L/C (Letter of Credit) serves to facilitate smooth transaction in international trade. Therefore, it is extensively used around the world. Exporters are recommended to do business on L/C basis particularly when doing business with foreigners with whom the exporter has little knowledge of their financial standing.

What is the mechanism of L/C?
The parties connected with L/C are (A) importer, (B) L/C issuing bank on the side of importer, (C) exporter and (D) notifying bank (negotiation bank on the side of exporter). (See Flow Chart: Opening a L/C).

The mechanism of opening a L/C is as follows:-

• When a sales contract is made between the exporter and the importer, both sides agree to do business on an L/C basis.
• The importer requests the issuing bank to issue an L/C.
• If the issuing bank determines that the importer's financial standing is acceptable, the bank will issue the L/C to the exporter (beneficiary of L/C). The bank may request the importer to make a deposit (security) in order to guarantee themselves.
• The issuing bank notifies the exporter through the correspondent bank (notifying bank ) by telegram first and then sends the original L/C to the exporter.
• The exporter executes the shipment according to the conditions of the L/C.
• The exporter presents the Bill of Exchange (Draft) based on the condition of the L/C together with a full set of the shipping documents and applies for negotiation of the documentary bill at the exporter's bank (negotiating bank).
• The negotiating bank checks the conditions of L/C and shipping documents. If the conditions of L/C are found to be consistent with the shipping documents, the bank pays the exporter. However, the exporter has to be very careful as the bank is not able to honor the Bill of Exchange, if there is any discrepancy between the conditions of L/C and the documents attached. If a discrepancy occurs, the exporter has to inform the importer and have him request the issuing bank for an amendment to the L/C accordingly.
  

What are Sight L/C, Acceptance L/C and Cash L/C?
If the L/C terms demand that the Bill of Exchange drawn by the exporter is the type which requires the importer to pay at sight, i.e. when the bill is presented to him by the reimbursing bank, L/C with such terms is called Sight L/C. On the other hand, the L/C which has terms allowing the importer a deferred payment is called Acceptance L/C. If the L/C terms require the importer to pre-arrange the amount of money for the import to be transferred from his bank to either the branch or correspondent bank in the exporter's country, so that the money can be paid from that account when the exporter presents the documents to the bank, such L/C is called cash L/C.

What is Irrevocable L/C?
Under Irrevocable L/C terms, L/C cannot be cancelled or withdrawn after is has been opened and notified to the exporter (who is the beneficiary of L/C) as long as there is no agreement on cancellation or withdrawal among the applicant of L/C, opening bank and the beneficiary. However, in the case of Revocable L/C, it can be cancelled anytime upon the applicant's request. Therefore, L/C should be irrevocable from the exporter's point of view. The exporter has to be aware that any L/C received which does not specify either as being revocable or irrevocable, will be regarded as being revocable.

What is the Confirmed L/C?
The confirmed L/C is the one which is confirmed and guaranteed by a third party bank for the payment in the event that the opening bank becomes bankrupt. The exporter can be assured of a safe transaction if the L/C is confirmed by a leading bank.

What is the Non-transferable L/C?
The beneficiary (exporter) can transfer the Transferable L/C to a third party, but he is unable to do this with the Non-transferable L/C.

What is the Restricted L/C?
Under the terms of a Restricted L/C (sometimes called special L/C), only a specific bank which is usually the notifying bank can purchase a bill of exchange from the exporter. However, under the terms of a General L/C, the purchasing bank is not specified, hence the exporter can present the bill of exchange to any bank and receive payment.