In International trade, a letter of credit is a financial document. It is a payment guarantee provided by the bank to the products seller. A "Letter of Credit" provided by a bank, acts as a guarantee to the seller of goods if the customer fails to pay for the products. Go through this blog where Dhanguard can assist you in acquiring a Letter of Credit in the UAE.
The following are the most popular or well-known letter of credit types:
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Letter of Credit (Revocable)
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Letter of Credit (Irrevocable)
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Confirmed Letter of Credit
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Unconfirmed Letter of Credit
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Deferred Payment Letter of Credit
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Standby Letter of Credit
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Negotiable Letter of Credit
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Revolving Letter of Credit
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Red Clause Letter of Credit
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Green Clause Letter of Credit
An Outlook on Letter of Credit
Letters of Credit, also known as “documentary credit”, are written statements issued by banks on behalf of their customers. Furthermore, the seller is assured that payment will be made upon the submission of a document as specified in the issued Letter of Credit. It also assures that if the buyer is unable to pay according to the written contract, the bank will be responsible for covering the payment requirements on the buyer's behalf.
Having a letter of credit in hand also protects the buyer's interests by ensuring that the payment will not be released until the items have been delivered to the buyer's port as agreed. Indeed, Letters of Credit play an important role in international or domestic trade by establishing a trust bridge between buyers and sellers.
Also Read - What are the Benefits of Letter of Credit in Business in UAE?
Documents Required for Opening a Letter of Credit
The following is a list of documents that will be required to open Letters of Credit on your behalf from our bank account
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A signed copy of a trade deal's preformed invoice;
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A copy of a company's registration / trade license and a Memorandum of Understanding between partners (if any);
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Photocopy of the Authorized Signatory's Passport;
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Utility bills proving the Authorized Signatory's address ;
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Also, a copy of the most recent six months' account statement.
Procedure for Opening a Letter of Credit
You must contact your bank about your trade transaction in order to open the LC on behalf of your firm. If you have access to your own bank accounts, your bank will approve and process your request. They may also need you to keep a specific proportion of the margin amount in order to issue the appropriate LC in some situations.
If you don't have access to a bank or don't have enough cash to hold as a buffer, the bank may then reject your LC request. On the other hand, if you are a new account holder and your bank does not know your financial history, you cannot expect your bank to assist you with trade finance.
The following procedure of Opening a Letter of Credit in UAE is given below
Obtaining a Letter of Credit
The importer asks the issuing bank to issue a Letter of Credit in favor of the exporter after the parties to the trade agree on the contract and the usage of the Letter of Credit. The issuing bank sends the Letter of Credit to the advising bank. The confirming bank (advising bank) validates the Letter of Credit's legitimacy before forwarding it to the exporter.
Delivery of Products
The exporter is expected to check the Letter of Credit to their satisfaction and begin the goods shipment process after receiving it.
Providing Documents
The exporter (either directly or through a freight forwarder) provides the documentation to the advising/confirming bank after the items have been transported.
Receiving Payment
The bank then transmits them to the issuing bank, where the money is paid, accepted, or negotiated, depending on the situation. The issuing bank confirms the paperwork and collects money from the importer. It transmits the documentation to the importer, who uses them to take possession of the products that have been shipped.
Letter of Credit vs. Bank Guarantee
A commercial instrument is a bank guarantee. It's a guarantee from the bank for a non-performing asset. The application, the recipient, and the banker are all involved in the bank guarantee process.
A Letter of Credit, on the other hand, is a letter of commitment. It is a guarantee for a performing activity offered by a bank or other financial institution. It ensures that payment will be made by the importer, subject to the LC's terms and conditions. The letter of credit involves four parties: the exporter, the importer, the issuing bank, and the advising bank (confirming bank).
Importance of Letter of Credit
UAE has business dealings all over the world, so letter of credit are more vital in trade. A documentary credit or letter of credit transaction necessitates trust in banks. Both the buyer and the seller should have faith in the bank's ability to meet its payment obligations. A letter of credit instills trust in both parties involved in the transaction.
Things to consider before Acquiring Letter of Credit
These are the points you should consider before acquiring Letter of Credit
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Exporters should keep in mind that they must present papers in a precise way in accordance with the terms and conditions of the letter of credit. Non-compliance with the LC might result in non-payment, payment delays, and payment disputes. The issuing bank should have a good reputation and be strong and stable enough to honor the LC when it is needed.
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Another element that must be resolved before obtaining an LC is the cost-bearing obligation. The cost of recovery will rise if costs are allocated to the exporter. A Letter of Credit is frequently more expensive than other forms of export payment.
Conclusion
Given the foregoing, documentary credit transactions require both the buyer and seller's trust in banks in order to remain convinced that Issuing or Correspondent Banks would honor their payment obligations. If you require some more detail regarding letter of credit, do make a contact with our experts at Dhanguard. Feel free to contact us .We provide the best of information among all.