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IMPORTANT POINTS FOR LETTER OF CREDIT AND BANK GUARANTEE

WHO IS?

APPLICANT:

The buyer /importer of goods: This person has to make payment of letter of credit to the issuing bank if the documents are in accordance with the terms and conditions of LC.

1. ISSUING BANK:

Importer’s or buyer’s bank who lends its name or credit is issuing Bank. It is liable for payment of LC in case the documents are received by it from the nominated or negotiating bank and the documents are in terms of letter of credit. This bank gets 5 days to check the documents.

2. Advising Bank

Issuing bank branch or correspondent in exporter country to whom the letter of credit is sent for onward transmission to the seller or beneficiary, after authentication of genuineness of the credit. Where it is unable to verify he authenticity, it can seek instructions from the opening bank or can advise the LC to the beneficiary, without any liability on its part. This bank has no obligation to negotiate the document.

3. Beneficiary:

The party to whom the credit is addressed i.e. seller or the exporter or the supplier of the goods. It gets payment against documents as per LC from the nominated bank within validity period of negotiation maximum 21 days from date of shipment.

4. Negotiating bank:

The bank to whom the beneficiary presents the documents for negotiation. It claims payment from the reimbursing bank or opening bank and gets 5 banking days to check the documents.

5. Reimbursing Bank:

Third bank which repays, settle or funds the negotiating bank at the request of its principal, the issuing bank.

6. Confirming Bank:

The bank adding confirmation to the credit, which undertakes the responsibility of payment by the issuing bank and on his failure to pay the confirmation, is added on request of the opening bank.

7. RED CLAUSE LC:

It refers to a packing or anticipatory credit where in a clause is incorporated in LC permitting the correspondence Bank in the exporter’s country to grant advance to beneficiary at the issuing bank’s responsibility. The PCL shall be adjusted out of the proceeds of the bill negotiated.

A GREEN CLAUSE LC:

It permits the advances for storage of goods in a warehouse in addition to pre-shipment credit. It is an extension of the red clause LC.

PRECAUTIONS TO BE TAKEN

BACKGROUND

The monitoring of non-fund based facilities is as important as the monitoring of fund-based facilities for controlling and monitoring of the credit risk of the borrower on whose behalf the non-fund based facilities are granted.

GUIDELINE

The important points to be observed and complied with in regard to monitoring of non-fund based facilities are outlined below:

LETTERS OF CREDIT

RESTRICTIONS ON OPENING OF LETTERS OF CREDIT

Some of the important restrictions that have to be kept in mind while opening LCs are listed below for ready reference:

a. Branches should not open LCs bearing the ‘without recourse’ clause.

b. No LC shall be opened to facilitate drawing of accommodation bills.

c. Branches should not open LCs on behalf of the frontal firms/ companies floated in the name of employees of the promoters or opening LCs in favour of such firms.

d. Letter of credit should not normally be opened for customers who do not enjoy credit facilities with the Bank.

e. LC facility sanctioned for working capital should not be used for opening LC for import of capital goods. Letter of Credit (Inland/ Import), for capital goods should be considered only if funds are arranged for retirement by sanction of Term loans wither by our own bank OR against Term loans sanctioned by other financial Institutions provided the concerned FIs issues Letter of Comfort in favour of our Bank i.e. they undertake to remit the amount directly to the Bank to honour the obligations.

f. No onerous clause detrimental to the interest of the Bank shall be incorporated in the Letter of Credit.

PRECAUTIONS TO BE OBSERVED WHILE OPENING LETTERS OF CREDIT

a. The commodity for which the LC is being opened should be consistent with the known trade practice of the borrower.

b. Opening of LCs for commodities which have hitherto been not dealt by the customer should be with the consent of the respective sanctioning authority only.

c. Verification of underlying commercial transactions such as sale/purchase contract, the quantity and value of transaction, payment terms, the mode of transport, etc.

d. Details of the beneficiary of the LC must be ascertained such as –

i. In case of frequent LCs being opened in favour of single beneficiary or in case of large value LC, CR from the beneficiary’s banker/CIBIL report should be obtained.

ii. Whether the beneficiary is regularly dealing in the items for which LC is being opened

iii. Whether the beneficiary is related to the opener or its subsidiary/front company.

iv. LCs in favour of sister concerns should not be normally opened by the Branches and wherever the same are required to be opened for genuine trade transactions, necessary approval should be obtained from the respective sanctioning authority.

v. In case LC facility is sanctioned under delegated powers of Branch Incumbent, approval for opening LC favouring sister concern should be obtained from Regional Office.

e. The entire cycle from opening of LC by Bank to the negotiation of the bills by the beneficiary’s banker and advising of the due date by our Bank should have a reasonable time lag. Special attention should be paid so as to have time for the execution of the intermediate stages between opening of the LC and negotiation of documents so as to ensure the genuineness of the transaction in all such cases.

f. In case of DA LCs, the cash flow of the transaction must be studied closely. The LC opener gets sufficient time to process/sell the goods and realize the sale proceeds thereof. As such, it must be ensured that sufficient funds are available for retirement of bills on the due date without devolving on the Bank. This could be either by way of –

i. Banking arrangement for fund based working capital facilities duly assessed and sanctioned either from our Bank or other bank.

ii. Build up of margin by progressively depositing sale proceeds regularly in their accounts with us.

- Where a customer enjoys working capital credit facilities with some other bank, the reasons for his approaching the bank for sanctioning L/C limits have to be clearly stated. A reference to the existing banker of the customer should invariably be made.

- The request of customer for sanctioning and opening of letter of credit should be properly scrutinised to establish the genuine need of the customer. The customer may be, required to submit a complete loan proposal including financial statements to satisfy our bank about his needs and also his financial resources, to ensure retirement of bills on the due date.

- Branches must satisfy themselves about retirement of bills received under LC by stipulating adequate margin or by a back up support of the credit facility approved in their favour. Liquidity aspect of resources available for retirement of bills must be kept in mind.

- LCs should not be issued for amounts out of proportion to the borrowers' genuine requirements. These may be opened only after ensuring that the borrowers have made adequate arrangements for retiring the bills received under LCs out of their own resources or from the existing borrowing arrangements;

- The branches shall obtain an undertaking from the borrower(s) that in respect of transactions relating to the import LCs, the borrower will undertake to bear exchange fluctuations risk, if any, and will arrange for necessary forward cover, whenever called upon to do so by the bank.

- The branches shall obtain an undertaking from the borrower(s) to comply with all the exchange / import trade control regulations of RBI in respect of the imports under the import LC limit.

- LCs should be issued under joint signatures of the Bank’s authorised officials in the approved format only.

PRECAUTIONS FOR OPENING REVOLVING LC

a. In case of Revolving LC, reinstatement clause be suitably worded and in no case it should be automatic.

b. No revolving LC be issued without re-instatement clause.

c. The reinstatement should only be permitted after a written confirmation from LC opening branch is received and liability against bills already negotiated is cleared by the applicant.

BANK GUARANTEE

MONITORING OF PERFORMANCE BANK GUARANTEESISSUED BY THE BRANCHES ON BEHALF OF OUR BORROWERS/CLIENTS

Purpose of issuing Performance Bank Guarantees

a. Performance Bank Guarantees are issued guaranteeing due performance of contract or obligation of the Borrower under the contract. In the event of non-performance of obligation in terms of contract the bank assumes monetary liability upto the amount specified in the Guarantee. Some of the purposes for which Bank Guarantees are issued are:

i. Due performance of a specific contract undertaken by a customer in favour of Govt. bodies / Others - for e.g. supply of materials, Construction of Roads, Buildings Dams, Civil Work, etc.

ii. To secure any claims by the buyer on the seller arising from default in delivery or performance of the terms of the contract (e.g. construction, assembly, execution).

iii. Due performance of an equipment/project after completion for a specific period due to possible defects appearing after delivery during warranty period of the equipments.

iv. Execution of Long Term Infrastructure Projects such as Seaports, Airports, Road Construction, Bridges, Sanitation and Sewerage Projects, Telecommunication Services, Construction of Educational Institutions and Hospitals, Generation/ Transmission/ Distribution of Power, etc.

b. Monitoring of Performance Bank Guarantees issued

c. It is very important that Performance Bank Guarantees issued by the Branches are monitored closely. The action to be taken would depend on the circumstances and gravity of the case.

SOME OF THE STEPS ARE BEING DETAILED HEREUNDER:

Area of Monitoring

Action to be taken by Branches and ROs

Bank Guarantees issued in case of Infrastructure Projects for executing the project for long duration beyond 3 years

a. Branch should scrutinize the Contract for which the Bank Guarantee has been issued regarding the time lines specified and conditions laid in the contract by the beneficiary whose fulfilment by the borrower is crucial.

b. Performance by our Borrower in executing the Contract / Job has to be tracked so that on a periodic basis it can be ascertained that the borrower is performing the job as per schedule

c. Confirmation reports from the borrower regarding the progress in execution of the contract may be obtained at quarterly intervals

Delay noticed in executing the project.

a. In case any delay is noticed the reasons for the same should be immediately ascertained and the chances of the Bank Guarantee being invoked should be assessed.

b. Discussions should be held with the borrower for corrective course of action. Detailed letter should be obtained from the borrower about the same.

c. The branch should immediately report the delay noticed to the Sanctioning authority and appraise the progress from time to time.

In case of Consortium Banking / Multiple Banking

a. Other Co-lenders should be kept apprised.

b.In case Bank Guarantees have been invoked with other Co-lenders the same should be taken on record and informed to the sanctioning authority.

c. Periodic exchange of information as prescribed for Consortium Banking / Multiple Banking should be ensured

In case the Bank Guarantee is for Mobilisation advance

a. The utilization of funds by the borrower should be tracked along with the billing for the work done by them.

b. Quarterly progress reports should be obtained from the Borrower

Issuance of further guarantees on behalf of the client

The sanctioning authority shall decide on this based on the circumstances and gravity of each case

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