Usance Letter of Credit – What you should know on it

Usance letter of credit has been given different names like Time LC, deferred letter of credit or Term LC. As you open a usance LC or a deferred LC, it means that the payment will be done after a pre-set time on a future date on confirming the documents. A usance letter of credit is just the opposite of Sight letter of credit. In case of a sight letter of credit, the payments are made to the seller only when the seller confirms the documents which are presented to the issuing bank. 

On the contrary, the payments of Usance LC are done on the receipt of documents that are issued by the issuing bank and it is also checked whether or not the documents abide by the predetermined terms and conditions that are mentioned in the original LC. The bank accepts the draft and pays on the maturity date according to the LC terms. 

Understanding usance letters of credit

A deferred letter of credit or a usance letter of credit is a typical term that is used in trade finance. But before you move on to understand usance letter of credit, you should first understand what a letter of credit is and why it is used. As long as international trade is concerned, there is enough lack of trust in such transactions and hence the mechanisms like letters of credit are utilized to reduce the risk. Letters of credit have different types like usance LC, site LCs and Standby LC. 

Letters of credit are utilised to facilitate trade between the sellers and buyers of goods all over the world. For aggravating trade, the letters of credit are kept at the right place by the seller and buyer. When the bank issues such LCs, it allows both the parties to trade in peace. Only after certain conditions are fulfilled, goods can be released and it is thereafter that the payment can be made by the purchasing bank. While taking a look at the various kinds of instruments, the factor of when a payment is done is of highest importance. 

Usance letters of credit – Know the types

Letters of credit are instruments of payment that are leveraged for improving transactions of international trade. The main purpose of letters of credit is that it mitigates the risk that is linked with international trade for the seller and the buyer. As with any other financial mechanism, letters of credit even have various secondary purposes. There are multiple types of letters of credit that serve different purposes and one such kind is usance letter of credit. 

A usance letter of credit offers deferred option for payment to the buyer and the tenure of payment is decided by the seller and the buyer. Similarly, the usance letter of credit can be categorized in 2 types based on the tenors:

 Payment within 90 days post the B/L or the Bill of Lading

Here, after the B/L is issued, the buyer is given a time of 90 days from the date of B/L to pay for the goods. 

 Payment within 30 days post sight

In this case, the date on which the issuing bank obtains the documents, from that date, the buyer will be given 30 days or a month to pay for goods. 

Usance letter of Credit – Why and when is it used

A usance letter of credit is used for the same reason for which credit terms are offered. The purchaser is allowed more flexibility, increased working capital and the option of selling stock before payment. Goods payment is easier at a later date as against paying on receipt. 

The financial instrument called usance letter of credit can be used only when there is a trust element between both the selling and buying parties. You need to have a clear understanding of the amount to be paid and the interest rate of the product. It is through the Letter of Credit that you can set out the actual payment date and time to maturity so that both the parties can take this as a reference. 

So, it can be safely concluded by saying that a usance letter of credit is used when the buyer receives an upper hand on the seller and when it is clearly a buyer’s market. This is why the seller agrees to abide by the lenient terms of a usance LC. 

Standby Letter of Credit – Is it a backup plan for ensuring payment

You can’t deny the fact that things may go wrong anytime during any transactions and hence standby letters of credit are kept in place to add a safety net on payments and transactions. Regardless of whether the fee charged is for the shipment of physical goods or a standby letter of credit, a standby letter of credit can always a wise and smart option for a buyer and a seller.

Standby Letter of Credit

Standby Letter of Credit – What is it?

If you don’t know what a standby letter of credit is, it is an arrangement where the bank warrantees payment to its beneficiary in case the latter is not able to pay due to some unforeseen and unavoidable issue. In order to do so, the bank issues a letter where the terms and conditions are described where the bank will be liable to make the payment.

Through a letter of credit, a promise is provided from the bank’s end and this needs to be a disinterested third party. In case the customer of the bank fails to make payments on time or complete a deal on time or satiate the terms of a specific agreement, the bank will be liable to pay the beneficiary on behalf of the customer. However, the funds actually come from the customer who has applied for this LC but the bank becomes responsible for paying the recipient.

Standby letters of credit, just as standard LCs are used especially for international trade and also for domestic transactions like building projects. Nevertheless, the key to such a letter of credit is that something drastic happens due to which the customer is unable to make payments.

Standby letters of credit – How they enhance security

When the beneficiary makes a third-party bank liable for payments, she becomes even more confident about receiving payments. If you use an export transaction for example, there are several reasons why a buyer might not be able to pay. Check them out:

•   The buyer is going through a financial crunch and is waiting for his customers to make     payments to him.
•   The buyer has recently gone out of business.
•  The buyer is not satisfied with the seller.
•  The assets of the buyer get frozen due to political unrest.
• The buyer is found to be dishonest.

It goes without mentioning that a bank is anytime more stable that majority buyers and it doesn’t get involved in disputes between sellers and buyers. Rather than engaging in such petty issues, the seller and the buyer agree to few conditions that trigger payment and the bank follows directions whenever such events occur. A standby letter of credit should be paid provided the beneficiary meets the requirements of the letter and the bank is still in full action.

Standby letters of credit vs. other letters of credit

In most ways, a standby letter of credit is similar in features to a standard LC. But what makes it different from the other types like sight letter of credit?

ü  Backup for payments: A standby LC plays the role of a safety net. Whenever someone is paid with a standby LC, this would mean that something went wrong. On the contrary, with a commercial letter of credit, the parties involved will expect that the payments will occur. Such letters pay when the exporters deliver a shipment to the importer successfully.

ü  In-country: Most often, standby letters of credit are utilized for domestic transactions like obtaining electricity services, completing building projects. For such reasons, commercial letters of credit have become more common for facilitating international trade. 

ü  Performance aspect: Standby letters of credit seem to be unique as they have performance component or negative performance. In case the service isn’t performed, the beneficiary receives the payment.

So, if you require a standby letter of credit, you have to speak to your bank to issue one. You have to work out a plan with the commercial division of the bank or their department of international trade. However, make sure you take enough time to understand the way the process works and on what situations the bank will be responsible for making payments. Try to hire a reliable attorney who can review documents.

Letters of credit – Knowing the different types

Generally the international traders need help of financial intermediaries like banks for guaranteeing payments and also the assurance of delivering goods on time. Letters of credit usually accomplish their goal by playing the role of a substitute to the credit of the bank to that of the client mainly for facilitating trade. Such a letter is issued by a bank to guarantee full payment and timely payment to the seller. Under a circumstance where the buyer is not able to make such a payment, the bank will either cover the entire amount or the remaining amount on the buyer’s behalf. This letter is granted against a pledge of cash or securities as collateral. Banks also collect a fee which is a percentage of the total amount of letter of credit. 

Letter of Credit

Letters of Credit - Their importance

International trade comprise of factors like different laws, distance, various laws pertaining to the countries involved and the dearth of contact during the process of trade. Amidst all this, letters of credit are used as a dependable mechanism of payment. The letters of credit that are used during international transactions are supervised by the International Chamber of Commerce Uniform Customs and Practice for Documentary Credits. 

Key elements of Letters of Credit

 The issuing bank gives a payment undertaking

 On the buyer’s behalf who is also the applicant

 To pay off a beneficiary (mostly a seller) for a specific money amount

 On providing the exact documents that are proof of the goods supply

 Within a stipulated time period

 Documents should abide by the terms and conditions that are mentioned in the LC

 Documents also need to be shown at a definite place

A letter of credit – How does it work?

Due to the fact that a letter of credit is more of a negotiable payment mechanism, the issuing bank has to pay the beneficiary bank or the bank that has been mentioned by the beneficiary. In case the LC is transferable, the beneficiary might appoint yet another person, third party or corporate parent as an entity that has the right to draw the amount. 

As already mentioned above, banks will need a pledge of cash or securities as collateral for issuing a letter of credit. A percentage of the size of the LC will be collected as a fee for providing the service. There are different kinds of LCs available. Read on to know on them. 

Types of Letters of Credit

There are many variations to Letters of Credit and each are suited for a separate situation. Let’s take a look at the main types:

1. Revocable: This letter type can be amended or cancelled by either the issuing bank or the buyer any time without any prior notice. However in the current version of UCP 600, revocable LCs have been removed for transactions that are done under their jurisdiction. 

2. Irrevocable: On the other hand, this letter can’t be cancelled or revoked unless the three parties – the buyer, seller and the third party agree to the terms and conditions. 

3. Transferrable: If the beneficiary is an intermediary for the actual suppliers of services, the payment has to be transferred to the actual suppliers. 

4. Un-transferrable: An un-transferrable letter of credit doesn’t allow any transfer of payments to a third party as in such a case, the beneficiary is the recipient. 

5. Confirmed: Here the LC will be given a ‘confirmed’ status as the bank that confirms the exporters has added the liability to the issuing bank. The liability will be either assurance of payment or guarantee of payment. 

6. Unconfirmed: This letter of credit is guaranteed by the bank issuing the letter and this implies that there’s no sort of confirmation from the advisory bank of the exporter. However, in areas of sluggish economy or uncertainty in political conditions, payments could be at risk in such cases. 

The letters of credit are therefore used as a tool to diminish the risk that has substantially grown over the last decade. The letters of credit serve various purposes that are perfect for different functions. The credit professional, on receiving the LC, should review all items to insure what’s expected from the seller and understand all terms and conditions.