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LETTER OF CREDITS

MITIGATE FINANCIAL RISK

WHAT IS LETTER OF CREDITS?

DLC is the most widely used instrument in international trade to mitigate financial risk, especially, in a higher amount of transactions. It protects both seller and buyer; the seller gets the payment and the buyer gets the goods. DLC is issued by a financial organization on request of the buyer, providing payment assurance to the seller once all the terms of the agreement are met.

ISLAMIC ALTERNATIVES FOR LETTER OF CREDIT

WAKALAH

Wakalah arrangements are used for Shariah-compliant letters of credit. Under these arrangements, the bank works as an agent for a client, such as a purchaser or supplier of goods. Unlike a conventional agency contract, where interest is paid, in a wakalah arrangement the client pays the banks fees and commissions. In this case the LC will be in customers name, but the full responsibility will be for the bank.

MURABAHA

This is the most common product in Shariah compliant trade finance. With murabahah products, buyers ask banks to import certain goods. The banks do this and then sells the goods to the buyers for a profit. In murabahah contracts, the bank typically uses its own capital to finance the letter of credit for such financing arrangements. In murabahah working capital products, firms are provided with working capital on a similar costplus-profit basis.

MUSHARAKAH

This facility is more suitable for the large buyer who wants investment in their infrastructure, machinery and land. In a mudaraba contract, one party is a financier (silent partner), and the other party (working partner) provides labor and entrepreneurship. But in a musharaka contract, all participants are working partners.

OUR PROCESS

01

Agreement between Seller and Importer

This step is quite important because all the terms of the contract will be settled among the exporter and importer. Like, what’s the time of delivery of goods, payment terms, transport and shipping conditions will be mentioned in this contract.

02

Request to open a LC

An importer will request his bank to open a letter of credit. An importer will complete an application form to open LC. It’s important to note here that the bank is not bound to trade contract between importer and exporter; the bank will only follow the terms and conditions which are explained in the application form.

03

Issuance of LC

The Issuing bank will open LC through the SWIFT network. Otherwise, it can be done by encrypted telex or by mailing a standardized form issued by the international Chamber of Commerce. Once LC is issued, the issuing bank will be liable to pay the beneficiary once all terms of the contract are fully met.

04

Opening Notification

Through the SWIFT network, the correspondent bank will get notification of LC. Then the bank will notify the exporter about the opening of LC. The advising will also add its confirmation or not, confirmation is a process for verifying terms of trade.

What are the different options in the Documentary Letter of Credit?

DLC or LC is considered to be a flexible tool, depending upon the type of LC. There are four options which are explained below:

Revocable Letter of Credit

This form of LC is usually not accepted by the seller because the issuing bank can change or cancel the LC without notifying the advising bank.

Irrevocable Letter of Credit

Unlike revocable LC, the buyer can’t make any changes unless accepted by the seller.

Un-confirmed irrevocable Letter of Credit

In this type, the advising bank acts like a middle man, who only makes payment to the seller when it has received from the issuing bank.

Confirmed Irrevocable Letter of Credit

Here the advising bank takes the responsibility of making payment to the seller assuming default of the buyer or the issuing bank. In that case, banks charge higher fees to add their conformation.

Expert Advice

Handling documents, setting a fair deal with parties and dealing with financial institutions can be a cumbersome process, to avoid any pitfall and make a fair deal; you can take advice from experts like rizq-consulting.org.

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