Issuing, Confirming, and Advising Banks

Issuing, Confirming, and Advising Banks. As noted, letters of credit are payable either at sight or on a time draft basis. Under a sight L/C, the issuing (buyer’s) bank pays, with or without a draft, when satisfied that the presented documents conform with the forms. An advising bank (most often the confirming or seller’s bank) informs the seller or beneficiary that an L/C has been issued. Confirmation means that a local bank guarantees payment by the issuing bank. Under a time (acceptance) L/C, once the associated draft is presented and found to be in exact conformity, the draft is stamped “accepted” and can then be negotiated as a banker’s acceptance by the exporter, at a discount to reflect the cost of money advanced against the draft.

Once the buyer and the seller agree to use an L/C for payment, and have worked out the conditions, the buyer or importer applies for the L/C at his or her international bank. Figure 5-1 is an example of a letter of credit application.

Types o f L / Cs. There are two types of letters of credit: revocable and irrevocable. Revocable credit means that the document can be amended or canceled at any time without prior warning or notification of the seller. Irrevocable credit means that the terms of the

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document can be amended or canceled only with the agreement of all parties thereto.

Using the application as its guide, the bank issues a document of credit incorporating the terms agreed to by the parties. Figure 5-2 exemplifies an L/C.

Figure 5-3 shows the three phases of documentary credit in their simplest form. In Phase I, the buyer’s (issuing) bank notifies the seller through an advising bank or the seller’s (confirming) bank that a credit has been issued. In Phase II, the seller then ships the goods and presents the documents to the bank, at which time the seller is paid. In Phase III, the “settlement” phase, the documents are transferred to the buyer’s bank, whereupon the buyer pays the bank any remaining moneys in exchange for the documents. Thus, on arrival of the goods, the buyer or importer has the proper documents for entry.

Special Middleman Uses of the Letter of Credit. There are three special uses of commercial letters of credit for the import/export middleman: transferable, assignment of proceeds, and back-to-back L/Cs. Figure 5-4 compares the risks involved with each method.

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Fig. 5-1. Request to open a letter of credit

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Fig. 5-1. Request to open a letter of credit (Continued)

Transferable LIC. Figure 5-5 shows how the transferable L/C works. The buyer opens the L/C, which states clearly that it is transferable on behalf of the middleman as the original beneficiary, who in turn transfers all or part of the L/C to the supplier. The transfer must be made under the same terms and conditions as the original L/C with the following exceptions: amount, unit price, expiration date, and shipping date. In this instance the buyer and supplier are usually disclosed to each other.

Assignment of Proceeds. Figure 5-6 illustrates the assignment of proceeds method, and Figure 5-7 shows a typical letter of assignment. It should be noted that the proceeds of all letters of credit may be assigned. In this instance the buyer opens the [IC as the beneficiary and relies on the middleman to comply so that he can be paid. Any discrepancy in middleman documents will prevent payment under the IJC. The middleman instructs the advising bank to effect payment to the supplier when the documents are negotiated. In this way, buyers and sellers are not disclosed to each other.

Back-to-Back L/C. When using the back-to-back method, shown in Figure 5-8, the middleman must have a line of credit.

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Fig. 5-2. Sample letter of credit

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Fig. 5-3. The three phases of a letter of credit

Fig. 5-4. Comparison of L/C risks

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Fig. 5-5. Transferable letter of credit

The reason is that the middleman is responsible for paying the second (backing) L/C regardless of receipt of payment under the first (master) L/C. Great care should be exercised when using this method because discrepancies on the first L/C will result in nonpayment, and the middleman’s ability to pay could be a substantial credit risk. Back-to- back L/Cs should be issued on nearly identical terms and must allow for third-party documents.

Cash in Advance. Cash in advance is the most desirable method of getting paid, but the foreign buyer usually objects to tying up his or her capital. On the grounds that seeing the merchandise is the best insurance, most foreign buyers try not to pay until they actually receive the goods. Furthermore, a buyer may resent the implication that he or she is not creditworthy.

Avoiding Bad Credit

Pick your customer carefully. Bad debts are more easily avoided than rectified. If there are payment problems, keep communicating and working with the firm until the matter is settled. Even the most valued customers have financial problems from time to time. If nothing else works, request your department of industry or commerce or the International Chamber of Commerce to begin negotiations on your behalf.

Information that is current and accurate is the backbone of good financing decisions. Basically there are two types of international credit information: (1) the ability and willingness of importing firms to make payment, and (2) the ability and willingness of foreign countries to allow payment in a convertible currency.

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Fig. 5-6. Assignment of proceeds

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Fig. 5-7. Typical letter of assignment

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Fig. 5-8. Back-to-back letter of credit

There are several sources of credit information on companies and their countries.

Information About Domestic Firms

Commercial banks

Commercial credit services, such as Dun & Bradstreet

Trade associations

Information About Foreign Firms

National Association of Credit Management (NACM)

Foreign credit specialists in the credit departments of large exporting companies

Commercial banks, which check buyer credit through their foreign branches and correspondents

Commercial credit reporting services, such as Dun & Bradstreet

Consultations with EXIMBank and the Foreign Credit Insurance Association (FCIA)

The U.S. Commerce Department’s World Trade Directory Reports

Information About Foreign Countries