Letter of Credit & Trade Finance Mastery 2026

In the next video, Dr. Jain talks about the role of trade financing by international banks and what products they provide to carry out such temporary and long-term financing.

Friends, in the last few episodes, I gave you a basic understanding of the operation of a letter of credit, or so-called documentary credit.

From the last few episodes, it would have become easier for you to understand why the involvement of a bank of international repute is required.

Basically, what happens is that the different types of instruments, which are very similar to the letter of credit or the letter of credit itself, are all considered documentary credit.

All these documentary credits or other kinds of guarantees by the banks are called international trade finance.

In the world today, almost 80 to 90% of the total world trade is conducted through some kind of international trade finance instrument, which generally involves these banks.

You can understand the kind of involvement that banks have in international business.

The main problem of having international banks involved in these international trade deals is the cost of the services provided by these banks.

Especially, the letter of credit instrument is the costliest instrument offered by international banks.

Ultimately, the cost is covered by the price that the exporter gives to the buyer.

Whatever the extra cost of the involvement of banks is, it is actually paid by the buyer.

In international business, buyers normally try to discourage exporters from signing contracts with a letter of credit instrument.

They try to use other kinds of instruments that are cheaper.

Even though banks may still be involved, some instruments are less expensive than a letter of credit.

Because of this, banks have introduced other instruments like bank collection, wherein the documents are sent through banks, and money is collected from the buyers.

It is a little unsafe for exporters, but it is a cheaper option than a letter of credit.

I will be discussing in the next few episodes the options available for exporters for receiving international payments, other ways of conducting international business and transactions, and other methods of financing international trade.

In the next video, Dr. Jain discusses the different options available to the seller and buyer to solve the issue of payments and shipment of the right goods.

The simplest and most secure method of receiving international payment for exporters is the advance payment method, which means the payment is made by the buyer in advance.

Normally, the buyer will not give the advance payment because, in that case, the buyer is at maximum risk.

In advance payment, the buyer remits the funds before the goods are shipped, which is very risky for the buyer.

The seller ships goods after funds are already received by him. The funds have already been received by the exporter in advance.

Obviously, the buyer can face, in such situations, risks of non-shipment, non-performance of the obligations in the export contract by the exporter, and issues that may relate to quality or even quantity.

The goods that are shipped may not have the right quantity.

In the advance payment method, the buyer is at maximum risk.

Another extreme method of receiving international payment is the open account.

What happens in the open account?

The exporter ships the goods, the goods are received by the buyer, and money is paid at a particular frequency.

Usually, the money is paid after the expiry of a certain number of days after receipt of the goods in good order and condition by the buyer.

In such a case, what happens?

The exporter is at the maximum risk.

Goods are dispatched directly to the buyer before payment.

The buyer pays on receipt of the goods after the expiry of a specified period.

As I have just mentioned, the seller is at the greatest risk in such situations.

The kinds of risks that are generally faced by the exporter in such situations are non-payment, delayed payment, or partial payment.

These kinds of risks are faced by the exporter in the open account system.

Prayers can help, but credit insurance or a standby LC as collateral is better.

If it is necessary to go for this kind of open account, the bank guarantees in the form of credit insurance or a standby LC.

Basically, standby LC works as a guarantee in the case of non-payment, especially in the case of the open account system.

The advance payment and the open account system form the two extremes of this spectrum of the different types of methods and modes of receiving international payments.

In this spectrum, the other methods of receiving international payments generally involve international banks of repute.

These are the different types of instruments, which are called trade financing or international trade financing instruments. And the different types of instruments have different fees and costs.

But generally, let me tell you that trade financing is more in favor of the buyers or exporters from the developed and rich nations, especially in those countries where interest rates are very low.

Banks offer these kinds of instruments at very low prices compared to similar kinds in the developing and least developed countries, in terms of their bank charges, especially in light of the poor monetary system and the high cost of finance in the developing and least developed countries.

This trade financing skews the whole business in favor of the rich and developed countries.

The business partners, whether they are importers or exporters in the developing and least developed countries, are at the receiving end of this system. But there is no other way.

In this spectrum of the different methods of receiving international payments, we have banking instruments and the involvement of international banks of repute, even though the whole trade financing system and the different instruments are not in favor of exporters or importers from developing and least developed countries.

These instruments, between the two extremes of the advance payment and open account system, are the documentary credits, like letters of credit, or they can be bank collection.

Documentary credit, or the letter of credit, is comparatively the most expensive method of international trade financing by banks.

A letter of credit, or LC, as it is popularly known, or the documentary credit, is a written undertaking by a bank given to the seller or exporter at the buyer’s request—that means the importer’s request—promising to effect the payment of a stated amount as per the export contract at a stated time, once certain conditions are met. These conditions are in the form of furnishing the principal commercial documents by the exporter proving the shipment of the goods, the quality of the goods, the origin of the goods, and whatever other documents are required by the letter of credit.

These have to be presented by the exporter after the shipment has been made.

The exporter or the seller, or in banking terms, the beneficiary, and the importer, or the buyer or the applicant in banking terminology, are the clients of these banks, and they are the first and second parties in the documentary credit system.

The bank’s role in this kind of payment method is related to documentation, documentation, and documentation only.

Banks have their limitations.

They do not deal with the goods. They are not concerned about the actual performance of the goods or the inspection of the goods. They are not concerned with the physical part of the transaction. They are only concerned with the documentation part.

If the documents are genuine, if the documents are original, if the documents indicate the performance of the exporter, if the documents indicate everything is in order, the banks are obliged to pay against the documentary credit.

This instrument becomes a necessary evil of international trade and business. It is good that the exporter receives the letter of credit from the buyer.

But, as I have already mentioned to you, buyers will not generally negotiate in this direction, as the letter of credit favors the exporter more than the importer.

Ultimately, the fees charged by the banks are paid by the buyer, and that is the reason buyers generally try to discourage this particular instrument.

Another instrument is offered by the banks, considering that many buyers would not be interested in having export contracts with the method of international payments through documentary credit.

Banks also offer a cheaper option. That can be DP (documents against payment), DA (documents against acceptance), and CAD (cash against documents).

This documentary collection system is a payment mechanism initiated by the exporter or seller using banking services to collect payment.

It should be noted that the documentary credit is initiated by the buyer as per the export contract.

But a documentary collection system is initiated by the exporter using banking services to collect payment from the importer.

The role of the bank is to collect the payment against documents.

Again, the parties involved are the exporter or the seller, also called the principal in the collection system, or the drawer. And the importer is also called the buyer or the drawee.

This is a good alternative when doing business with people you can trust and know.

But let me tell you, in international trading and business, however well you may know your trade partners internationally, depending on the nature of your business and the competition in the business, it is always advisable to go for the documentary credit, even if it is costly, because the consequences of not receiving the international payments can be really very awkward and drastic, given the fact that most local governments would blacklist exporters from the export-import regime in their country if the payments are not received in a specified time.

It is always better to go for the banking instruments of trade financing in the form of a documentary credit rather than a documentary collection.

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In order to carry out successful exports transactions and receive timely and full payment for the goods exported, an international seller has limited choices. LC, while being a costly option, is certainly a safe bet for new exporters or when dealing with a new customer.

In the last few episodes, I discussed with you the different methods of receiving international payments and the different methods of international trade financing, mainly involving international banks of repute.

Now, it is very clear to you that, despite the existence of many methods of receiving international payments, the most popular and most used methods are the instruments provided by the banks for international trade financing. Among these instruments, the best method remains the letter of credit, in spite of the fact that it is costly and it really increases the price of international transactions.

In the later episodes, I will give you an idea of what kind of fees are charged by different international banks based in different countries.

I also mentioned to you that this whole system of letters of credit and its costs, fees, and service charges is skewed towards rich and developed countries, and it is not favorable to businesspersons in developing and least developed countries.

But in spite of all these facts, the instrument of choice for international business transactions, exports, and imports for receiving international payments remains the letter of credit or documentary credit.

In this episode, let us now discuss how this letter of credit works. How does this documentary credit work?

This is the basic letter of credit cycle.

A very layman’s understanding.

A very simple understanding of the LC means that the letter of credit for the exporter plus the transport documents—these can be a bill of lading, an airway bill, or some other document accepted by international banking practices, which I will explain to you later.

Any transport document that is accepted by the system, along with the commercial invoice, which is a very important document I have mentioned in several of my courses—and which I will also be talking about in this course—remains crucial. The commercial invoice is important because it is the summary of the export contract.

In the LC system, the export contract is not encouraged to be linked with the letter of credit. This means the role of banks is independent of any association with the export contract, which is a matter between the exporter and the importer.

The only way to link the shipment, the goods, and the performance—which are not guaranteed by the banks—is through the commercial invoice.

Transport documents, commercial invoices, letters of credit, and the packing list are the key elements.

The packing list is important because it is an integral part of the commercial invoice.

It contains the details about the goods that are sent—the quantity, the weight, and the dimensions.

This is the only method by which the bank understands the shipment because the bank does not deal with the physical goods; it only deals with the documents.

The main identification documents remain the commercial invoice and the packing list.

In a very basic form, the letter of credit, the transport document, the commercial invoice, and the packing list equal the payment that the exporter can receive from the issuing bank. If there are certain additional documents to be presented by the exporter, they will be mentioned in the letter of credit.

But these are the documents that will definitely be part of the LC documents.

The compliant presentation, along with the letter of credit, means payment within the specified time.

If it is an immediate payment—that is, the letter of credit payable at sight—the payment will be made by the issuing bank.

It will be transferred by the issuing bank in 5 to 7 days, depending on the UCP version.

That is, the Uniform Customs and Practice version used and applicable in a particular LC.

On a case-by-case basis, within 5 to 7 working days, the payment will be transferred by the issuing bank to the advising bank or the negotiating bank.

Typically, in a documentary letter of credit, an exporter who is the beneficiary of the LC must arrange the typical commercial documents. When presented on time and in the desired manner to the bank, exporters can definitely expect payment against the documentary L/C

As I have just explained to you, the letter of credit cycle is typically initiated by the buyer when the buyer approaches the issuing bank.

I have made it clear in the earlier episode also. I am just repeating this for simplification and clarification purposes. The issuing bank issues the letter of credit. As you can see here, the blue arrow is there.

The issuing bank issues the letter of credit.

The letter of credit is advised by the advising bank, which is the local bank, to the exporter, who is the seller.

And this is the factory of the seller, where, upon the receipt of the letter of credit and the acceptance of the letter of credit by the seller, the goods are manufactured and then shipped by the carrier.

It can be by sea or by air to the port of discharge.

Once the goods have been shipped at the port of loading, the documents as required by the letter of credit, along with the commercial documents like transport documents, commercial invoices, packing list, and any other required documents, are submitted and presented by the exporter to the negotiating bank.

This negotiating bank again is a local bank, and it can be the same bank as the advising bank, or it can be different, as the case may be.

This negotiating bank sends this set of documents to the issuing bank. On receipt of the documents presented by the exporter and sent through the negotiating bank, if the issuing bank does not find any irregularity and the presentation is compliant, the issuing bank releases the money.

This red arrow you can see here is the flow of the money.

This money is credited to the negotiating bank, which further credits this amount to the seller.

Ultimately, this money comes from the buyer.

With this money only, the buyer can receive this set of documents in order to claim the goods at the port of discharge from the shipping company.

This is how the typical letter of credit cycle works.

To make it clearer, I will now explain to you which different parties are involved in this basic letter of credit cycle, what role is played by whom, and what the exact steps are in this basic letter of credit cycle.

As you can see here, the main parties in the basic LC cycle are: first of all, the buyer, who in banking terms is called the applicant; second, the issuing bank, which is the bank of the importer, normally in the same country where the buyer is located; and the seller, that is, the exporter.

In banking terms, the exporter is called the beneficiary in the case of a documentary credit, that is, a letter of credit. The advising bank is the local bank, whose role is to advise on the letter of credit issued by the issuing bank.

In a typical letter of credit cycle with these parties in the whole game, the first step is the sales contract between the buyer and the seller.

Once this sales contract has been signed, the buyer applies for the letter of credit to the issuing bank as per the export contract.

The sales contract and export contract are the same thing, based on which the buyer applies for the LC to the issuing bank and gives the LC opening instructions.

Now the bank, which is the overseas bank, the buyer’s bank, and the importer’s country bank, issues the letter of credit and sends it to the seller’s bank.

The seller’s bank is the local bank, which means the bank in the country of the exporter, and it is called the advising bank because it advises the letter of credit to the exporter.

Once the LC is received by the advising bank, the advising bank authenticates the letter of credit using its experience and knowledge of the UCP, that is, the Uniform Customs and Practices for Documentary Credit.

By having this understanding and experience, and using different protocols and charters, it authenticates the letter of credit.

It also checks whether the LC is genuine, whether the sender, that is, the issuing bank, is genuine, and after authentication, it advises the LC to the exporter. If required, it also explains in layman’s terms all the conditions and requirements of the letter of credit.

This is the work of the advising bank.

In the second part of the cycle, when the LC has been received by the seller and has been accepted by the seller, goods have been shipped, and the pre-shipment documents have been received by the seller, the parties remain the same.

The four main parties in the basic LC cycle are the buyer (the applicant), the issuing bank (the importer’s bank), the seller (the beneficiary), and the negotiating bank.

Here, it is not the advising bank but the negotiating bank.

It may be the same local bank as the advising bank, or it may not be.

Now what happens?

The shipment is made by the seller, and all the documents are procured.

All shipment documents are procured by the seller, including the transport document (in the case of sea shipment, the bill of lading), the commercial invoice, the packing list, and other documents as required by the LC. The main ones can be the quality certificate, inspection certificate, or certificate of origin.

There can be different types of documents depending on the export contract, the nature of the goods, and the export sales conditions.

While the issuing bank or the negotiating bank is not concerned with the export contract, the LC conditions may be dependent on the LC instructions given by the importer, which may be equivalent to or the same as what was given in the export sales contract.

Although the export sales contract is not normally encouraged to be referenced in the letter of credit—which I will explain to you in a later episode—this can happen.

After the shipment and procurement of the documents, the seller presents the documents as per the LC requirements to its local bank, which is the negotiating bank.

This negotiating bank receives the documents and generally checks them to see if they are in order and as per the LC. A preliminary check is done by the negotiating bank to see whether the presentation is compliant.

That means it is as per the letter of credit, which may or may not be accepted by the issuing bank.

That part is not guaranteed by the bank.

The preliminary check by the negotiating bank does not definitely mean a compliant presentation.

It only provides a preliminary idea of whether the documents are correct or not, based on its own experience and knowledge of the LC requirements, the LC cycle, and guideline documents like UCP or ISBP, which I will explain to you later.

The negotiating bank, after scrutinizing the documents, forwards them to the issuing bank.

This is the issuing bank.

The issuing bank debits the buyer’s account for the payment and releases the original documents to the buyer, in case the payment has not already been received by the issuing bank from the applicant, that is, the buyer.

To check whether there are any pending dues from the buyer, it will debit those amounts. But it will only do this step once it is satisfied that the documents presented by the exporter and sent through the negotiating bank are compliant and are as per the LC that was issued by the issuing bank.

On checking compliance with the LC terms, the issuing bank reimburses the negotiating bank by debiting the buyer’s account.

If any dues are there, or if the payment has not been procured by the issuing bank, it will procure the payment and reimburse this amount to the negotiating bank in the name of the exporter.

The negotiating bank, on receiving the payment, credits this amount to the seller’s account.

After the presentation and the documents being forwarded by the negotiating bank to the issuing bank, and the documents received by the issuing bank electronically or in physical form, as the case may be, it normally takes 5 to 7 days for the transfer of the reimbursement amount as per the LC by the issuing bank to the negotiating bank. In case the issuing bank finds any discrepancy in the documents, it will issue the rejection letter within the same time period.

Friends, this is how this basic letter of credit cycle happens.

This is how the letter of credit works. This is how the different parties in the LC cycle function. 

They play their role, and the LC is issued.

The presentation is made, and the remittance of the amount of the LC is done.

That is how the whole system supports international payments and their receipt from the importer to the exporter.

The main challenge of international trade of goods and services comes from the significant differences among humans living in different parts of the world. Differences in terms of economy, technology, culture, legal system, and political systems make this world extremely challenging to deal with. It is especially so when it comes to the business of selling and buying goods overseas.

Looking at the different learnings we had in the last several episodes, now we know the essential nature of the letter of credit, the invincibility of the letter of credit instrument or any documentary credit, the different types of documentary credit, and the different variations of the letter of credit, which I will be talking about later.

These instruments of international trade financing are invincible.

They are essential for international trade, international business, exporting, and importing.

The fact remains that 80 to 90% of the total trade in the world happens with the help of some kind of international trade financing.

Looking at these facts, we have to see the whole system of documentary credit, the letter of credit, from the point of view of the challenges this system faces.

The biggest challenge for this system is the differences in this world: the differences in legal systems, differences in culture, differences in language, and differences in ideologies.

There is no common international law.

There is no common international parliament that can govern the operation of international transactions, the operations of the banking system, or the fact that certain banks located in some countries are promising to pay. Whether they will pay, and if they do not pay, how the situation will be tackled and how the disputes will be resolved.

There is no common system in this world because this world is full of differences.

The system still works.

How does it work?

What is behind this system that makes it work?

This whole background of the letter of credit, the documentary credit, and any international trade financing instrument is governed by customs and practices that are accepted by bankers from different countries.

There are certain standard practices, uniform practices, that they agree to abide by in spite of the fact that there is no common legal system.

Even though the law of the land changes with different countries, the bankers, the so-called bankers, irrespective of which country they belong to, adhere to certain banking principles and practices. These practices, in known history, were started by the International Chamber of Commerce in 1933 in the form of the so-called UCP: Uniform Customs and Practice for Documentary Credit.

To this day, there have been six revisions of these guidelines and practices. And the top and the best banks, the reputed international banks, abide by these practices and rules.

That is why they call themselves bankers.

For them, banking is a religion that is not governed by any international law or regulation.

It is purely based on trust.

It is purely based on the egalitarian philosophy and ideology of being a banker and abiding by the rules of the ICC, which governs the banking system. Thousands and thousands of banks follow these uniform customs and practices, and that is what drives this system of documentary credit.

Let us look at this system, which is so important and which drives international trade.

We have seen in recent decades the growth of international trade by leaps and bounds.

There has been a lot of contribution from this UCP system in facilitating international trade and reducing disputes and conflicts among traders.

Remarkably, a private organization like ICC, based in Paris, France, has been extremely successful in solving several challenges related to receiving international payments through banking channels. The role of this organization is discussed by Dr. Jain in the next video.

Let us look at the latest version of UCP, that is, the Uniform Customs and Practices, which is called UCP 600 revisions—Uniform Customs and Practices for Documentary Credit.

These are the revised rules from 1st June 2007, and they are being used by banks and financial institutions around the world for documentary credit.

It is not binding.

The letter of credit can follow the earlier version also.

For example, the LC can be prepared as per UCP 500 or 400.

Of course, 400 is very old. Nobody uses 400, but UCP 500 is still very popular with many banks.

The latest version remains UCP 600, and the majority of letters of credit, in present times, are based on the UCP 600 version.

Let us try to understand what UCP is.

UCP is the common reference for the Uniform Customs and Practice for Documentary Credits.

It was first published by the International Chamber of Commerce, Paris, France, in 1933, as I just mentioned. The objective of UCP was to create a set of contractual rules that would establish uniformity among the conflicting national regulations, differences, dichotomies, and the conflicting nature of the nationals of different countries.

This uniformity is very important for being a banker.

This uniformity is very important to be able to trade internationally.

Without this uniformity, trade cannot happen, and the chances of conflict and disputes would increase manifold.

This UCP system is now recognized as a standard practice by more than 38,000 banks in over 196 countries, or even more. These figures are just indicative.

Banking practices, especially international trade financing practices by banks, are largely governed by the UCP only.

Now, let us try to understand the main features of UCP.

I will talk about UCP 500 or 600 in great detail later, but I will just give you the gist of UCP, its impact on the system, what it entails, and what kind of basic structure it creates.

UCP creates the basic uniform structure, the basic banking practices, and the thinking on which even a layman can understand what an LC can do and what an LC cannot do.

Those limitations of the LC, those limitations of the banks, and those limitations of the documentary credit system will be clearer with some of these slides, which I am going to show you to explain the very basic pillars and inferences of UCP.

As per UCP, whether it is the latest version or an earlier version, the parties to international transactions can be the buyer, seller, buyer’s bank, or seller’s bank. The buyers can be named as importer, applicant, account party, or drawee.

These words can be used in the letter of credit.

Different countries use different words, but UCP defines these terms.

Going beyond these terms could bring conflicts and disputes.

The parties defined in UCP are these: seller, exporter, beneficiary, drawer, or buyer’s bank, which can be the issuing bank, paying bank, or collecting bank (which, in the case of documentary collection, collects the money). The bank can also be a collecting bank.

The seller’s bank can be the advising bank.

It can also be the confirming bank, which confirms the documentary credit received from the overseas importer and the importer’s bank. It can also be the negotiating bank, which will negotiate the documents on behalf of the seller with the issuing bank. It can also be the remitting bank because it remits the money received from the issuing bank—the overseas bank—to the local exporter in domestic transactions.

The remittances are received by this bank, which is why it may be called the remitting bank.

These are the terms defined in UCP.

Going beyond these terms is not desirable and can bring a lot of confusion.

This is the starting point to let you know the scope of UCP.

Who are the players in this UCP system?

These are the main players.

Any other kind of intermediary or agency is normally not encouraged to be included in any letter of credit document or documentary credit statement.

These are the parties that are limited in this whole game of UCP.

In the next lecture, Dr. Jain discussed the rationale of LC as explained and conceptualized in the UCP document.

Now, the UCP starts by explaining the rationale of the LC, because the rationale has to be understood.

Only then can we actually use the letter of credit or the documentary credit in the way it can practically be applied, and in the way it can be expected by all the parties I just mentioned.

The rationale for the buyer for the LC: because a documentary credit is a conditional undertaking by the bank, payment is made on behalf of the buyer against the documents, not by the buyer, but by the issuing bank, the third party. These documents may represent the goods and give the buyer rights to them.

These documents, especially the transport documents along with the commercial invoice and the packing list, will give the buyer the right to go to the shipping company and collect the goods which have already reached the port of discharge.

That right exists.

The rationale of the LC is that this system provides the right of ownership through these documents.

This is one rationale of the LC for the buyer: it provides documentary ownership of the goods.

That connection has been established.

For the seller, because the documentary credit is a bank undertaking, the seller can look to the bank for the payment instead of relying on the ability or willingness of the buyer to pay, or even the soundness of the buyer. The soundness of the buyer can drastically change with time.

The buyer can become insolvent, intentions can change, and the business situation can change. But the third party, the bank that opens the letter of credit, is the nodal point.

That is the paying point on which the seller can rely.

That is the rationale for both the buyer and the seller. At the same time, when we talk about this rationale for the buyer and the seller, because the undertaking is conditional, the seller only has the right to demand payment if, and only if, all the requirements—all the documentary requirements of the documentary credit or the letter of credit—are met.

Since the bank deals with documents only, the seller has to meet the documentary requirements.

It is therefore unwise for the seller to proceed with the shipment until he is aware of these requirements, is confident and satisfied that he can procure these documents, can generate these documents, and can meet those requirements.

Only then should he go for the shipment. Even if the LC is obtained, even if he has accepted the letter of credit—in fact, before accepting the letter of credit—the seller should be very confident and satisfied that he can meet the conditional requirements mentioned in the letter of credit.

Only then does it make sense for the seller.

Otherwise, the payment will not be made by the issuing bank.

UCP smartly limits the scope of L/Cs and defines its limitations and capabilities. The idea is to control the game in such a way that the same can be played by the rules it sets. Otherwise, it would be free for all, and the solution is likely to fail.

Friends, what can an LC do and what can it not do?

Let us try to understand that.

What it can do: it can provide a means of prompt payment to the seller, provided the conditions are fulfilled.

It can eliminate extensive credit investigation of the buyer since the seller's credit risk has been assumed by the issuing or confirming bank. It can eliminate the extensive credit investigation of the buyer, as the credit risk for the seller has been assumed or taken by the issuing bank or the confirming bank.

The confirming bank is the local bank that confirms the letter of credit.

It can assure the buyer that payment will only be required if the conditions of the credit are met. Otherwise, the money remains with the buyer. If the conditions are met, the buyer is more secure.

He will get the goods on time. He will get the goods in his country at the designated port of discharge, and he can collect the goods in a much safer manner, with better prospects and better security.

It can provide a base for a bank to engage in temporary inventory and receivables cycles of international trade financing. It is a kind of system of international trade financing, and the LC provides a base for banks to engage in temporary inventory. It is like an escrow account.

The money is generally collected by the issuing bank in advance, unless the buyer has an overdraft limit.

The bank acts as a third party with the inventory of the money that is to be paid by the buyer at the right time and the right place.

That role is taken over by the bank.

What it cannot do: it cannot substitute for the integrity of the seller or make background and integrity checking unnecessary. That checking and due diligence remain.

It cannot lend soundness to transactions that were not basically sound in the first place.

If the whole transaction is a bad transaction or a dirty transaction, the bank will not know. The bank will purely rely on the originality and genuineness of the documents.

What happens behind those genuine and original documents, the bank is not able to verify.

It is not possible.

Therefore, the LC cannot lend soundness to such nefarious transactions if they have been artificially created.

The LC cannot absolve the seller or the buyer from contractual liability, the export sales contract, or any international contract between the buyer and the seller.

That is not the concern of the bank.

The bank cannot go into that.

It purely relies on the LC opening instructions given by the buyer.

Whether those instructions are as per the contractual liability of both parties, the bank is not concerned with that, and banks should not be concerned with that.

Otherwise, this system cannot work.

It cannot remove the risk of foreign exchange fluctuations. That foreign exchange fluctuation risk will remain, and it has to be managed by the first and second parties—that is, the buyer and the seller.

It also cannot guarantee that the shipment will be made by the seller.

As I told you, the physical part cannot be taken care of by the bank, and therefore it purely relies on the documents—transport documents, their genuineness and originality, and, to the best of the bank’s knowledge. Again, it is possible that the documents may not be original but may appear to be original. The entire system relies purely on the bank's experience and its long involvement in international trade financing.

Being a reputed bank, it will apply the best of its knowledge and training to detect any discrepancy in the documents, but it cannot be 100% correct or foolproof.

Finally, documentary credit or the letter of credit, by their nature, are separate transactions from the sale or other contracts on which they may be based, and banks are in no way concerned with or bound by such contracts.

Again, I am telling you that the bank purely depends on the LC opening instructions of the buyer.

Under the UCP, it is always discouraged to give any reference to such contracts, which are beyond the letter of credit, because the letter of credit itself is a contract between the bank and the buyer at one end, and between the bank and the exporter at the other end.

The bank is not concerned with any other contractual obligation or the presence of any other contracts.

Even if any reference whatsoever to such contracts is included in the credit—although UCP discourages this—even if it is included, the bank will not give heed to such contracts and will absolve itself from such contractual obligations beyond the letter of credit.

In the next video, Dr. Jain talks about the basic tenets of a documentary letter of credit, which duly explains the role, limitations, and scope.

Friends, the basic tenet of the letter of credit as defined in the various clauses—some 30 to 40 different clauses of different versions of UCP—

The basic fact, which is the gist of this whole system, is that the banks handling the letter of credit deal in documents and documents only. They actually will not be able to go beyond the documents.

Any dispute with regard to the quantity or quality of the merchandise bears no relation to the bank's responsibility to examine documents as presented under the letter of credit.

The scope of the bank is purely on the presentation and compliance.

If the presentation of the documents as per the LC is compliant, if, to the best of the knowledge of the bank, it feels that the documents are genuine, and with the knowledge and application of the banking mind of the issuing bank, if they are satisfied with the documents, they will pay the money.

What happens beyond that?

The bank is not concerned because banks deal with documents and documents only.

This is what I wanted to convey to you: the UCP, the Uniform Customs and Practice for Documentary Credit, whose latest version is UCP 600.

Six revisions have already been done by ICC, Paris, France.

This provides the template; it provides the guidelines.

It provides the basis of this whole international trade financing through documentary credit. In summary, UCP creates the ecosystem of banking practices, international banking practices for international trade financing, for international transactions of exports, imports, or any other types of goods or services movement.

Documentary credits, therefore, are arrangements by the banks for settling international commercial transactions.

This is a banking arrangement.

It provides a form of security for the parties involved—the parties I just mentioned to you: the buyer, the seller, the buyer's bank, and the seller's bank, along with the different names defined in UCP.

It provides a form of security for those parties.

It can ensure payment, provided that the terms and conditions of the letter of credit have been fulfilled.

The conditional undertaking is there, and those conditions have to be met by the seller. It also means that the payment by such means is based only on documents, because that is the limitation of this banking system.

They deal only with documents and not with the merchandise or services involved.

There is no way for the bank to physically check the goods or the movement of services, or the physical transaction taking place through transportation modes like sea, air, or any other means.

Those things cannot be brought into the scope of the bank and this banking system.

This clarity has to be made if the system is to work as per UCP.

In the next few videos, some of the more popular types of L/Cs and their features are discussed.

Welcome back to the course. In the last few episodes, we have discussed the rationale of the letter of credit, the role of UCP in driving this documentary credit system in the world, and the role of documentary credit in the growth of international trade. We also discussed many things that give a very good foundation to this topic of the letter of credit.

In the next few episodes, I will be discussing the letter of credit itself.

What are its types? How is it issued?

What is the format of the LC instructions—letter of credit instructions—which are given by the importer to the issuing bank, based on which the LC is created?

What are the typical formats?

I will be discussing that, and I will also discuss with you some more issues related to the letter of credit, such as the kind of precautions the exporter must take while accepting the letter of credit.

I will talk about the letter of credit, why there are different types of letters of credit, what their purposes are, and what type of letter of credit is used in what situation.

These things I will be discussing in this particular section.

Let us first discuss the different types of letters of credit provided by typical international banks.

These are the typical types.

Although there can be hundreds of types of letters of credit, the reason for having different types is that the nature and situation of diverse international export-import deals require different treatment, different conditions in the letter of credit, and even different types of letters of credit.

For certain situations, you need methods to reduce the price of the letter of credit.

You can reduce the cost of the services given by the banks.

Overall, the aim of any international businessman is to reduce the operational costs of transactions.

To achieve this, banks try to help international traders by offering different products and different documentary credit instruments.

That is the reason different types of letters of credit have emerged.

I will be discussing with you some very common types of letters of credit that are used in different situations.

The most common type of letter of credit, which is normally used in international trade transactions, is the merchandise LC.

It is also called the commercial LC or the trade LC.

The purpose of this LC is to deal with individual transactions of merchandise, commercial transactions, or international trade.

The majority of LCs issued are for payment for goods in shipment or current services performed.

Payment is normally made against documents for goods shipped, and the majority of international trade happens through this kind of LC.

When we talk about a letter of credit, normally by default, we are talking about the merchandise letter of credit, in which the importer requests the issuing bank to open the LC and give LC instructions. Based on this, a very typical type of merchandise LC is opened by the issuing bank, which gives the conditional undertaking.

Those conditions are documented, and against those documents, payment is made to the exporter after a compliant presentation.

This is a very normal, very common type of letter of credit, which is very popularly used.

Generally, when we are talking about the merchandise letter of credit, we are talking about individual shipments.

It deals with individual shipments.

There can be situations where the same type of transaction, for example, is made month to month for a very long period.

Every month, there are transactions happening.

If you go for a merchandise LC for every transaction every month, which is of a very similar nature, then you end up paying monthly LC charges to the bank, which becomes very costly.

For example, in this situation, you need a certain letter of credit or a certain type of documentary credit, which is of a different nature.

There can be many other situations where a typical merchandise letter of credit may not be the best option.

Another type of letter of credit is called the irrevocable letter of credit. In UCP 600, by default, all letters of credit, especially merchandise letters of credit, are irrevocable. This means once it is opened by the issuing bank, either on the request of the importer or at the willingness of the issuing bank, the LC cannot be revoked.

However, there can be a possibility of creating a letter of credit that is revocable in nature, which means it can be amended or canceled by the issuing bank at any moment and without any prior notice to the beneficiary.

Articles 6 and 8 of UCP 500 deal with this. In UCP 600, there is a provision for a revocable letter of credit, although by default, all merchandise LCs, even if nothing has been mentioned, are irrevocable, which was not the case in UCP 500.

This is a new development that has happened in UCP 600.

If the LC has been based on UCP 600, by default, it is irrevocable.

Now there can be letters of credit, and in fact, the majority of such letters of credit are unconfirmed, which means the guarantee associated with the letter of credit is only of the issuing bank.

There is no further confirmation by a local bank or any other intermediary or financial institution.

Such kinds of letters of credit are called unconfirmed LCs. At the same time, confirmation is possible by the local bank or some intermediary, which may be a third country or an international intermediary. In cases where the issuing bank may not be of great stature, may not be a reputed issuing bank, or may not be listed among the top 100 or top 1000 banks of the world—the so-called first-class banks—confirmation becomes important.

In this case, there is a possibility of non-payment by the issuing bank. In such cases, the concerns of the exporter and the credit risk of the exporter are assumed by the intermediary, which can also be a confirming bank. The local bank would be able to confirm a letter of credit.

A confirmed letter of credit is a credit in which a second guarantee is added to the letter of credit by another bank.

Article 9 of UCP 500 deals with both the unconfirmed letter of credit and the confirmed letter of credit.

This can be seen in these articles, and there are corresponding articles in UCP 600, also, with very few modifications.

The most popular and most sought-after letter of credit is called the Sight LC or Sight Letter of Credit, where the payment is at sight. This means that the drafts and documents are honored if there is no irregularity, if there is no discrepancy, and all the documents are in order, by the issuing bank making payment without any delay.

The period of payment for a Sight Letter of Credit in the case of UCP 500 is seven working days, but it has been reduced in UCP 600 to five working days.

If the LC is based on UCP 600 and it is a Sight LC, which means it is payable at sight, the payment would be made within five working days.

Different from the Sight LC, another type of LC is called the Usance LC or Time LC, where there is a Usance period of the credit.

In such types of letters of credit, the draft is honored by being accepted by the issuing bank.

It accepts the draft if there is no irregularity, if there is no discrepancy, and everything is in order, for payment at a future specified date, which can be 30 days later. It can be 60 days, or it can be 90 days.

Payment is delayed until the maturity of the draft, depending on the specified number of days.

Generally, this Usance period does not exceed 180 days.

For example, in the case of Indian exports, the Central Bank of India, that is, the Reserve Bank of India, specifies that it is illegal to enter into a contract with a letter of credit that is a Usance LC beyond 180 days, because in the Indian context, the guidelines of the foreign trade policy of India say that the money should be realized by the exporters within 180 days of the dispatch of the goods.

There can be another type of letter of credit, which is called a revolving letter of credit. It comes into use where similar types of transactions happen regularly. Therefore, for transactions happening at a regular frequency, this is the best letter of credit and a cheaper option, wherein the amount is renewed or reinstated without specific amendments to the letter of credit being needed. It can revolve in relation to time or value.

Now, there can be another type of letter of credit, which is called a revolving letter of credit. It comes into use in situations like the one I just explained to you, where a similar type of transaction happens on a monthly basis or on a quarterly basis. For transactions happening at a regular frequency, this is the best letter of credit and a cheaper option, wherein the amount is renewed or reinstated without specific amendments to the letter of credit being needed.

It can revolve in relation to time or value.

What happens in this case?

The transaction is very similar.

The port of loading is the same, the port of discharge is the same.

The exporter is the same, the importer is the same.

What probably changes is the date of shipment, which occurs every month or at some approximate frequency, and the value of the goods may also change.

The dates may differ, or the value may be different.

Otherwise, the description of the goods in the commercial invoice is the same.

The transport documents are similar in nature, which means the requirements of the documents in the LC and the LC conditions also remain the same. There is no real amendment in the letter of credit except for the dates of dispatch, the last date of the letter of credit, or the value of the credit.

Those factors can change. In this case, the banks offer this revolving LC, which would revolve a specified number of times—maybe three times, six times, ten times—and the overall cost to the exporter and the importer by having this kind of letter of credit becomes much more affordable.

Banks can give better terms because there are no major changes in the letter of credit.

It is just that the letter of credit is revolving.

The amount is actually renewed and reinstated in this LC.

Otherwise, the bank has no other work to do for this LC, so they give better terms in such a case.

Now there is a type of letter of credit which is called the red clause credit.

A red clause credit LC authorizes the advising bank or the confirming bank, which is generally a local bank, to make advances against the letter of credit to the beneficiary even before the presentation of the documents.

The purpose of this type of letter of credit is that the beneficiary, that is, the exporter, can take advances against the letter of credit to purchase raw materials and manufacture the goods.

It basically benefits the exporter.

At the same time, it also benefits the importer because it facilitates this particular transaction, which is also in the interest of the importer.

Then there is another type of letter of credit, which is called the transferable credit.

This type of letter of credit, the transferable letter of credit, can be transferred by the original beneficiary, who is named in the letter of credit, to one or more other parties.

What happens in some cases is that when the type of goods is very commoditized or in bulk, and the procurement brings a lot of challenges where the quantities are very large, generally, the per-unit value of such commodities is not very high.

It is in the interest of the importer to provide the transferable letter of credit, so that if the original beneficiary is not in a position to procure the material within the specified time, he can transfer this LC to another party.

Sometimes it also happens that the person who receives the letter of credit is a merchant exporter who consolidates the supplies from several manufacturers. The manufacturers want the letter of credit to be transferred in their name.

In many such cases, the letter of credit is also divisible, which means the LC amounts can be divided among several other beneficiaries to whom the original beneficiary transferred the letter of credit.

A transferable, divisible letter of credit helps the importer to procure the most challenging products, especially commodities of lower value.

One example of this is soybean meal, which is exported from India from Raipur district in Chhattisgarh, where many manufacturers extract soybean oil. The byproduct of that extraction is soybean meal, which is animal feed. The cost of such a commodity is very low, and it requires transportation by sea in chartered big ships, where the quantity requirements for a particular LC are very high, quantities that a single manufacturer cannot satisfy for the importer.

In such cases, the main beneficiary tries to get the transferable, divisible letter of credit and transfers and divides the letter of credit among several exporters.

The result is that by doing this, it becomes possible to procure the material in shipload quantities.

In many cases, what happens is that the main beneficiary of the letter of credit requires the local bank to open another letter of credit for the third party, who can be another manufacturer of similar goods or the same goods mentioned in the letter of credit. In this case, the beneficiary offers the main LC—that is, the overseas LC—as security to the second credit-opening bank, which can be an advising bank or a local bank that opens the back-to-back LC to the secondary beneficiary.

This is required in order to avoid any advances or extra costs of getting those advances from the banks.

Instead of doing that, the main beneficiary can get a second credit against the main documentary credit as a back-to-back, so the second credit becomes the back-to-back LC.

There are several types of letters of credit, and the ones I just discussed are a few of the very popular documentary credits.

These are the types of documentary credit in international trading, international transactions, and international banking.

Many such documentary credit instruments are offered by the banks.

Many times, they are very innovative in nature, and often these letters of credit are not even mentioned in UCP 500 or 600. However, the banks try to match those innovative documentary credit instruments with the existing articles of UCP 500 and 600.

Once a sales contract is signed or a proforma invoice supported with written emails discussing the various terms of trade is finalized, it is the role of the seller to initiate the process of L/C. It is a good practice for both the seller and the buyer that the seller drafts the L/C opening instructions, based on which the buyer applies to the issuing bank to open the letter of credit. Why? Let us understand the same in the next 2 videos.

Welcome back to the course.

Now I want to congratulate you because you now know a lot about the letter of credit.

You know what types of letters of credit there are, what the rationale of the letter of credit is, how UCP defines the scope and guidelines for the letter of credit, and how this whole international banking payment system works.

You now have incredible knowledge of how this system works, what is behind it, and what the principles are.

What is the philosophy? What is the ideology?

And what is so-called banking as a religion, not as an entity governed by any international laws?

The human mind has created this method of international gathering of humans and the human mind to a common cause—maybe a religion or whatever you call it.

But definitely, it is not governed by any enforceable international law.

Yet it works.

That's very interesting. That is how it works.

It works on goals, trust in principles, and conviction in the system of banking and bankers, who adhere to certain guidelines and principles, and who know their limitations.

Within those limitations, they carry out incredible work that is so deep-rooted in the international system that, as I have mentioned to you, data shows almost 80 to 90% of international trade relies on some kind of international trade financing—maybe in the form of documentary credit, collection, bank guarantees, or standby letters of credit.

Some method is being used for 80 to 90% of world trade.

That is a huge involvement of a system that works on conviction, on principles, and on confidence in the protocol and guidelines of an organization—the International Chamber of Commerce, France.

They have brought about consistent revisions of the guidelines, addressed disturbing areas, and rectified those issues to the extent possible in a very democratic system, a system that is unique in itself. That is truly incredible and very interesting.

Now, let us look at things from the point of view of the businesspersons, the exporter, and the importer.

Obviously, when the sales contract has been signed between the exporter and the importer, it is natural that the exporter would advise, based on mutually agreed terms, the importer on what kind of letter of credit instructions should be given by the importer to the bank. This ensures that the LC opened by the issuing bank is in the interest of the exporter and is probably acceptable to the exporter.

It makes a lot of sense.

The starting point should be with the exporter, who should send a document to the importer to frame the LC opening instructions for the importer's bank in the way the exporter has suggested, to the extent possible.

An LC opening instruction draft is usually prepared by the exporter, based on all agreed terms of trade in a particular export transaction. It may be based on a formal written contract or the official communications made via any other means between the exporter and the importer.

Let us look at this document.

This document is called a letter of credit instruction, which is given by the exporter.

The exporter frames this letter of credit instruction mostly based on the sales contract. I have given here a sample of one of the letters of credit instructions.

Typically, the format that the exporter will be using would look like this: the date is there, the name of the buyer is there.

Whatever the buyer's name is, he will write the exact name and the address, so that the buyer knows what is in the record of the exporter.

What buyer's name is there?

Because ultimately, these details have to appear in the commercial documents.

He writes: “Gentlemen, the following are the particular details we wish to have included in your documentary letter of credit, issued in reply to our proforma invoice number (or it can be a sales contract number).”

Obviously, this proforma invoice or the sales contract, which are one and the same except that the proforma invoice is very minimal in nature, does not have the kinds of conditions given in the sales contract. It is not so detailed, but many times for small transactions, the trade is done using the so-called proforma invoice, which is very similar and serves as the basis for the commercial invoice.

He writes here that in reply to our proforma invoice number so-and-so, dated so-and-so, please instruct your bank to open and issue this credit in accordance with the following terms and subject to the Uniform Customs and Practice for Documentary Credit by International Chamber of Commerce, publication 500.

Or it can be 600 also.

If you do not write anything, by default it will be 600.

Generally, even today, many exporters go for 500 because they understand it better. Their staff is more conversant with UCP 500. They may not have updated themselves according to UCP 600.

Many exporters try to get the letter of credit as per UCP 500, but it is always advisable to go for UCP 600.

The letter of credit instruction format further states: “We have made every effort in these instructions to provide you with terms which can be easily accommodated.”

The language of the LC instructions should show that you are taking care of the interests of the buyer also, and whatever has been understood in the sales contract or the proforma invoice, and whatever has been discussed orally or through some kind of email communication, even that is quite good.

If you have written communication in the form of emails, that can be a very good basis and a very good support document with the proforma invoice, because it will include the agreed terms and conditions in written form, which is as good as a detailed export contract.

It states: “If you or your bank, that means the importer's bank (the issuing bank), is unable to comply with these terms and conditions, please consult with our office before issuance of the letter of credit, to avoid any delay or the non-shipment of the goods.”

International trading transactions are of mutual interest to both the buyer and the seller. While the seller expects everything to be in order and within the acceptable scope of the seller, the importer also wants the goods to be of good quality, on time, and in the right quantity.

It is in the interest of both parties to have this type of understanding: what should be involved in the letter of credit, which means what conditions and what documents have to be incorporated in the letter of credit, and what is the nature of the letter of credit.

What is the type of letter of credit?

What are the payment terms of the letter of credit?

Whether it is a sight LC, whether it is an irrevocable letter of credit, a red clause letter of credit, or a revolving letter of credit, the nature of the transaction, the value of the transactions, the understanding, and the communication between the seller and the buyer will define all these conditions. All of these details should be included in this document.

It states: “The letter of credit shall be irrevocable, issued under the rules of UCP 500” (or it can also be 600).

Depending on the choice of both the seller and the buyer—if the seller says 500 and the buyer says 600—that should be acceptable.

“The credit shall be advised and confirmed by…” Here, the seller specifies the bank, which is nominated to play the role of the advising bank as well as the confirming bank, which would be the same as per the request of the seller to the buyer. He writes the name of the bank, the local bank of the seller.

Generally, it is the bank with which the seller has the main business account, because it makes things very easy for the seller. If it is possible for the issuing bank as well as the importer (the buyer) to accommodate this nominated bank, it would be good for both parties.

He writes the name of the bank and the address of the bank.

Normally, the address is given for the foreign exchange branch of the bank, because it is possible that the actual account of the seller may not be in the foreign exchange branch. In that case, he will invariably give the bank name along with the address and details of the foreign exchange branch and the other details, such as the current account number or business account number, depending on the country of export.

All this information is given in the letter of credit instruction.

Further, the letter of credit instruction talks about the nature of the letter of credit.

That is, the credit shall be freely negotiable.

The meaning of this is that the seller would be in a position to use any local bank as the negotiating bank. Freely negotiable means the issuing bank is advised not to nominate the bank that would act as a negotiating bank. Freely negotiable means the seller wants the freedom to choose the bank of his choice to act as the negotiating bank for negotiating the documents and getting the remittance from the issuing bank.

This request has been made in the instructions.

The fourth request, which is made in this instruction, is that the credit shall show the beneficiary's exact name.

Here, the exporter will write the exact name, generally the business name that is also in the bank’s record, and under which the current account has been created in the local nominated bank.

The exact name has to be shown here so that there is no mistake in the letter of credit.

The credit shall be payable in the currency, which in this case is the US dollar.

The total amount is also mentioned here to avoid any misunderstanding or miscommunication.

Further, it says that the credit shall be payable at sight, which means, as I mentioned to you, that the request of the seller is to get a sight LC, which is payable on presentation of the document.

There is no Usance period, or if there is a Usance period as agreed in the sales contract or the proforma invoice, the number of days after which the payment will be made after acceptance of the compliant documents is written here. It may be 30 days, 60 days, or 90 days.

Whatever the time period is, it will be mentioned here.

The Usance period will be mentioned here.

The credit shall show that all banking charges, except for the seller's bank charges, are for the account of the applicant.

Here, as I mentioned to you, the applicant means the buyer—the importer.

For banking purposes, the applicant is the buyer, and except for the charges which will be on the account of the seller’s bank charges (the local bank charges), all other charges have to be in the applicant's account.

This request has been made in the letter of credit instruction.

All reimbursement charges are for the account of the applicant.

All kinds of letter of credit-related charges and reimbursement charges have to be on the account of the applicant.

The applicant will not have any objection to this.

The buyer will not object for a simple reason: even if it is in the account of the exporter, it will reflect in the price because the export price will obviously be increased by the exporter.

Ultimately, all the costs and payments are paid by the buyer only.

This kind of request is very logical and valid.

Another condition and request that has been made is that the confirmation charges, the local confirmation charges, are on account of the applicant.

Here, there can be some differences of opinion, as it is in the interest of the seller to have the local confirmation. The applicant may say that the charges will be borne by the beneficiary.

But again, as I mentioned to you, the export price will go up. The requirement for confirmation arises if the issuing bank—discussed in earlier communications—happens to be a bank not on the list of first-class banks. In such cases, the contention of the buyer would be weaker, and the seller would say that, since the bank does not have the required level of due diligence, it is the right of the beneficiary to have the local confirmation for the safety of the transaction.

In that case, logically, it makes sense to have the request that the confirmation charges be borne by the applicant—that is, the buyer.

The next request made in the letter of credit instruction is that the credit shall show that all the charges for amendments to the credit, including related communication expenses, are for the applicant to pay.

Here again, clear instructions are being given to the applicant.

If there are discrepancies or differences in the letter of credit and some kind of amendment has to be done, the fault is obviously not of the beneficiary.

It is very logical to ask for this condition: all these expenses should be to the account of the applicant.

Another instruction given is that partial shipments are permitted, depending on the nature of the goods and the agreed terms.

It is possible that the goods may not be ready by the time the export has to be effected and the shipment has to be made. If the buyer has agreed that he is flexible about the quantity, in case the letter of credit is made for a certain quantity and that quantity is not available before the due date, partial shipment should be allowed.

This will also be in the interest of the buyer, because if it is not allowed and the goods are not ready, then, depending on the nature of the goods, the whole shipment will not reach the buyer, which would not be in his interest.

Another condition given is that transshipment is not allowed.

Transshipment means the goods are being shipped by some means—this issue mainly arises in sea transport. In air shipments, it is more difficult to determine whether transshipment is happening, and air shipments are faster and more complex.

In sea transportation, transshipment means that the goods are unloaded from the ship to be further loaded during transit at some intermediate point. This means the ship carrying the goods is not going directly from the port of loading to the port of discharge.

This is not a good idea because in sea transportation, loading and unloading are a major peril, a major transit risk.

Normally, buyers will not agree to transshipment unless there are no regular sea routes and sea services from the port of loading to the port of discharge, in which case transshipment may be necessary.

In the case of transshipment, marine insurance charges are also usually higher.

It is not in the interest of the buyer. If direct routes are available and the possibility of sending the goods directly on a single ship exists, it will be in the interest of both the buyer and the seller to ship the goods without transshipment.

Generally, this condition—that transshipment is not allowed—will be included.

Shipment from any Indian port or airport: here, a lot of flexibility is being taken by the seller, both in terms of the port of loading, which can be any port in a large country like India, as well as the mode of transportation.

The choice of mode of transportation—the freedom for this—is taken by the seller.

This would not be of major concern to the buyer because it will not create any significant operational issues for him.

This kind of request is generally very comfortable and desirable for the seller, and it will not really affect the interest of the buyer.

The letter of credit expiration date shall be mentioned here.

Generally, it would be a date 2 to 3 weeks later than the desired shipment date (the last date of shipment).

The expiration should allow sufficient time for the presentation to be made to the local bank for negotiation with the issuing bank.

It is always good practice to have at least a 2 to 3-week gap between the last date of shipment of the goods and the expiry date of the letter of credit.

Here, the latest shipping date is also mentioned, which serves as the date beyond which the bill of lading would be termed stale and would not be considered a clean on-board bill of lading, which is the desired condition in the interest of the buyer.

The latest shipment date will be mentioned here.

He does not have any other kinds of intention.

It would really not be objectionable to the buyer, and he will agree to this requirement of having the consignee named in the bill of lading and consigned to the issuing bank.

The name of the exporter would be there in the documents, but the consignee's name would be the issuing bank.

Here you will also be writing the other documents that have been agreed upon between the buyer and the seller, as per the requirements of the customs of the port of discharge, meaning the customs of the buyer’s country.

Normally, these would include the certificate of origin, the quality certificate, or perhaps the insurance certificate, depending on whether it is a CIF contract, a CNF contract, or an FOB contract.

Which international commercial term has been used—meaning which Incoterm has been applied for the delivery—determines which documents may be requested by the buyer and agreed upon by the seller in the communication.

Those documents must be ones the seller can actually procure.

It should not contain any document that is not within the scope of the exporter to obtain locally or by any means.

Only documents that are possible and doable will be mentioned here.

It also states: “Your cooperation is very much appreciated. Please contact us for any questions that you may have.”

This is a very professional type of communication by the seller to the buyer when giving the letter of credit instruction.

This is a very good starting point for an international export transaction, wherein the seller gives point-wise requests to the buyer to be incorporated in the LC opening instructions.

The other document, which will now be created by the buyer and submitted to the issuing bank, will form the basis on which the issuing bank will open a letter of credit.

You can download the sample cum format of a real-world typical letter of credit from the download resources section of this lecture.

What are the common L/C flaws to look for when a seller receives the L/C and before accepting it? Watch the next video.

Hello, friends.

Welcome back to the course.

Now your knowledge about letters of credit is getting strengthened.

You are now able to understand the fine print of the letter of credit. You can understand how the letter of credit works, what the different types of letters of credit are, what the role of the letter of credit opening instructions is, and what the role of the document sent by the exporter to the importer regarding the LC opening instructions is. This is a very important document.

Everything is very logical here.

The system works in a very logical fashion.

It has been well tested over the last 80 to 90 years.

This system has been working very smoothly.

Certain changes that have occurred have been reflected in the different new versions of the UCP—Uniform Customs and Practices—the latest version of which is UCP 600.

Going forward, let us now look at when the LC is opened by the issuing bank and advised by the advising bank to the beneficiary, that is, the exporter.

Now it is the turn of the exporter to review the letter of credit and decide whether it is acceptable or not, and to check whether the letter of credit advised is in line with the LC instructions which the beneficiary had given to the applicant, that is, the importer, through the draft LC instructions. If there are any differences, changes, or variations from the LC instructions given by the exporter to the importer, the exporter must decide whether those changes are acceptable, whether the conditions in the letter of credit are doable, and whether the exporter can arrange those documents.

There are certain fine details the exporter should check before accepting the letter of credit.

I will now share with you a checklist of the things that should be checked step by step before accepting a letter of credit.

Let us look at this checklist.

The first thing to check in the letter of credit is whether the names and addresses of both parties—the beneficiary and the applicant—are correct.

The address should be correct, the name should be correct, and these details should match exactly. These names and addresses will appear on several documents, and they must match in spelling, format, and correctness.

This first step is very important—checking the name and the address.

The second thing to check by the beneficiary in the letter of credit is whether the credit amount (the LC amount) is in line with reality, with the calculation, and with what the beneficiary (the exporter) has indicated in the LC instruction. Is it sufficient? This has to be checked carefully.

The third thing to check is the list of documents required.

These are commercial documents, also called LC documents or principal documents.

Principal commercial documents, also called the letter of credit documents, are listed in the letter of credit and can vary according to the terms of trade.

Here, the exporter must check whether these documents are obtainable, whether they are in line with the terms of trade, the terms of the sale, and the sales contract, or whether they match the written communication (emails or letters) between the exporter and the importer. Any discrepancy must be noted.

The fourth thing to check is the points of shipment and destination.

Are they correct? This means the port of loading and the port of discharge.

If the LC is flexible about the port of loading, that is good for the beneficiary. If the LC mentions a specific port of loading that is convenient for the beneficiary, and if it was requested in the LC instructions, then it will work.

The fifth thing to check is the insurance coverage, including the terms, conditions, and scope of insurance.

What is the insurance requirement in the letter of credit?

Can those requirements be met and obtained? Are they in line with what was agreed in the sales contract or in the written communication between the exporter and the importer?

The sixth thing to check in the letter of credit is the shipping date for the shipment of the goods.

The exporter must check whether manufacturing, packing, preparation of the documents, and all other formalities can be completed in time, and whether space can be booked on a ship from the port of discharge.

This has to be verified with the shipping company, the CNF agent, or whoever is responsible for the shipment, to confirm that the dates are convenient and achievable.

The seventh point to check in this checklist is the expiration date of the letter of credit.

Does it allow sufficient time for the presentation of the draft and documents?

Normally, banks allow 17 to 18 days after shipment for presentation, as per the latest UCP. Clearly, the expiry of the LC should align with that timeline.

The last thing to check in the letter of credit is the description of the goods.

Logically and technically, it should be in line with what has been agreed.

All documents, such as the certificate of origin or any other third-party documents, should match the description.

The description must also match the ITC HS code on which the deal and pricing are based. If the ITC HS code changes, the entire calculation can change.

The description of the goods has to be correct from both the importer’s and the exporter’s perspectives.  The description should be clearly and properly indicated simply.

It should not be too complex or too difficult to understand.

This has to be checked carefully.

The worst thing that can happen to the seller is that the documents presented to the issuing bank are rejected. It is better to learn about common documentary discrepancies observed by several international banks worldwide. And it is better to avoid such discrepancies. Watch about it in the next video.

I will now share with you the common discrepancies that occur when the exporter prepares the goods, ships the goods, procures the documents, and presents the documents to the negotiating bank. The negotiating bank negotiates with the issuing bank and sends the presented documents.

These are the common discrepancies observed by issuing banks around the world. I will share them with you, and the exporter should be very aware and knowledgeable about these discrepancies so that sufficient care is taken while dispatching the goods, procuring the documents, and ensuring that the process does not result in any of these types of discrepancies.

Let us look at these common discrepancies among the letter of credit documents.

These are the discrepancies normally observed in export documents, and exporters are advised to keep them in mind while tendering the documents for negotiation by the negotiating bank.

A common type of discrepancy is that when the presentation is made, the credit has already expired.

This normally happens when the expiration date of the letter of credit is very close to the last date of shipment. Sufficient time is not allowed by the letter of credit for the presentation of documents. If due diligence and care are taken, the chances of this discrepancy are very low.

A second very common discrepancy observed in many letter of credit-based document presentations is that the shipment date in the transport document is later than the latest date by which the shipment must have been made. The last shipment date has been crossed, and the transport documents have become stale. This is a very common discrepancy. Sufficient care should be taken by the beneficiary to ensure this situation does not arise.

The third very common discrepancy in presented documents is that the bill of lading is not a clean on-board bill of lading.

It is a claused bill of lading, which means either the quantity is not as per the commercial invoice, and the gap between the quantity mentioned in the commercial invoice and the actual situation is significant, or the goods loaded on the ship are damaged, dirty, or have some other problem as noted by the ship’s captain. In such a case, the bill of lading will be a claused bill of lading.

It will not be a clean bill of lading. Most LCs require a clean on-board bill of lading, so sufficient care must be taken by the beneficiary to ensure that the loading of the goods or any other issue does not result in a claused bill of lading.

Another very common discrepancy observed by issuing banks is that the documents are presented to the issuing bank after the allowed date for shipment documents.

Generally, the time allowed is 16 to 18 days after the shipment of goods. If the documents reach the issuing bank beyond this allowable period, the presentation will not be compliant.

Another very common discrepancy is that the shipment is not in the quantities required by the letter of credit.

This generally happens when a partial shipment is not allowed. In such a case, if the quantity does not match the LC requirement and is short, the documents will not be compliant. This is treated as a short shipment, and the bank will object.

Another discrepancy observed is that the credit amount mentioned in the commercial invoice and demanded by the exporter is more than the allowable LC credit. This again is a discrepancy.

Another very common discrepancy is that the insurance requirements have not been met by the beneficiary.

If the type of insurance, the coverage, or the value of the insurance as per trade practices has not been arranged by the exporter in the exact way mentioned in the letter of credit, then the shipment will be considered underinsured. This means the insurance part has not been fully taken care of.

Another discrepancy commonly observed by issuing banks is that the description of the goods on the invoice does not match the description given in the letter of credit.

This is very important. The goods shipped, the documents created for that shipment, and the information in all the main LC documents should reasonably match the requirements in the letter of credit.

If there are differences or variations in the description and details indicated in the letter of credit, a discrepancy will be raised by the issuing bank, and the bank may not accept the documents.

Sometimes the documents also indicate marks and numbers that are different from what the LC mentions in the packing list. If the marks, numbers, or part numbers shown in the documents do not match the LC requirements, the issuing bank may not accept the documents.

Another very common discrepancy observed in the presented documents is that they mention the goods have been shipped and decked—that the goods have been placed on deck—while the requirement of the LC makes it clear that the goods should not be decked, but should be below deck.

If that condition has not been met, the documents may be rejected by the issuing bank.

Many times, the transport documents, bill of lading, insurance documents, and the bill of exchange are not properly endorsed or signed, or they have not been signed by the right person. As per the guidelines of the UCP, the authorized person must sign, and if this requirement is not met, the documents may not be accepted by the issuing bank. If any document required by the letter of credit is missing from the presented set, the issuing bank may also reject the documents.

Often, instead of the insurance policy, the beneficiary supplies an insurance certificate. The difference between the policy and the certificate should be clearly understood by the exporter. He must ensure that if a policy is required, then a policy is given; if a certificate is acceptable, then the certificate may be given. Such mistakes should be avoided.

Another very common discrepancy observed worldwide by issuing banks concerns measurement and weight. These may differ from one document to another.

All the documents presented to the bank against a particular LC pertain to the same shipment, so the weights, measurements, and other identifiers of the shipment must match.

Another issue arises with the type of transport document. It can be a house bill, a combined transport bill of lading, or a charter party bill of lading. The type of transport document required by the LC must be procured. Sufficient care must be taken by the exporter to obtain the correct and acceptable documents; otherwise, the documents may be rejected.

Another very common discrepancy is that the insurance cover, or other documents, are issued in a currency different from the LC currency. All documents must adhere to the LC currency. If it is the US dollar, then the amounts shown in all documents, including the insurance cover, must be expressed in US dollars. If not, the documents may be rejected by the issuing bank.

Signatures are another frequent issue. If signatures are missing from any document or if endorsements have been made by a party not authorized under UCP guidelines, the documents may be rejected.

Transport documents sometimes show the name of the exporter or consignee differently from other documents, especially the commercial invoice, and most importantly, differently from the LC. The transport document, like the commercial invoice, is a very important negotiable document. If the wrong parties are shown in the wrong places, the issuing bank may reject the documents.

Discrepancies may also arise in the bill of exchange if it is not drawn as per the tenor stated in the documentary credit. The bill of exchange should reflect the tenor mentioned in the LC, and the draft should be presented accordingly.

The nature or extent of insurance coverage obtained by the exporter may sometimes not match the requirements of the LC. The scope and risks covered must align with the LC requirements. If not, the documents may be rejected.

It is also common that the effective dates of insurance coverage do not match the shipping dates. The insurance must cover from the start of shipment until the end, and these dates should logically align. The exporter must ensure that the insurance coverage has effective dates matching the shipment needs and LC requirements.

In cases where the delivery terms (Incoterms) are C&F or CIF, the onus of paying freight is on the exporter. The transport document should clearly indicate that freight has been paid. Even if not explicitly mentioned in the LC, this is required. If the transport document does not indicate freight paid, the documents may be rejected.

As most letters of credit require a clean on-board bill of lading, the transport document must state “shipped on board.” Only then will it qualify as a clean on-board bill of lading. It must not be claused; it must clearly show the shipped-on-board stamp to be accepted by the issuing bank.

Another very common discrepancy is that the amounts on the invoice and the bill of exchange do not match. Such mistakes must be avoided.

Shipments made between ports other than those stated in the LC also lead to rejection. When accepting the LC, exporters must carefully check the ports of loading and discharge, and these must match in the transport documents.

Issues may also arise regarding transshipment or partial shipment. If the LC specifies that transshipment is not allowed but the documents indicate it has occurred, or if partial shipment is not allowed but the shipped quantity is short, the documents may be rejected.

These are some of the most common discrepancies.

This checklist is very important and should be handy for exporters. They should write it down. In this course, in the resource section, you can download a checklist for both checking the LC before acceptance and reviewing common discrepancies observed worldwide by issuing banks.

Both checklists are provided in the resource section. You can download them and keep them handy for the smooth conduct of export shipments. Due diligence and care must be taken by the exporter while obtaining all documents for presentation to the bank to ensure that none of these discrepancies—or any other discrepancies, depending on the goods and the contract—arise.

In the next video, Dr. Jain takes the example of the central bank of India, which is the Reserve Bank of India. To explain the impact of the local FX control policies.

Welcome back to the course.

I hope you are able to understand the concepts I am teaching in this course.

These are very simple concepts.

They are very logically created. They are well-tried.

Now you know what the different types of letters of credit are, what precautions the exporter should take before accepting the letter of credit, what the role of the LC instructions is, and what the common discrepancies in the letter of credit are.

These are some of the things that are very important for awareness about the letter of credit and the whole international trade finance instrument—that is, the documentary credit, which is also called the letter of credit in simple language.

Now we know the role of the International Chamber of Commerce, which frames the UCP—Uniform Customs and Practices—and another document that they frame for the comfort and convenience of banks and banking professionals.

They also created one more document, like UCP, a simplification of UCP, which I will talk about in later episodes.

Today, I will tell you that apart from the role of ICC France, there are other bodies, especially local bodies, that impact the letter of credit system. We will discuss how these local bodies affect the system, which bodies they are, and what role they play in the letter of credit system.

The first very important local body that directly impacts the way letters of credit and international payments are handled is the central bank of each country. Central banks have a very strong role to play when it comes to dealing with inbound and outbound foreign exchange. Every country is concerned about its foreign exchange reserves and about ensuring that foreign exchange management is well handled and beneficial for the people of that country.

Central banks frame policies to manage the inflow and outflow of foreign exchange from the country.

Let me take the example of the Central Bank of India, the RBI (Reserve Bank of India), and its exchange control regulations.

What are those regulations? And how do they directly or indirectly impact the whole system of letters of credit?

For example, if you look at the exchange control regulations in India under the Reserve Bank of India, the central bank of the country, you will see that India has different exchange control regulations.

Here is a very short summary:

Every country has its own central bank exchange control regulations, and while they are different, they are often similar in nature. Taking India as an example, here is the gist of the exchange control regulations of the Reserve Bank of India.

As per the RBI exchange control regulations, the payment for goods imported or the remittance for goods sold outside India has a time limit of six months.

This means that whatever goods are exported from the country, the remittance should come within six months.

The same applies to the payment for goods imported into India.

These regulations must be clear to anyone opening a letter of credit in India—whether dealing with Indian exporters or Indian importers.

Another regulation of RBI in India is that advance payment is allowed only for books, periodicals, life-saving apparatus, capital goods and machinery, and a few other items. For the majority of items, advance payment is not allowed.

This means that if somebody is importing goods into India, in most cases, they will use the documentary credit route—the letter of credit route.

Another regulation important for those dealing with India is that the Indian rupee is fully convertible on the current account but not fully convertible on the capital account.

For non-residents, the rupee is almost fully convertible. There are no restrictions on the repatriation of disinvestments and profits for non-residents.

This is the reason it is almost fully convertible on both current and capital accounts for non-residents.

Indian residents, however, have restrictions on transferring their earnings out of India. This regulation stems from the fact that the rupee is not fully convertible on the capital account.

Only a handful of items are in the prohibited category of imports.

In India, most items can be freely imported, and they fall under the OGL (Open General License) category.

Therefore, people dealing with India—both importers and exporters—should be aware of these facts.

Local FX dealer associations are commonly found in almost all countries. They frame their own rules and regulations, keeping in line with the local realities. Such rules and regulations do impact the operations of International L/C. Learn how in the next video.

Now, friends, I will talk about another organization.

Very similar organizations exist in all countries.

These directly and indirectly impact the letter of credit and spearhead the local banking ecosystem.

Every country has its banking industry.

This kind of organization deals with the day-to-day issues, guidelines, training, and management of banking in that particular country.

Every country has such an organization.

For example, in India, we have the Foreign Exchange Dealers Association of India.

In short, it is called FEDAI.

This organization was set up in 1958 as an association of banks dealing in foreign exchange in India.

These banks, dealing in foreign exchange all over the world, are normally referred to as Authorized Dealers (ADs).

FEDAI is the association of ADs in India.

Similar organizations exist in almost all countries, and their regulations, guidelines, and policies impact the letter of credit and the cost of credit.

This includes the cost of opening the letter of credit, or advising, confirming, or negotiating it.

The different roles of banks are affected by the guidelines and regulations of such associations.

They are local bodies, and they have a direct impact on the cost of letters of credit opened or supported by the banking industry in that country.

For example, FEDAI in India, established as a self-regulatory body, is not directly regulated by the government.

Generally, in most countries, such associations are self-regulated or banking industry-regulated bodies, incorporated under a specific companies act.

In India, FEDAI is incorporated under Section 25 of the Companies Act of 1956.

They are authorized by the Government of India through an act, which is part of the Companies Act.

The major role of FEDAI in India, for example, is to frame guidelines and rules for foreign exchange business.

Similar guidelines and rules are framed by local associations in other countries.

They also provide training for bank personnel in the field of foreign exchange.

The type, intensity, and quality of training given to personnel in each country also impact the letter of credit system.

Although the system is spearheaded and guided by ICC’s documents, such as the UCP and another document I will discuss later, the training by local bodies has a major impact.

Certain local practices come into play, and as a result, interpretations of ICC documents may differ from country to country because of the training provided by local associations.

This association also gives accreditation to foreign exchange brokers, banks, and all ADs.

Thus, the complete ecosystem of the local banking industry that deals with foreign exchange—including accreditation and recognition—is managed by such associations.

In India, FEDAI performs this role.

Another role played by FEDAI in India, and by similar associations elsewhere, is advising and assisting member banks in settling disputes.

For example, if there is an LC dispute with banks for either an exporter or importer, one way is to go to ICC for arbitration. Another way, if acceptable to both parties, is to go to the local association.

Another role played by FEDAI in India is to act as a representative for member banks in matters related to the government, the Reserve Bank of India, or any other body connected directly or indirectly with foreign exchange.

Their scope is limited to their own country.

They normally do not represent banks outside their country.

Another responsibility of FEDAI, for example, in India, is announcing daily and periodical FX rates to member banks.

If you look at the guidelines, they have a strong impact on the letter of credit system.

These guidelines are called rules but are actually more like guidelines, with flexibility and freedom provided to authorized dealers.

Although called rules, they function mainly as guidelines because ultimately, banks follow their primary documents, which are ICC documents, especially in international letter of credit dealings.

For example, in India today, banks are free to set their own charges for services related to handling documentary credits, including letters of credit.

This is a new development.

Earlier, FEDAI set fixed charges for advising, negotiating, confirming, or even opening LCs. That has now changed.

Now, banks are free, like commercial organizations, to set their own fees depending on their service quality and market reputation.

Other guidelines are provided in the set of rules:

• Rule 1: Hours of business

• Rule 2: Export transactions

• Rule 3: Import transactions

• Rule 4: Clean instruments

• Rule 5: Foreign exchange contracts

These rules, although called rules, are again more like guidelines.

They impact how letters of credit are handled, for example, in India, but the same applies to other countries, as all have their own associations, guidelines, and rules.

Additional rules include:

• Rule 6: Early delivery, extension, and cancellation of foreign exchange contracts

• Rule 7: Business through exchange brokers

• Rule 8: TT settlements (inter-bank TT settlements and dispatch)

These are mostly operational matters in rules and regulations.

The biggest impact they have on letters of credit is on operational efficiency:

• The time required to handle documentary credits in international transactions

• The fees involved

Depending on each country and the needs and expectations of its local business community, these guidelines are framed.

Although they do not override ICC’s guidelines, they definitely have an impact.

At the ground zero are the real soldiers dealing with operations of international L/Cs. Their mistakes can lead to colossal losses, both monetary and reputation-related. It is very difficult for the ground staff to be completely aware of the rules and concepts of UCO, which are written in a very general form. The day-to-day practice instructions are provided by ISBP. Watch the next video on how ISBP helps and ground zero bank professionals.

Welcome back to the course.

Friends, we have talked about the various entities that impact letter of credit operations, how LCs are managed internationally, and the local effect—that is, the agencies in local banking ecosystems like central banks and banking associations. Their guidelines and practices do have an impact on the operations of letters of credit.

I will now talk about another very important document that ICC France produces, apart from the UCP (Uniform Customs and Practices), which is the main document.

First of all, let me tell you the purpose of this other document. The ideas, guidelines, and concepts given in UCP are more general in nature, and they can be interpreted differently by different banks. To make practices more uniform and understandable, without requiring too much conceptual thinking from ground workers—the people working in the foreign exchange branches of banks around the world—another type of publication was needed.

Day-to-day activities require a document that tells them what to do in specific situations, something that UCP cannot do.

UCP is more of a conceptual paper. It defines the principles of uniform customs and practices and the method of operating letters of credit.

The other document is ISBP, that is, the International Standard Banking Practice for the Examination of Documents under Documentary Credit.

As I mentioned, UCP rules are written in a very general manner.

ISBP was prepared by ICC France to fill the gap between the general principles in the UCP document and the daily practices of banking professionals when dealing with documents, confirming letters of credit, advising letters of credit, negotiating letters of credit, and issuing letters of credit.

These daily practices required a document that is more practical in nature.

ISBP gives step-by-step methods of handling documents in a very concrete and practical manner. That is the purpose of the International Standard Banking Practice for the Examination of Documents under the Documentary Letter of Credit.

This is ISBP, and the ICC publication number 645 is this ISBP, announced in 2007. It is UCP 600 compliant and is a revised document.

It consists of ten chapters and 185 consecutive paragraphs.

It is a detailed document that provides step-by-step methods of handling letters of credit for banks.

Topics covered include preliminary considerations, general principles, drafts and calculation of maturity dates, handling invoices, transport documents covering at least two different modes of transport, bills of lading, charter party bills of lading, air transport documents, road, rail, and inland waterway transport documents, insurance documents and coverage, and certificates of origin.

These are the chapters in ISBP. Banking professionals who are supposed to adhere to UCP 600 should refer to ISBP 2007 in order to handle letters of credit under UCP 600. For UCP 500, there is an earlier version of ISBP that can be referred to.

Some practical examples of ISBP include copies of transport documents and documents for which UCP 600 transport articles do not apply. It clarifies which transport documents are commonly found in the set of documents presented, but do not come under the purview of UCP 600.

For example, documents like delivery notes, delivery orders, cargo receipts, forwarder’s certificates of receipt, and forwarder’s certificates of shipment.

These documents do not fall under the definition of transport documents in UCP 600 and cannot be regarded as transport documents for letters of credit.

This is a major advantage of ISBP: it clarifies what a transport document is and what is not under UCP 600.

Another example ISBP gives is the details required on transport documents—for instance, which boxes, fields, or spaces must be completed. If they are missing, it results in a discrepancy.

Expressions are another area: ISBP 2007 defines several expressions that are not in UCP 600 but are commonly found. These expressions should not be used in letters of credit, but in practice, they are often found. Some of those, especially related to transport, are listed in ISBP.

ISBP contains many such chapters and paragraphs.

It explains exactly what is part of UCP 600 and what is not. It clarifies many articles of UCP 500 or UCP 600, depending on which ISBP is being used.

The latest ISBP, the 2007 publication, is UCP 600 compliant and is a very important document for day-to-day practices in handling letters of credit.

As with all international methods of doing international trade, there are pitfalls with the rules and systems of UCP, as well as in the foolproof operations of international payments through a documentary letter of credit. Let us understand in the next video why such frauds happen and how to prevent them.

Now, friends, I will talk about the common letter of credit fraud carried out by businesspersons around the world who try to use the system in the wrong manner.

These LC frauds basically arise from the design of the letter of credit.

There are certain loopholes that every UCP document tries to address, but still, some remain, and these are exploited by anti-social elements who resort to letter of credit fraud.

The LC cycle is very comparable to credit card transactions. Credit card transactions are done very quickly, and you may not realize that a similar system exists in the case of letters of credit. The cycle is very similar to credit card transactions, and just as in credit card transactions, such fraud is also common.

LCs are dependent on certain principles.

The main principle of the letter of credit is the independence principle, which means the letter of credit is independent of the sales contract or export contract.

It is an absolutely independent document issued by the bank.

The bank becomes the main party, the main payer.

The second principle of the letter of credit is the principle of compliance, which means the letter of credit is conditional in nature, and payment is made only if the conditions are met.

If the conditions are met, the payment will be made. If the documents are compliant, the payment will be made.

Obviously, what happens is that the banking community has no way to physically check the goods or investigate whether the transaction has actually taken place.

They purely depend on the documents.

If the documents are compliant, and since the LC is independent of the sales contract, it works in its own silos.

This means that if the parties are able to meet the requirements of the letter of credit, payment will be made, regardless of the sales contract.

The banking system has this obvious weakness because physical checks of the goods are not possible for banks.

The whole system depends on the documents, on the independence principle, and on compliance.

Since export transactions through sea routes involve long shipment times, LC fraud may take place during this period, taking advantage of the time factor.

Seller-related frauds include presenting documents for false shipments—shipments that have not physically taken place.

The bill of lading may be false, or the shipment may actually be short. The documents may show the correct quantity, but in reality, the quantity is short.

In such cases, payment will still be made by the bank because the LC is independent of the deal between the exporter and the importer. Even if there is a short shipment or no shipment at all, if the documents are correct and compliant, the payment will be made.

The problem arises for the buyer because he does not receive the goods in the right quantity or may not receive them at all, but the payment is made.

These kinds of LC fraud are possible by exporters, the sellers.

Similarly, there can be LC fraud by buyers.

Buyers may resort to third-party collusion. For example, they may collude with the shipping company so that documents are not correctly endorsed, the date is altered, or other collusion occurs to ensure that goods are shipped but payment is not made.

Because of such collusion by the buyer with the shipping company or another authority, the bill of lading can be issued incorrectly, ensuring that the exporter does not get paid.

These things happen, and there are many examples of such LC frauds.

They are possible because banks have their own limits and weaknesses.

The system has limitations because of the independence principle, the compliance principle, and the fact that banks deal only with documents, not beyond that.

Because of these limitations, such frauds are possible.

There are also very common frauds that generally happen in domestic business, called kite-flying LC frauds.

In these cases, fake user LCs are created to obtain cheap credit for unspecified uses with wrongful intentions.

Normally, these involve trades within the same country or even the same city.

Now, friends, it is still very much possible to avoid or at least reduce the onslaught of such letter of credit frauds.

If we talk about the exporters, meaning the sellers, what they can do to avoid such LC frauds is, first of all, as a precaution, they should thoroughly check the letter of credit received from the buyer.

They should not accept the letter of credit at face value.

They should make a thorough investigation.

They should check the letter of credit, they should check all the conditions, whether they are doable, and whether there is any possibility or space for the buyer to take advantage of the LC conditions.

Secondly, the exporter should make a credit check of the issuing bank.

As I have already mentioned, the exporter should always insist on an LC from a first-class bank.

The list of these first-class banks is readily available, including all the big banks.

Your banker can arrange for this list of first-class banks.

In case the LC is not issued by a first-class bank, the exporter should insist on confirmation of the letter of credit, the charges for which should be paid by the buyer.

This kind of credit check by the issuing bank is very important.

Thirdly, knowledge of the laws and procedures of the country of the buyer and the issuing bank should be thoroughly checked.

The exporter should study the different procedures and laws because it is possible that loopholes in the laws and procedures could be used by the buyer to their advantage.

That kind of knowledge gathering has to be done by the exporter.

As I have mentioned, the exporter should insist on confirmation of the LC from a home country bank if the LC is not opened by a reputed bank from the list of first-class banks.

That can really help the exporter.

Another very important part of this LC business, when receiving payments internationally through letters of credit, is for the exporter to deal with reputed shipping companies, CNF agents, and insurance agencies that are internationally recognized and independent in nature.

It is difficult to collude with such agencies.

Any indiscreet agency suggested by the buyer, or any condition by the buyer requiring the use of a particular shipping company or CNF agent nominated in the LC, should definitely be avoided by the exporter.

They should absolutely ensure that they are dealing with intermediaries who are independent in nature.

The possibility of collusion between the buyer and such entities should not exist.

Of course, all conditions and terms given in the letter of credit must be thoroughly checked by the exporter.

For the importers, that is, the buyers, to avoid seller-related fraud, they should thoroughly check the credit rating of the exporter and their record.

They should conduct complete due diligence of the exporters they are dealing with. They should check the past performance of the seller, their profile on platforms like Alibaba.com, the certificates the company holds, the history of the company, and who its existing clients are.

These things are very important for the buyer to check thoroughly.

Similarly, the buyer should have complete knowledge of the laws and procedures of the seller’s country and of the nominating bank, if any.

If the exporter has nominated a bank and insisted on using a bank in his own country, this should be thoroughly checked.

The buyer must insist on a third-party, independent entity of international repute. The buyer must insist on inspection by such a third party.

Normally, highly reputed agencies like SGS (an internationally recognized quality inspection agency) are used for this purpose, but there are others as well.

The buyer must insist that the letter of credit include a requirement for quality certificates or quality inspection certificates issued by such third-party organizations of repute.

These are some of the precautions that importers can take to avoid LC fraud.

Similarly, banks can also be at the receiving end of fraudsters determined to exploit LC transactions.

For banks, precautions that can be taken include thoroughly checking the credit rating of the applicant (the importer).

If the bank is not aware of the applicant’s reputation or has no past dealings with the applicant, it should insist on 100% margin money for opening the letter of credit.

Secondly, the bank should carefully and thoroughly check the presentation of documents to ensure they are compliant as per the latest UCP (500 or 600), and they should adhere to ISBP, whichever is applicable.

This will help banks avoid mistakes or situations where they face fraud carried out by either the applicant or the beneficiary.

Banks should also carefully examine the LC terms and conditions.

They should not blindly follow whatever the applicant writes in the LC opening instruction.

Banks should raise objections wherever they feel something is wrong.

After all, banks have a lot of experience dealing with letters of credit.

They should use that experience and not simply follow what the applicant wants.

Similarly, banks should also keep in mind the interests of the seller, ensuring that the conditions given by the applicant are not biased against the seller.

Such situations should be avoided by the banks.