Letter of Credit (LC) Discounting is a short-term credit facility provided by the bank to Exporter. Seller/Exporter bank purchases the invoice and discounts 85-90% of amount upon due diligence & limits availability with applicant bank. This product offering comes with minimal cost which has to be borne by exporter/importer depending upon the terms and condition agreed upon in LC.
Letter of Credit Discounting:-
Letter of Credit Discounting is a product offered to the exporter for Usance LCs .In trade usually Buyer wants to have credit period and sellers want to have quick payment, to address this issue, bank supports exporter with LC discounting.
Below are the advantages of LC Discounting:
- Exporter gets immediate payment;
- Importer obtains the goods along with the credit period to pay
LC Discounting Charges :
Fees paid by exporter to the bank to avail service of Foreign Bill Discounting is known as LC discounting charges. These charges are usually mentioned in LIBOR+ BPs . Typically this interest cost will vary between 6-10% Per annum. The cost may even go up to 14% Pa if LC Confirmation is added.
LC Confirmation:- Exporter bank attempts to protect interest of exporter for which they will insist on adding confirmation to LC, which typically means that, in the event of default of applicant or bank, Confirming bank will take responsibility of honoring LC. Confirmation is usually added if in case credibility of the applicant or applicant’s country is less. This again adds to overall LC discounting cost. This cost can again run up to few percentage points.
LC Discounting cost typically depends on
1. Applicants Bank credibility
2. Applicants country’s market risk
3. Amount of LC discounting
Basic Documents Required for LC Discounting
- Bills, drawn under irrevocable LC. (Revocable LCs are not discounted)
- Beneficiary Bank to submit all the docs as per LC clause.
- The bills of exchange documents certifying bonafide trade transactions.
Letter of Credit Discounting Process
Upon the receipt of LC exporter, necessary documents are submitted to beneficiary bank. This LC acts as a guarantee to the seller/exporter. Sellers Bank sends these documents to the issuing/applicant bank or confirming bank. Applicants bank/Buyers or confirming bank checks the authenticity of the document. Upon successful inspection of documents, applicant bank communicates back to beneficiary on acceptance of bill. On the Post Acceptance of bill by the buyer, beneficiary bank discounts LC upto 85-90% of total bill.
Process involved in LC Discounting
Step 1 - Buyer to apply for LC.
Step 2 - Seller bank to issue LC.
Step 3 - Bank to advise the LC.
Step 4 - Exporter/Seller to dispatch goods to Importer
Step 5 - Exporter/Seller to submit transportation documents to Issuing Bank.
Step 6 - Importer to accept documents and notification to be sent to sellers bank by Importers bank.
Step 7 - LC to be discounted and funds credited upon acceptance.
Advantages of LC Discounting
1. Ease of working capital cycle / Liquidity for Exporter
2. Beneficiary receives payment much before the due date, thus help him to have better cash flows
4. Gives Beneficiary better bargaining power to negotiate, on basis of longer credit payment terms
5. FLC rates are usually offered at Libor Rates, which makes it a cheaper loan.
Disadvantages of LC Discounting
1. Bank Charges a fee for discounting LC. This reduces business margins to the Exporter.
2. Physical Verification of goods are not done, only documents are verified
3. Discounting rates vary from bank to bank as lines available may vary from each bank.
4. FEMA and other regulatory compliance related activities to be adhered to
5. FLC is associated with forex fluctuation risk which could lead to huge forex losses. In case, seller wish to hedge forex exposure it adds to additional cost.