Credits: Pinaki Roy & Bhaskar Das; Banking, Reliance Industries Limited
LC: or Letter of Credit is supplier way of making sure that buyer will be making the payment on time, in fact letter of credit ensures that the issuing bank will pay the seller with virtually no connection to buyer financial condition (or its willingness) to pay.
This document contains clauses something like this:
40A: Form of Documentary Credit
IRREVOCABLE
i.e a number_capital alphabet: Description
ANSWER
After the introduction, you have stage wise payment details along with necessary document required to be produced before the bank. At the end you have the clarifications regarding the account (buyer or seller) on whose charges of LC will be put to.
"ALL BANK CHARGES OUTSIDE INDIA ARE TO THE ACCOUNT OF THE BENEFICIARY. UCP ART 37C NOT APPLICABLE" ... this clearly clarifies that charges on seller side will be borne by seller and if seller fails buyer wont pay those charges and LC will stand cancelled.
Confirmed LC: seller bank checks the authentication of the LC from Buyers bank and confirms to stand responsible for negotiating, collecting payment etc … By adding “confirmation” sellers bank too becomes equally responsible to make payment.
Revocable: If terms allow one single party to be able to make changes to the LC unilaterally.
Sight LC: paid immediately after showing document
Future/ credit LC: paid in future after showing document
Bank Guarantee: a bank takes responsibility for payment of sum of money in case, it’s not paid.
· Direct: less expensive, subject to law of issuing country
· Indirect: second bank involved, representative of the issuing bank in the country to which beneficiary belongs.
· Confirmed guarantee: foreign bank confirms and assumes the responsibility
In LC: 4 parties are involved , in BG 3 parties
BG becomes only active when customer fails to pay.
SBLC: or Stand By Letter of Credit is a document which secures a buyer for his advance payment. Which means, if seller defaults or purchase order stand cancelled, buyer can go to the issuing bank and take money as paid as advance.
The advantage here is as a buyer you won't have to struggle through all those legal issues and stuff all you need is the necessary document (which are normally explicitly written in the SBLC) certifying the seller has defaulted.
These SBLC are normally valid till waraanty plus six month and if this becomes really long duration, you can have automatic renewal clause as well.
SBLC are better than Bank Guarantee (BG) because a BG is a simple obligation subject to civil law whereas a SBLC is issued subject to UCP 500 and ISP98, both well-accepted banking protocols.
There are basically two clauses in an SBLC
Transferability
Availability
Small word changes like availability on remittance vs availability on receipt can be a surprisingly big issue for bankers because for them the risk is in terms of millions :), so better to check each word carefully and put all the burden of decision on banking people :)
As a procurement person, your aim should be to get SBLC from seller in lieu of advance and pay them on cash against document rather than LC, since LC charges could be somewhere around 0.3% to 0.4% of the value per year !!