Basic letter of credit procedure

There are different types of letters of credit and various scenarios in which letters of credit (L/C) are used. The basic letter of credit procedure:

Step 1. Purchase and sales agreement

The buyer and the seller draw up a purchase and sales agreement. The purchase and sales agreement between the buyer and the seller stipulates that payment is made through a letter of credit.

Step 2. Buyer applies for letter of credit

The buyer requests his bank to issue a letter of credit. The letter of credit must be in accordance with the purchase and sales agreement.

Step 3. Issue letter of credit

The issuing bank sends the letter of credit to the advising bank.

Step 4. Advise letter of credit

The advising bank verifies the authenticity of the letter of credit, and forwards the letter of credit to the seller.

The seller checks if:

  • The letter of credit corresponds to the terms and conditions of the purchase and sale agreement.
  • He can meet the requirements of the letter of credit within the specified period or by the specified date.
  • He can produce the documents stipulated in the letter of credit. These documents include the invoice, transport documents such as the bill of lading, or quality certificates.
Step 5. Prepare shipment

After ensuring that the terms of the letter of credit can be met, the seller produces the goods and prepares shipment.

Step 6. Present documents

The seller prepares the documents that prove that the goods are ready for shipment and presents these documents to the advising bank. The advising bank sends the documents to the issuing bank.

Step 7. Payment

The issuing bank checks the documents and if approved, the issuing bank transfers the payment to the seller through the advising bank.

Step 8. Document transfer

The issuing bank hands over the documents to the buyer. The documents allow the buyer to clear the goods from the customs and take possession of the goods. The buyer pays the issuing bank.

Amendments

When the letter of credit is advised to the seller by the advising bank, the seller checks if the requirements of the letter of credit can be met. If the seller is unable to meet any term or condition of the letter of credit, or the letter of credit differs from the purchase and sale agreement, the seller must notify the importer and request an amendment to the letter of credit.

For example, the seller asks to extend the expiry date and the latest shipping date if they are unable to manufacture the merchandise in time. An importer can request an amendment to increase the value of the letter of credit to purchase a higher quantity of merchandise.

When all parties agree, the amendment is incorporated into the terms of the letter of credit and advised to the exporter through the advising bank. The seller starts shipment after the amendments have been agreed to.

Related topics