Meaning of Letter of Credit (LC)
A letter of credit (LC)is a financial acclaim issued by the HSBC Bank as a guarantee letter for the payment issued to the buyer. It sanctions the quoted amount and ensures the timely commitment of the payment to a seller. It is the most customary mode of payment for international goods trading. Domestic Letter of credit (LC) are also prevalent and may banks including HSBC Bank may help your business avail a letter of credit (LC) by visiting the branch or placing an online request thereof.
The letter of credit (LC) is a constitution of three entities; the HSBC Bank, the business owner and the trader. It secures both the avenues of buyer’s and seller’s perspective. The buyer has the credit to purchase the goods and impart the requisite services while assuring the customer of its timely payment as well. It helps in the smooth functioning of the business operations.
Types of Letter of Credit (LC)
There are different types of letter of credit (LC) issued by the HSBC Bank and various other banks. Their acceptance and use vary according to the different markets and functioning of the business. Different types of letter of credit (LC) have their own features and are used during different business scenarios. The major two types of Letter of Credit (LC) being issued by the HSBC Bank are inland or domestic letter of credit (LC) and import/export letter of credit (LC). As the name suggests the former is related to trades happening within the domestic borders and the latter relates to export and import of goods. The various types of letter of credit (LC) are defined hereunder.
Commercial Letter of Credit (LC)
The commercial letter of credit (LC) is termed as the export letter of credit (LC) or the import letter of credit (LC). The commercial letter of credit (LC) can either be used for import or export trading purposes by the importer or exporter respectively. A Business can make letter of credit (LC) request through Home Branch of HSBC Bank or through online medium.
Standby Letter of Credit (LC)/ (SBLC)
It is a financial contract made in the favor of the seller by the buyer’s bank authorities. It is called the standby letter or credit as it acts as a standby mechanism of payment to the seller when the buyer fails to do so. It is an alternative plan set aside in case of payment failure by the buyer and is initiated by the bank authorities.
Back-to-Back Credit LC/Letter of Credit
It is an intermediary letter of credit *LC) issued for the non-disruption of the trading services. It is intended to be used when one of the suppliers fails to deliver the goods and services for any reason and a second credit is issued to another seller to deliver the unfulfilled services. Such types of credit letter are used for various trading houses.
Transferable Letter of Credit (LC)
A transferable letter of credit (LC) is utilized for added financial assistance in which the bank transfers the money. There is an aforementioned amount approved in the letter of credit (LC) to be given to another seller at the request of the original seller or beneficiary.
Revocable Letter of Credit (LC) and Irrevocable Letter of Credit (LC)
The revocable letter of credit letter of credit (LC) and irrevocable letter of credit (LC) is bound by the varying terms and conditions issued by the seller to the seller. The revocable letter of credit (LC) has terms and conditions that are subject to change or cancellation at any point in time by the bank. No prior notice shall be given to the added beneficiaries. An irrevocable letter of credit (LC) is under the restraint of terms and conditions of the HSBC Bank which cannot be changed or cancelled as committed to the seller.
Usance Letter of Credit or Sight LC
The sight or the usance letter of credit (LC) is the guaranteed approval of payment issued to the seller after the presentation of the required documents by the bank.
Revolving Letter of Credit (LC)
It is a financial letter consisting of an approved credit amount for multiple freights. This letter of credit (LC) is on renewable terms for increasing the credit limit or for the available timeline. This is beneficial for sending shipments regularly in case of the same sellers.
Confirmed Letter of Credit (LC)
Confirmed letters of credit (LC) are issued when there is financial insecurity regarding the issuing bank or terms and conditions of the country. There are consents taken from the advising banks to confirm the credit payments to the seller from the issuing bank. The advising bank becomes the main bank for crediting the payment to the seller for being an additional security benefit.
Eligibility for Letter of Credit (LC)
Every bank, including HSBC Bank, uses its own set of eligibility criterion to assess the business before issuance of letter of credit. The following is a common list of eligibility criteria that should be met for the issuance of a letter of credit:
- The turnover of the company is Rs 500 crores and above.
- The board of directors should approve and support the credit and payment guarantees agreed upon on behalf of the joint stock companies.
Documentation Required for a Letter of Credit (LC)
HSBC Bank and all other banks have a prerequisite list of documents that needs to be presented to the banking authorities for clearance and issuance of letter of credit (LC).
Following is the list of documents that need to be prepared:
- General undertaking duly signed and stamped.
- Partnership deed or board resolution as applicable for the type of company.
- A deposit letter to be written on a letterhead by the depositor of the business enterprise
- Import/Export Code to be presented (IEC)
- OGL cum FEMA declarations
- Deed of partnership for companies as formed in case of the partnership firms or by board of resolutions
- The invoice or the purchase order or Performa invoice
- Insurance details like – FOB (free on board) and C&F (cost of the freight of the goods) criteria under an assurance cover whose details should be presented
- Annexure of the letter of credit (LC) covering all the details
- Cargo shipment details made through any transport mediums (airways, railways, or road) invoice documentation details required.
Fees Associated with a Letter of Credit
There are some fees associated with the letter of credit (LC) that will be charged by the HSBC Bank, this needs to be considered and can be compared with others for better terms and charges.
- Documentation Fees
- Processing Fees
- Temporary overdraft charges (TOD)
- Overdue/Penalty charges
- Commitment charges
- Collateral charges
- Foreclosure charges
- Subsidy charges
- Certificate fees
- Collateral swap fees
Importance and Need of Letter of Credit (LC)
The business operates on both ends as a vendor and as a seller. The letter of credit (LC) is the most integral part of running a successful business and catering to the international or domestic markets alike. It works as a security in international trading and a guaranteed payment tool in the domestic market for a business in terms of money circulation and operations.
The International Chamber of Commerce publishes the Uniform Customs and Practices for Documentary Credits (UCP). This is aimed to set a global standard and norms for the use of letter of credit (LC) for international trades.
Importance of Bank Letter of Credit (LC) issued by HSBC Bank
- It manages the financial distance between the buyer and seller in the business
- It acts as the major source and medium of international deals
- It helps the payment backstops between a buyer and sellers
- It works well in favour of abiding by the different trading laws of the countries
- It helps in building trust within businesses creating a smooth flow of work
Need for Bank Letter of Credit (LC) issued by HSBC Bank
- Letter of credit (LC) issued by HSBC Bank aids in business expansion both at national and international levels. This provides an edge to flourish and prosper in new landscapes with existing business partners or newly established relationships.
- Letter of credit (LC) issued by HSBC Bank is a customized documentation with differing terms and conditions serving as an assurance within the businesses. It acts as a mutual set of clauses agreed between a trader and the customer with crediting amounts, number of transactions (to one or more sellers), and time-frame.
- Flowing credit to a business on fulfilling terms is an added asset to international trading. The issuing bank, in this case HSBC Bank, checks all the credit ability of the necessary documents concerning the business and the two parties before issuing the credit. The issuing bank is independent of any obligations by offering the two parties its desirable terms.
- Letter of credit (LC) issued by HSBC Bank is a credit certificate which improves the creditworthiness of the buyer or the business owners or importer to maintain the credit limit, re-issue, or maintain worthiness within the exporters and sellers.
- Letter of credit (LC) issued by HSBC Bank acts as a shield to a seller in case the buyer is into any form of financial crisis. Any financial loss or bankruptcy at the buyer’s end will not put the seller at any risk of not getting the payment. The credit issuing bank authorities are under the obligation of the letter of credit (LC) for paying the concerned amount to the seller.
- Letter of credit (LC) issued by HSBC Bank serves as a financial claim by the seller in case of any payment dispute between the vendor and seller. The letter of credit (LC) abides under the clause of ‘pay now and litigate later’ in the formed terms and conditions document of the letter of credit. The buyer cannot withhold or deny the payment on the terms of low-quality goods as the letter of credit (LC) stands as an obligation to the HSBC Bank and buyer that needs to be fulfilled to the seller.
Example
For instance, HSBC Bank is the bank that offers the letter of credit (LC) in countries such as Asia, Africa, the Middle East, Eastern Europe, and Latin America. Generally, the letter gets issued within two working days. The letter issued by HSBC Bank covers the financial risk to the importers residing in place or in case of economically weakened situations.
Some of the banks that help in issue the credit letter apart from HSBC Bank are:
- HDFC Bank
- HSBC Bank
- HSBC Bank
- State Bank of India (SBI)
- Union Bank of India
- Kotak Mahindra Bank
- HSBC Bank
- Bandhan Bank
- Punjab and Sind Bank
- Developmental Bank of Singapore (DBS)
- Lendingkart Finance
The Difference Between a Letter of Credit (LC) and a Bank Guarantee
Meaning of Bank Guarantee (BG)
A Bank guarantee by HSBC Bank is a financial mechanism that is issued by the banks and Non-Banking Financial Corporations (NBFCs) to meet the requirements of the customer. In case, the customer is unable to pay or fulfill the requirements as per the agreement, the HSBC Bank steps in to pay as per the agreed conditions of the letter.
The money credits issued under HSBC Bank guarantees work well within business enterprises. It helps in running operations such as sale and purchase of goods as in raw materials, manufacturing machinery, equipment, and improving services. To know more read our blog on Bank Guarantee
Difference Between BG and Letter of Credit (LC)
A letter of credit (LC) by HSBC Bank is an assured payment that the trader’s bank gives to the seller after the presentation of the valid documentation. It is a confirmed payment avenue given to the seller ensuring that the seller
A Bank guarantee is the guaranteed payment given to a third party as authorized on behalf of the customer by the issuing bank. It is a way of assisting the financial needs of the customer to successfully run the business operations.
A Bank guarantee is initiating the required payment to the beneficiary even after not fulfilling the agreement. Whereas the letter of credit (LC) issued by the HSBC Bank or any other bank, provides the said credit after fulfilling the agreement terms with the beneficiary.
How to Apply for Letter of Credit (LC) with HSBC Bank
Letter of credit (LC) is varied across different types of work, within industries, and marketplaces in countries. A letter of credit (LC) gets issued by the buyer’s bank by agreeing upon certain terms and conditions of trading with both parties. All the requisite documents highlighting the details of the buyer and business should be presented for approval of the letter of credit.
To begin with, if the business is applying for the letter of credit (LC) for the first time with HSBC Bank, the bank will conduct a due diligence assessing the business. This is mostly a one-time activity and if found eligible, it will open avenues for any future credit services.
Following is the procedure to apply for the letter of credit (LC) in international trading scenarios:
- The importer, authorizing bank, like HSBC Bank, and exporter should agree to all the conditions of the sales agreement to make transactions easier.
- The HSBC Bank initiates drafting the letter of credit (LC) after the sales agreement terms and conditions are agreed upon by the importer, exporter, and the bank. The finalized letter is then sent to the bank authorities of the exporter and its reviewing bank.
- When the draft gets approved by the exporter’s bank, the business operations with respect to the shipment of goods and services proceed as mentioned in the outline of the letter of credit (LC).
- All the necessary documents are submitted to its reviewing bank which are then thoroughly checked and should align with the terms and conditions mentioned in the letter of credit (LC).
- All the submitted documents after a thorough evaluation are then submitted back to the importer’s bank, or in this case, the HSBC Bank.
- When all the documentation with the signed contract and the letter of credit (LC) agreed upon by both parties is submitted to the importer bank, the transfer of funds is initiated to the exporter bank as per the letter of credit (LC) issued by the HSBC Bank.
- This approved financial assistance helps the importers receive the shipment of goods for a smooth flow of import-export business trading.
Precautions to be Considered for Letter of Credit (LC)
Some of the precautions that need to be taken for the letter of credit (LC):
- The business owner or the buyer should be a regular banker with a verified beneficiary.
- The letter of credit (LC) issued for overseas trading should be confirmed and preferably from a leading Bank like HSBC Bank that have experience in dealing with such credit instruments.
- The freight of the goods as decided in the terms and conditions should be checked whether it is pre-paid or included.
- The bank charges need to be paid individually by both the buyer and the seller in their respective countries. In this case, the buyer may be required to open the beneficiary’s account in HSBC Bank.
- All the expenses in the business operations need to be mentioned in the applicant’s and beneficiary’s accounts.
Benefits and Limitations of a Letter of Credit (LC)
Benefits:
There are various advantages and disadvantages concerning the letter of credit (LC). A few are enumerated below:
- It acts as a payment reassurance to the seller as confirmed from the buyer’s end by default.
- It is a medium of building trust and dependability between two parties for business within domestic and international sectors.
- It is an official and customized form of document that can be outlined to specific terms and conditions.
- The letter is a well-drafted frame of financial credit and timelines set for both the business parties to operate.
- It helps in smooth fund transfers easing out complex international transactions.
Limitations:
- It has a limitation of paying a certain amount of fee which limits the business choices.
- The approval of the letter of credit (LC) can sometimes take more than the stipulated time from both the importer and exporter sides.
- It does not qualify on parameters such as quality of goods and delivery time-frame.
- It doesn’t fit under certain criteria such as unstable exchange rates, supply-chain imbalance, or political instability.
Letter of Credit (LC): Fraud Avoidance
The letter of credit (LC) document is sometimes a part of fraudulent activities such as investment schemes, false documentation, or non-shipments of goods. In such cases, a letter of undertaking (LoU) that acts as a provisional financial guarantee by the bank is allowed to the client. This LoU helps in raising short-term credit from any foreign branch of some other bank. The foreign bank requires a marginal fee to be paid for the LoU and a credit limit will be approved.
When a trader needs credit in the foreign land and foreign currency, it may leverage its credit relations with the domestic bank like HSBC Bank to issue a LoU to an overseas bank that will release the amount required/ agreed upon in foreign currency. Th amount is sent to a nostro account and can be used by the trader in a foreign land.
To avoid fraud, it is important that the HSBC Bank conducts a through due diligence of the traders especially in case of new trading partners.
Conclusion
Letter of credit (LC) acts as financial collateral which is a very valuable asset in banking, startups, and business. It acts as the strongest back-up in the running of business given by the bank authorities to its client or the buyer which serves as a financial security to the seller. There are various types of letter of credit (LC) issued by various banks, depending on suitability. It is favorable for its creditworthiness, money circulation, and timelines as per the agreed particulars; in the contract by both parties. Letter of credit (LC) helps you create a good impact as well as a strong foothold in domestic and international markets. Though we see letter of credit (LC) as one transaction it actually involves multiple parties, various related documents and multiple jurisdictions. Please contact us to know more on how BankKeeping can help you manage your banking needs better.