How to open an LC?


A letter of credit is a term that practically everyone in the business world is familiar with. What exactly is a Letter of Credit? How does LC function? What is the procedure for opening a Letter of Credit? What are the benefits of a Letter of Credit to an Exporter? How does LC benefit the importer? Is there any disadvantage to the importer for a Letter of Credit consignment? What are the drawbacks of LC for an exporter? Who are the parties involved in the Letter of Intent?How to Start an LC  How can I open a Letter of Credit Credit? How can the authenticity of LC be determined? What exactly is a Prime Banker? Yes, I intend to cover all of these topics on this website. I'm hoping that after reading those Letters of Credit articles, 


In this essay, I will go over the fundamentals of opening a Letter of Credit. A letter of credit is an assurance granted by the buyer's bank as the opening bank to the seller as the beneficiary against the sale of goods in accordance with the terms and conditions specified in the letter of credit.

Opening a Letter of Credit (LC) involves several steps that require coordination between the buyer (applicant), the buyer's bank (issuing bank), and the seller (beneficiary). An LC provides assurance of payment to the seller and outlines the terms and conditions of the trade transaction. Here's a general outline of the procedures to open a Letter of Credit:

1. Negotiation and Agreement:

  • The buyer and seller negotiate and agree on the terms of the trade transaction, including the goods or services to be exchanged, price, quantity, delivery terms, and any other relevant conditions.

2. Selection of LC Type:

  • Determine the type of LC that best suits the transaction, such as sight LC (payment upon presentation of compliant documents) or a deferred payment LC (payment at a later date).

3. Contact the Issuing Bank:

  • The buyer initiates the process by contacting their bank (the issuing bank) and expressing the intention to open an LC.

4. LC Application:

  • The buyer submits an LC application to the issuing bank. The application includes details of the transaction, such as the beneficiary's name, amount, terms, and required documents.

5. Issuing Bank's Review:

  • The issuing bank reviews the application and ensures that the buyer has sufficient credit and financial standing to open the LC.

6. Issuance of the LC:

  • If the application is approved, the issuing bank issues the LC to the beneficiary's bank (advising bank) or directly to the beneficiary, depending on the method chosen.

7. Advising the LC:

  • The advising bank authenticates and notifies the beneficiary about the LC's issuance, terms, and conditions.

8. Seller's Confirmation:

  • If required, the beneficiary requests the advising bank to confirm the LC, providing additional assurance of payment.

9. Shipments and Document Preparation:

  • The seller ships the goods and prepares the required documents according to the LC's terms. These documents often include a bill of lading, commercial invoice, packing list, certificate of origin, and inspection certificates.

10. Document Submission:

  • The seller presents the required documents to the advising bank or the issuing bank (as specified in the LC) within the stipulated time frame.

11. Document Examination:

  •  The bank examines the documents to ensure they comply with the terms and conditions of the LC.

12. Payment and Release of Documents:

  •  If the documents are in order, the bank releases payment to the seller and forwards the documents to the buyer.

13. Funds Deduction:

  • The issuing bank deducts the LC amount and any related charges from the buyer's account.

14. Receiving the Goods:

  •  The buyer receives the goods and inspects them to ensure they match the terms of the transaction.

15. LC Closure:

  • Once the transaction is completed and all obligations are fulfilled, the LC is considered closed.

It's important to note that the specific procedures may vary based on the involved banks, the type of LC, and the terms of the trade transaction. Communication and coordination between the buyer, seller, and banks are crucial to ensure a smooth and successful LC process. Both parties should thoroughly understand the terms of the LC before initiating the transaction.




Buyer's 'How to Open an LC'- "Procedures to Open a Letter of Credit"


You (buyer) signed an agreement with your overseas supplier to import machinery for manufacturing at your plant. According to your contract, you (buyer) must open a Letter of credit (LC). In this situation, your bank (or another opening bank) opens a letter of credit, and the beneficiary of the letter of credit is your foreign seller of machinery. A letter of credit is a guarantee issued by your bank (not you) to your buyer's bank on your buyer's behalf. The LC amount is transferred in accordance with the terms and circumstances specified in the letter of credit. Please check other Letter of Credit articles on the same page to learn more about Letters of Credit.

Procedures for establishing a Letter of Credit.

 
You can ask your bank to open a Letter of credit for you. The bank's responsible official assists you in completing the essential application to open an LC. Because the LC is opened on the basis of your purchase contract, a copy purchase order / export contract, together with other needed papers, must be produced. Your bank may request that you hold a specific percentage of the'margin amount' with them.


When opening a Letter of Credit, what is the'margin amount'?

The "margin amount" in the context of opening a Letter of Credit (LC) refers to a security deposit or collateral that the issuing bank may require from the buyer (applicant) before issuing the LC. This amount is typically a percentage of the total LC value and is held by the bank as a form of security to cover potential risks or liabilities associated with the transaction. It is also known as a "margin" or "security margin."

The margin amount serves as a safeguard for the bank in case the buyer defaults on payment or fails to meet their obligations under the LC. It provides a level of assurance to the bank that it can recover any potential losses in the event of non-payment or disputes.

The margin amount is distinct from the actual value of the goods being traded or the payment to the seller (beneficiary). It is an additional sum that the buyer must deposit with the bank as part of the LC issuance process. The specific percentage of the margin amount can vary depending on factors such as the buyer's creditworthiness, the nature of the transaction, and the policies of the issuing bank.

It's important to note that the margin amount is separate from the funds used for payment under the LC. Once the terms of the LC are fulfilled, and the transaction is completed, the margin amount may be released back to the buyer or used to cover any outstanding fees or charges associated with the LC.

The requirement for a margin amount is a common practice in trade finance to mitigate risks and ensure the financial integrity of the LC process. Buyers should inquire with their bank about the specific margin requirements and guidelines applicable to their LC transactions

Let us speak with your bank about your creditworthiness while keeping the'margin amount to open LC' in mind. You cannot expect financial assistance from your bank if you are a new account holder and the bank is unaware of your previous financial situation. You must keep 100% of the margin amount with your bank. If the LC amount is USD 10,000, the amount is blocked from your account to pay the LC amount to your overseas seller on the maturity date. You may have had a solid relationship with your banker for many years, and your banker is aware of your fixed assets, fixed investments with the bank, other financial transactions, and are satisfied with the credit worthiness, and the bank determines the amount of margin.to be gathered from you in order to open the Letter of Credit. As previously said, it can range from 1% to 100%. I hope you learned the fundamentals of opening a letter of credit.