023, the United States experienced...

    From Boom to Bust: Lessons from the Barings Bank Collapse

    Published on Feb 23, 2024 62 

    Barings Bank was one of the oldest merchant banks in England with a long history...

    Decoding FX CFD 2.0

    Published on Feb 20, 2024 70 

    This article is aimed at availing information and knowledge essential to intermediate forex traders. It...

    Weekly Updates 19/2/24 – 23/2/24

    Published on Feb 19, 2024 89 

    This weekly update is designed to help you stay informed and relate economic and company...

    Unlock Prosperity with 5 Sure-Fire Financial Instruments!

    Published on Feb 14, 2024 200 

    In Singapore, the concept of guaranteed returns may evoke the spirit of prosperity, reminiscent perhaps...

    Contact us to Open an Account

    Need Assistance? Share your Details and we’ll get back to you

    IMPORTANT INFORMATION

    This material is provided by Phillip Capital Management (S) Ltd (“PCM”) for general information only and does not constitute a recommendation, an offer to sell, or a solicitation of any offer to invest in any of the exchange-traded fund (“ETF”) or the unit trust (“Products”) mentioned herein. It does not have any regard to your specific investment objectives, financial situation and any of your particular needs. You should read the Prospectus and the accompanying Product Highlights Sheet (“PHS”) for key features, key risks and other important information of the Products and obtain advice from a financial adviser (“FA“) pursuant to a separate engagement before making a commitment to invest in the Products. In the event that you choose not to obtain advice from a FA, you should assess whether the Products are suitable for you before proceeding to invest. A copy of the Prospectus and PHS are available from PCM, any of its Participating Dealers (“PDs“) for the ETF, or any of its authorised distributors for the unit trust managed by PCM.  

    An ETF is not like a typical unit trust as the units of the ETF (the “Units“) are to be listed and traded like any share on the Singapore Exchange Securities Trading Limited (“SGX-ST”). Listing on the SGX-ST does not guarantee a liquid market for the Units which may be traded at prices above or below its NAV or may be suspended or delisted. Investors may buy or sell the Units on SGX-ST when it is listed. Investors cannot create or redeem Units directly with PCM and have no rights to request PCM to redeem or purchase their Units. Creation and redemption of Units are through PDs if investors are clients of the PDs, who have no obligation to agree to create or redeem Units on behalf of any investor and may impose terms and conditions in connection with such creation or redemption orders. Please refer to the Prospectus of the ETF for more details.  

    Investments are subject to investment risks including the possible loss of the principal amount invested. The purchase of a unit in a fund is not the same as placing your money on deposit with a bank or deposit-taking company. There is no guarantee as to the amount of capital invested or return received. The value of the units and the income accruing to the units may fall or rise. Past performance is not necessarily indicative of the future or likely performance of the Products. There can be no assurance that investment objectives will be achieved.  

    Where applicable, fund(s) may invest in financial derivatives and/or participate in securities lending and repurchase transactions for the purpose of hedging and/or efficient portfolio management, subject to the relevant regulatory requirements. PCM reserves the discretion to determine if currency exposure should be hedged actively, passively or not at all, in the best interest of the Products.  

    The regular dividend distributions, out of either income and/or capital, are not guaranteed and subject to PCM’s discretion. Past payout yields and payments do not represent future payout yields and payments. Such dividend distributions will reduce the available capital for reinvestment and may result in an immediate decrease in the net asset value (“NAV”) of the Products. Please refer to <www.phillipfunds.com> for more information in relation to the dividend distributions.  

    The information provided herein may be obtained or compiled from public and/or third party sources that PCM has no reason to believe are unreliable. Any opinion or view herein is an expression of belief of the individual author or the indicated source (as applicable) only. PCM makes no representation or warranty that such information is accurate, complete, verified or should be relied upon as such. The information does not constitute, and should not be used as a substitute for tax, legal or investment advice.  

    The information herein are not for any person in any jurisdiction or country where such distribution or availability for use would contravene any applicable law or regulation or would subject PCM to any registration or licensing requirement in such jurisdiction or country. The Products is not offered to U.S. Persons. PhillipCapital Group of Companies, including PCM, their affiliates and/or their officers, directors and/or employees may own or have positions in the Products. Any member of the PhillipCapital Group of Companies may have acted upon or used the information, analyses and opinions herein before they have been published. 

    This advertisement has not been reviewed by the Monetary Authority of Singapore.  

     

    Phillip Capital Management (S) Ltd (Co. Reg. No. 199905233W)  
    250 North Bridge Road #06-00, Raffles City Tower ,Singapore 179101 
    Tel: (65) 6230 8133 Fax: (65) 65383066 www.phillipfunds.com