The bank issues a letter of guarantee to its client by making a
promise to the recipient (receiver) a guarantee that if the client
acts in compliance with the terms and conditions as agreed upon
in the letter of guarantee. This prevents damage to the receiver of the
letter of guarantee and if the client fails to make payment, the bank will
make payment to the amount specified in the letter of guarantee. eg, guarantee of bidding tender, guarantee of construction
contract, guarantee of payment for electricity, etc. The method of
issuing a letter of guarantee helps the client & avoids cash
as a guarantee.It also acts as a safeguard between both parties.
The buyer and seller agree terms,
including means of transport, period of credit offered, latest date of
shipment and the relevant Inco-term to be used.
The buyer applies to the bank for a
letter of credit to be issued.
The bank will then evaluate the buyer's
credit rating, and may require cash cover and/or reduction of other
The issuing bank will issue a letter of
credit. This will be sent to the advising bank by airmail, telex or
The advising bank will establish
authenticity of the letter of credit using signature books or test
codes, then informs seller (beneficiary).
The advising bank may confirm the letter
of credit, i.e. add its own payment undertaking.
The seller should check that the letter
of credit matches the commercial agreement, and that the terms and
conditions can be satisfied in goodtime.
If there is anything that may cause a
problem, an amendment should be requested.
The seller ships the goods and gathers
together all the documents asked for in the letter of credit including
the invoice, bill of lading, insurance policy certificate, as well as
the certificates of origin and quality.
Before presenting the documents to the
bank, the seller should check them for discrepancies against the letter
of credit, and correct the documents where necessary.
The documents are presented to one of the
banks, usually the advising bank.
The advising bank checks the documents
against the letter of credit. If the documents are compliant, the bank
pays the seller and forwards the documents to the issuing bank.
The issuing bank will also check the
documents. If they are in order the issuing bank will reimburse the
seller's bank immediately.
The issuing bank debits the buyer and
releases the documents (including transport document), so that the buyer
can claim the goods from the carrier.
It should be noted that the letter of
credit refers to documents representing the goods, and not the physical
goods themselves. The banks do not examine the goods on behalf of their
customers but instead only care about the documents representing the
HOW ITS DONE:
Irrevocable Letter of Credit
goods using a letter of credit, the buyer must meet terms and
conditions that are acceptable to both parties. Compliance with these
terms and conditions will ensure prompt shipment of buyer’s order. Any
deviations from the terms and conditions without our agreement may
result in additional bank charges and a delay shipment until the Letter
of Credit can be amended.