What is Discounting of Letter of Credit
Discounting of Letter of Credit (LC) is a short-term credit facility provided by the bank. In the Letter of Credit discounting process, the bank purchases the documents or bills of the exporter and in return make him the payment for a security or a fee. LC discounting is actually a term used for ease in place of ‘LC Bill Discounting’, which means discounting of a bill backed by LC.
For businesses that export or import, letters of credit are the financial security of international trade. A letter of credit allows an importer to make sure that an order is filled and shipped before payment is made and the exporter is guaranteed that money will paid for the goods shipped overseas. The discounting of letters of credit allows exporters to get their money faster.
When using Letter of Credit, the client can choose various ways of payment, including the delayed payment option. In this case the client receives the payment with a slight delay that can create difficulties in financial flow, therefore we offer an option to discount the Letter of Credit.
- Discounting of Letter of Credit is a short-term crediting of the seller by the bank. The bank can finance the client in case of Letter of Credit for export (if the client is seller in the transaction) by negotiating or by purchasing the documents or by making the early disbursement of the postponed payment. This means that the bank pays to the client the amount indicated in the agreement before receiving the payment from Letter of Credit issuing bank.
- Letter of Credit issuing bank’s commitment to pay the amount mentioned in the Letter of Credit at a certain date serves as a credit guarantee to the bank. SEB bank will carefully evaluate the bank that has issued the Letter of Credit and its risk limit.
- For discounting the Letter of Credit the bank applies corresponding discounting fee.
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Discounting of Letter of Credit
Letter of Credit Discounting Definition
To understand the meaning of Letter of Credit Discounting, we need to understand the meaning of Letter of Credit in short. Letter of Credit is a guarantee given by the bank to pay to the seller for the buyer’s obligation, in case buyer fails to make the payment. In simple words, bank promises to pay for the goods which buyer has purchased from the seller.
Coming back to Discounting of Letter of Credit; it often happens that a seller is willing to get quick payment. Whereas the buyer does not want to pay immediately. So to resolve this difficulty, the bank offers the seller to get immediate payment or say advance payment, even if the buyer wants a longer credit period for payment. LC discounting is helpful to all the parties in the trade.
- The seller gets immediate payment for his sale
- The buyer receives the goods along with the credit period to pay
- The bank receives a premium from the buyer when he makes the payment to the bank.
Benefits of LC Discounting
- Bills, drawn under irrevocable LC. (Generally, bills backed by revocable LCs are not discounted)
- Bills drawn should strictly conform to the terms mentioned in Letter of Credit.
- The bills of exchange need to be related to bonafide trade transactions.
As an exporter, you want an assurance that you will get paid when you ship goods to an overseas buyer. To facilitate the payment for an export shipment, the buyer goes to his bank and establishes a letter of credit. Your bank confirms with the buyer’s bank that the letter is valid and then you can ship your goods with the knowledge that you will get paid. When all of the terms of your deal have been met, your bank collects on the letter of credit and passes the money on to your exporting business.
As the seller and exporter, to get paid for an order you must present to your bank the required documents to verify your order has been shipped to the customer. Your bank then forwards the documents to the customer’s bank that holds the letter of credit and when that bank verifies the documents, the money will be transferred to your bank and then paid out to your business. The trigger to start the process to claim a letter of credit payment occurs when the export and shipping documents are completed and delivered to you, the seller.
- It speeds up the cash flow movement in the organization as the beneficiary receives an advance payment which helps in the smooth movement of working capital in the organization.
- The beneficiary receives immediate payment before the maturity date of the bill. The beneficiary can use this amount for his business during the production process to pay his suppliers and for funding the operations.
- LC Discounting eliminates the credit risk, as the bank gives assurance to the beneficiary for the buyer’s obligation.
- LC Discounting is a safe and secure mode of getting funds, as the bank discounts LC only after verifying the authenticity of both of the parties.
- Prevailing discount rates are applicable on the letter of credit. Hence, it eliminates the chances of manipulating the discount rate.
- It offers the beneficiary an opportunity to give longer payment terms to his trading partner. This not only puts the beneficiary in a better position to negotiate for the deal but also helps to build a strong relationship with their trading partner.
- Bank charges a fee or margin for discounting LC. This results in beneficiary paying up extra fees for the amount due to him.
- Focus is only on documentation and not on the physical verification of goods like the quality of goods, its quantity, etc.
- Since the discounting rates vary from bank to bank, the applicant may be troubled in selecting which bank to visit for LC discounting.
- A lot of documentation is required which results in consumption of huge resources of the applicant.
- It is a time-consuming process, as various rules need to be complied by the beneficiary and verified by the bank.
- Forex risk is associated with LC discounting. The exchange rate keeps on changing which may result in a loss to the beneficiary.
- Rules governing discounting of LC are complex.
Discounting of Letter of Credit Frequently asked questions (FAQ)
If you do not have any credit limit.
If we receive the documents by 9am on a working day, we can process them on the same day. If we receive the documents after 6pm, we will process them within the next working day. Processing time is subject to our comfort on the LC issuing Bank and country
Yes, A letter of credit discount occurs when your bank offers to advance you the letter of credit payment before you have completed the steps needed to present the sales and shipping documents. It is called a discount because you do not receive the full payment amount. The discount represents the interest or fee the bank earns for providing the money before you have completed the terms of the sales agreement and letter of credit.
The letter of credit discount could benefit your export business in several ways. After receiving an order from an overseas customer, it can take several months to manufacture the goods and get them onto a ship, at which point you could collect on the letter of credit. With the discount, you get most of the money during the production process, funding your operation. Another way to use the discount involves giving your customer an extended term to pay. For example, you may give the customer 90 days after receipt of the goods, so that company has time to resell your products before the foreign bank must make good on the letter of credit. Your bank gives you the discounted advance so your business does not wait three months to get paid.