Letter of credit (LC) is an undertaking letter issued by the importer’s (buyer’s) bank wherein the seller is assured of full payment of goods/service sold by him on a condition that the supplier fulfills his part of the sale contract embodied in Letter of Credit. Generally, there are eight parties involved in letter of credit transactions, out of which four principal parties involved in any transaction.
Four principal parties involved in Letters of credit transaction.
- Applicant/opener: The bank opens the Letter of Credit on behalf of the applicant (customer) who is normally a buyer of goods. The customer on whose behalf the LC opened is called ‘applicant’ or ‘opener’.
- Issuing bank: The bank which opens (issues) a LC and undertakes to make payment to the beneficiary on submission of documents as per terms of L.C is called LC issuing Bank..
- Beneficiary: Beneficiary of LC is one in whose favour LC is issued. Beneficiary is normally the seller who has to get payment from the buyer.
- Advising bank: The bank through whom LC is advised to the beneficiary is called Advising Bank. Advising bank will be situated normally in the place or country of the beneficiary.
Apart from above four principal parties to LC, the following four are ordinarily involved in letters of credit transactions they are;
- Confirming Bank (Optional): When LC issuing bank is unknown to the exporter (seller) another reputed bank of exporter’s country adds its confirmation to the LC. It means in addition to LC issuing bank, LC confirming bank undertakes the responsibility of payment under the credit.
- Negotiating Bank: Whichever bank negotiate the documents received under LC is called negotiating bank.
- Paying Bank or nominated bank: The issuing bank nominates/authorizes another bank to make payment under the credit. The bank which makes the payment under credit is called paying bank. It is important to note that it is not obligatory on the part of nominated bank to honour the documents presented to it unless the nominated bank and confirming bank is same. In practice, the nominated bank presents the documents received by it either to Issuing bank or Reimbursing bank for payment and transfers the credit proceeds received by it to the beneficiary’s account.
- Reimbursing bank: LC issuing bank will have the foreign currency accounts (NOSTRO Accounts) with the banks of other countries. LC issuing bank authorizes the bank where it maintains accounts to honour the LC reimbursement claim of negotiating bank. The bank which makes reimbursement of claim under LC is called reimbursing bank.
Related article: (i) Things to know about Letter of Credit (LC) transactions, (ii) Dissecting different types of LCs (Letters of credit) (iii) Meaning of Standby LC of different types.