Letter of Credit – A common term known to almost all business world. What is Letter of Credit? How does LC work? How to open a Letter of Credit? What are the advantages of Letter of Credit to Exporter? How LC is benefited to Importer? Are there any disadvantages to importer for a consignment under Letter of Credit? What are the disadvantages of LC to an exporter? Who are the parties involved in Letter of Credit? How to check authenticity of LC? What is Prime Banker? Yes, I am going to discuss all of these in this website. I hope, once after reading those articles about Letter of Credit, you will have a good knowledge to handle LC gently.
In this article I am going to explain basic information to open Letter of Credit. Letter of Credit is an assurance given by buyer’s bank as opening bank to seller as beneficiary against sale of goods as per the terms and conditions mentioned in Letter of Credit.
‘How to open an LC’ by buyer- “procedures to open an Letter of Credit”
You (buyer) entered in to a contract with your overseas supplier to import machinery for production at your factory. As per your contract each other, you (buyer) need to open a Letter of credit (LC). In this case, Letter of credit is opened by your bank (or other opening bank) and beneficiary of letter of credit is your overseas seller of machinery. Letter of credit is a guarantee given by your bank (not you) to your buyer’s bank on account of your buyer. The amount under LC is transferred as per the terms and conditions mentioned in Letter of credit. Please also read other articles about Letter of Credit in same website to know more about Letter of Credit.
Procedures to open a Letter of Credit.
You can approach your bank to open a Letter of credit. The concerned officer at bank helps you in filling up necessary application to open an LC. Since the LC is opened on the basis of your purchase contract, a copy purchase order / export contract has to be produced with along with other required documents. Your bank may ask you to keep certain percentage of ‘margin amount’ with bank.
What is ‘margin amount’ while opening Letter of Credit.
As I have explained to you, bank is guaranteeing the payment. In turn, what guarantee are you providing to bank against the amount of LC? So a margin amount is blocked in your bank account to make the payment under the said letter of credit. Certainly you may ask, what would be the ‘margin’, bank blocks. This amount is determined, purely based on your financial relationship with your bank.
Let us discuss about your creditworthiness with your bank while keeping ‘margin amount to open LC’. If you are a new account holder for your bank and bank does not know your other financial status, you cannot expect any financial support from your Bank. You need to keep 100% margin amount with your bank. If the LC amount is for USD 10000, your amount of USD 10000 is blocked from your account to pay LC amount to your overseas seller on maturity date. You may have a good relationship with your banker for the past many years, and your banker knows your fixed assets, your fixed investments with bank, other financial transactions and are happy with the credit worthiness, bank decides the amount of margin to be collected from you to open the Letter of Credit. It ccan be from 1% to 100%, as explained. I hope, you came to know the basic procedures to open Letter of credit.
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