Dynamics of Documentary Credit

Dynamics of Documentar

y CreditAdnaan JamileeSenior Executive OfficerCredit Risk ManagementIDLC Finance Limited.

May 15, 2012

International Trade

• International trade is the backbone of our modern, commercial world, as producers in various nations try to profit from an expanded market, rather than be limited to selling within their own borders.

International Trade Payment Methods

• Cash in Advance – the seller receives cash from the buyer prior to shipment

• Open Account – goods are shipped to the buyer and payment is made through an arrangement negotiated in advance with the seller

• On Consignment – the seller ships goods to the agent but retains ownership. Payment is made if and when the agent sells the goods completely

• Collection – The goods the are shipped to the buyer. The seller’s draft and documents covering the shipment are presented through the buyer’s bank for payment

• Letter of Credit (LC) – It is a bank’s conditional undertaking of payment

International Sales Contract

• The contract to buy and sell any goods between two parties (located

in two different countries) is the starting point of international trade.

• An international sales/purchase contract with specifications of the

terms of payment comes into being when an exporter makes an offer

and the importer accepts it.

• If the contract calls for payment by Letter of Credit (LC), the importer

requests its bank for issuance of letter of credit by submitting

properly filled-up forms and documents.

International Transportation of Goods

Seller/Exporter/Beneficiary

Place of Receipt

Buyer/Importer/Applicant

Delivery Point

Forwarder Customs Broker

Goods

International Shipment

Goods

Import Under LCAF (without opening of LC)

• Yearly permissible limit – for import of any item by making payment from

Bangladesh is not over US$ 50,000.

• Import from Myanmar – food items (rice, wheat, soybean oil, palm oil,

onion, fish etc.) not exceeding US$ 20,000 per consignment.

• Under government arrangement – Import of rice for US$ 2,000,000 per

consignment irrespective of yearly ceiling.

• Under approval from Drugs Administration, pharmaceuticals companies

are allowed to import chemical goods.

LC Authorization Form issued by the customs.

Import Under LCAF (without opening of LC)

• Perishable Food items through Teknaf custom station – US$ 10,000 to US$

15,000 per consignment

• Other Land Ports – US$ 5,000 to US$ 7500 per consignment

• Industrial raw materials and capital Machinery – irrespective of value

restrictions permissible for import

• For import without opening of LC, the importers are required to be

registered with the Authorized Dealer (AD) branches of banks.

. . .Process Flow of

Documentary Draft Transaction or Non-LC Import

Documentary Draft Transaction (Non-LC)

Exporter Importer

1.International Sales Contract

Carrier at Departing

Port

2. Goods

3. Transport Documents

RemittingBank

PresentingBank

4. Draft & Transport Documents

5. Draft and Transport Documents

6. Draft

7. Payment


Carrier at Arrival Port

8. Payment

9. Payment


12. Goods

Definition of LC

• A letter of credit is a written commitment by a bank to make payment at sight of a defined amount of money to a beneficiary (exporter) according to the terms and conditions specified by the importer (applicant). The letter of credit should set a time limit for completion and specify which documents are needed to confirm the transaction's fulfillment.

• More properly called a documentary letter of credit, it is important to remember that a letter of credit is an additional contract dealing with credit between the applicant (importer) and the issuing bank and separate from the original grain contract.

Parties to Documentary Credit Applicant (Opener): Applicant which is also referred to as account party is normally a buyer

or customer of the goods, who has to make payment to beneficiary. LC is initiated and issued

at his request and on the basis of his instructions.

Issuing Bank (Opening Bank) : The issuing bank is the one which create a letter of credit and

takes the responsibility to make the payments on receipt of the documents from the

beneficiary or through their banker.

Beneficiary : Beneficiary is normally stands for a seller of the goods, who has to receive

payment from the applicant. A credit is issued in his favour to enable him or his agent to

obtain payment on surrender of stipulated document and comply with the term and

conditions of the L/c.

If L/c is a transferable one and he transfers the credit to another party, then he is referred to

as the first or original beneficiary.

Advising Bank : An Advising Bank provides advice to the beneficiary and takes the responsibility for

sending the documents to the issuing bank and is normally located in the country of the beneficiary.

Confirming Bank : Confirming bank adds its guarantee to the credit opened by another bank, thereby

undertaking the responsibility of payment/negotiation acceptance under the credit, in additional to

that of the issuing bank. Confirming bank play an important role where the exporter is not satisfied

with the undertaking of only the issuing bank.

Nominated Bank: The Negotiating Bank is the bank who negotiates the documents submitted to

them by the beneficiary under the credit either advised through them or restricted to them for

negotiation. On negotiation of the documents they will claim the reimbursement under the credit and

makes the payment to the beneficiary provided the documents submitted are in accordance with the

terms and conditions of the letters of credit.

Parties to Documentary Credit

• Reimbursing Bank : Reimbursing Bank is the bank authorized to honor the

reimbursement claim in settlement of negotiation/acceptance/payment

lodged with it by the negotiating bank. It is normally the bank with which

issuing bank has an account from which payment has to be made.

Second Beneficiary : Second Beneficiary is the person who represent the first or

original Beneficiary of credit in his absence. In this case, the credits belonging to

the original beneficiary is transferable. The rights of the transferee are subject to

terms of transfer.

Parties to Documentary Credit

Bill of Lading

• Bill of Lading is a document given by the shipping agency for the goods shipped for transportation form one destination to another and is signed by the representatives of the carrying vessel.

Certificate of Origin

• The Certificate of Origin is required by the custom authority of the importing country for the purpose of imposing import duty. It is usually issued by the Chamber of Commerce and contains information like seal of the chamber, details of the good to be transported and so on.

Commercial Invoice

• Commercial Invoice document is provided by the seller to the buyer. Also known as export invoice or import invoice, commercial invoice is finally used by the custom authorities of the importer's country to evaluate the good for the purpose of taxation.

Major Documents Used in LC: According to UCP. 600

Bill of Exchange

• A Bill of Exchange is a special type of written document under which an exporter ask importer a certain amount of money in future and the importer also agrees to pay the importer that amount of money on or before the future date.

Insurance Certificate

• Insurance Certificate certifies that goods transported have been insured under an open policy and is not actionable with little details about the risk covered. It is necessary that the date on which the insurance becomes effective is same or earlier than the date of issuance of the transport documents.

Packing List

• Packing List contains details about the packing materials used in the shipping of goods. It also include details like measurement and weight of goods

Inspection Certificate

• Certificate of Inspection is a document prepared on the request of seller when he wants the consignment to be checked by a third party at the port of shipment before the goods are sealed for final transportation.

Documents Used in LC: According to UCP. 600

How Does Letter of Credit Operate?

• Step 1 – Exporter and importer sign the sales contract

• Step 2 – Importer requests his bank (issuing bank) to issue a LC in favor of

the exporter after submitting pro forma invoice

• Step 3 – Issuing bank sends the LC to advising bank in the exporter’s

country

• Step 4 – Advising bank authenticates and advises the LC to the exporter

• Step 5 – Exporter ships the goods

• Step 6 – Exporter prepares and collects documents then presents to the

nominated bank for negotiation/payment/acceptance

How Does Letter of Credit Operate? (cont’d)

• Step 7 – The nominated banks checks the documents and pays the seller if

documents are in order

• Step 8 – Nominated bank sends the documents to issuing bank

• Step 9 – Nominated bank claims reimbursement from the issuing bank or

from a bank specified in the LC

• Step 10 – Issuing bank delivers documents to the importer after

settlement of payment

• Step 11 – Importer exchanges the documents of title with the carrier, or

carrier’s agent for the goods

Documentary Credit Transaction

Exporter Importer1.International Sales Contract

Carrier at Departing

Port

Carrier at Arrival Port

Nominated Bank Issuing Bank

Advising Bank

2. Application

3. SWIFTMessage

4. LC

5. Goods

6. Transport

Docs

7. Carriage of Goods

8. LC and Transport Docs

9. Payment



11. Payment

12. Payment

14.Transport

Docs

15. Goods

Documentary Credit Transaction

Types of Documentary Credit

• Revocable Letter of Credit

A revocable letter of credit may be revoked or modified for any reason, at any time by the issuing

bank without notification. It is rarely used in international trade and not considered satisfactory for the exporters but has an advantage over that of the importers and the issuing bank.

• Irrevocable Letter of Credit

In this case it is not possible to revoked or amended a credit without the agreement of the

issuing bank, the confirming bank, and the beneficiary. Form an exporters point of view it is believed to be more beneficial. An irrevocable letter of credit from the issuing bank insures the beneficiary that if the required documents are presented and the terms and conditions are complied with, payment will be made.

• Confirmed Letter of Credit

Confirmed Letter of Credit is a special type of L/c in which another bank apart from the issuing

bank has added its guarantee. Although, the cost of confirming by two banks makes it costlier, this type of L/c is more beneficial for the beneficiary as it doubles the guarantee.

Types of Documentary Credit (cont’d)

• Sight Credit and Usance Credit

Sight credit states that the payments would be made by the issuing bank at sight,

on demand or on presentation. In case of usance credit, draft are drawn on the issuing bank or the correspondent bank at specified usance period. The credit will indicate whether the usance draft are to be drawn on the issuing bank or in the case of confirmed credit on the confirming bank.

• Standby Letter of CreditInitially used by the banks in the United States, the standby letter of credit is very

much similar in nature to a bank guarantee. Unlike a traditional letter of credit where the beneficiary obtains payment against documents evidencing performance, the standby letter of credit allow a beneficiary to obtains payment from a bank even when the applicant for the credit has failed to perform as per bond.


• Transferable Letter of Credit

A transferable documentary credit is a type of credit under which the first beneficiary which is

usually a middleman may request the nominated bank to transfer credit in whole or in part to the second beneficiary. This type of L/c is used in the companies that act as a middle man during the transaction but don’t have large limit.

The first beneficiary or middleman has rights to change the following terms and conditions of the letter of credit:

Reduce the amount of the credit.

Reduce unit price if it is stated

Make shorter the expiry date of the letter of credit.

Make shorter the last date for presentation of documents.

Make shorter the period for shipment of goods.

Increase the amount of the cover or percentage for which insurance cover must be effected.

Substitute the name of the applicant (the middleman) for that of the first beneficiary (the buyer).


• Back to Back Letter of CreditBack to Back Letter of Credit is also termed as Countervailing Credit. A credit is known as back-to-back credit when a L/c is opened with security of another L/c. The back to back import LCs shall be opened on usance basis for a period not exceeding 180 days.

The parties to a Back to Back Letter of Credit are: 1. The buyer and his bank as the issuer of the original Letter of Credit. 2. The seller/manufacturer and his bank, 3. The manufacturer's subcontractor and his bank.

The need for such credits arise mainly when :

The ultimate buyer not ready for a transferable credit

The Beneficiary do not want to disclose the source of supply to the openers.

The manufacturer demands on payment against documents for goods but the beneficiary of

credit is short of the funds

Back-To-Back Letter of Credit Transaction

Exporter/Beneficiary

Importer/ Applicant

Exporter/Beneficiary

Issuing BankNominated Bank

Advising Bank

Commitment Charges

• The fee charged by the L/c opening bank during the commitment period is referred to as commitment fees. Commitment period is the period from the opening of the letter of credit until the last date of negotiation of documents under the L/c or the expiry of the L/c, whichever is later.

Usance Charges

• Usance is the credit period agreed between the buyer and the seller under the letter of credit. This may vary from 7 days usance (sight) to 90/180 days. The fee charged by bank for the usance period is referred to as usance charges.

Retirement Charges

• The advising bank charges an advising fee to the beneficiary unless stated otherwise The fees could vary depending on the country of the beneficiary. The advising bank charges may be eventually borne by the issuing bank or reimbursed from the applicant.

Fees & Charges related to Documentary Credit

Ascertainment of Duties and Taxes

The followings are the components used in calculating the cost of

importable goods:

Cost and Freight

Assessable Value

Insurance Cost

Landing Charges

Custom Duty

Supplementary Duty

Value Added Tax

Advance Income Tax (AIT)

Ascertainment of Duties and Taxes (cont’d)

• Cost and Freight (CFR) is the actual amount paid by the

importers for the goods and shipment.

• Insurance cost (as a percentage of CFR) is added to the CFR.

• After adding Insurance cost, landing charges is being

calculated.

• Assessable value (AV) is the summation of CFR, Insurance Cost

and Landing Charges.

• Custom Duty is computed on the assessable value.

• Supplementary Duty is also calculated on the assessable value

• VAT is computed after custom duty and supplementary duty

are added to assessable value

• Advance income tax is calculated on assessable value

Ascertainment of Duties and Taxes (cont’d)

Derivation of Duties and taxes

Particulars AmountCost and Freight (CFR) 820,000 Add: Insurance Cost BDT 820,000*1% 8,200 828,200 Add: Landing Charges BDT 828,200*1% 8,282

Assessable Value (AV) 836,482

Duties and Taxes: Custom Duty (25% of AV) BDT 836,482*25% 209,121 Supplementary Duty (20% of AV) BDT 836,482*20% 167,296 Value Added Tax {15% of (AV+CD+SD)} 181,935 Advance Income Tax (3% of AV) BDT 836,482*3% 25,094

Total Duties and Taxes 583,446

If,CFR = US$ 10,000 or BDT 820,000/-Insurance Cost= 1%, Landing Charges= 1%Custom Duty=25%, Supplementary Duty= 20%VAT= 15%, AIT= 3%

Incoterms

EXW

• Ex works means that the seller (exporter) delivers when he places the goods at the disposal of the buyer (importer) at the seller's premises or another named place (i.e. works, factory, warehouse, etc.) not cleared for export and not loaded on any collecting vehicle.

FCA

• Free Carrier means that the seller (exporter) delivers the goods, cleared for export, to the carrier nominated by the buyer (importer) at the named place. If delivery occurs at the seller's premises, the seller (exporter) is responsible for loading.

FAS

• Free Alongside Ship means that the seller (exporter) delivers when the goods are placed alongside the vessel at the named port of shipment. This means that the buyer (importer) has to bear all costs and risks of loss of or damage to the goods from that moment.

FOB

• Free on Board means that the seller (exporter) delivers when the goods pass the ship's rail at the named port of shipment. This means that the buyer (importer) has to bear all costs and risks of loss of or damage to the goods from that point.

CFR• Cost and Freight means

that the seller delivers when the goods pass the ship's rail in the port of shipment. The seller must pay the costs and freight necessary to bring the goods to the named port of destination but the risk of loss of or damage to the goods, as well as any additional costs due to events occurring after the time of delivery, are transferred from the seller to the buyer.

CIF

• Cost, Insurance and Freight means that the seller delivers when the goods pass the ship's rail in the port of shipment. The seller must pay the costs and freight necessary to bring the goods to the named port of destination but the risk of loss of or damage to the goods, as well as any additional costs due to events occurring after the time of delivery, are transferred from the seller to the buyer.

CPT

• "Carriage paid to..." means that the seller (exporter) delivers the goods to the carrier nominated by him but the seller (exporter) must in addition pay the cost of carriage necessary to bring the goods to the named destination. This means that the buyer (importer) bears all risks and any other costs occurring after the goods have been so delivered.

Incoterms

Thank You

Adnaan JamileeSenior Executive OfficerIDLC Finance Limited

Dynamics of Documentary Credit

Documents

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