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:
- 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.
- 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.
- Issue letter of credit
- 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.
- Prepare shipment
After ensuring that the terms of the letter of credit can be
met, the seller produces the goods and prepares shipment.
- 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.
- Payment
The issuing bank checks the documents and if approved, the
issuing bank transfers the payment to the seller through the advising bank.
- 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.