How to open a letter of credit?

Whatever sector you might be located, you may have to open a letter of credit throughout your professional career one day. Letter of credit is a payment method in international trade which is used by almost all sectors from textile to machinery, food manufacturing to construction, oil trading to customer goods. You may assume that there are big differences exist on letter of credit application process for all these different sectors. But this is not correct. You have to follow similar procedures when opening a letter of credit regardless of the sector you may be located. ( please keep in mind that oil sector uses letters of credit which have different characteristics and features. )  

Who opens the letter of credit ?

Issuing banks are opening letters of credit according to the instructions they have received from the importers.  We can say that letters of credit are opened by importers' bank in favor of the exporters according to the instructions they have received from the importers. Importers define conditions of the letters of credit.

Step-by-step procedures to open a letter of credit :

Step 1 : Importers who are called as applicants play a key role in letters of credit transactions from start to end. Please keep in mind that I will be explaining letter of credit issuance process through the eyes of the importers. Let me start explaining the letter of credit issuance process. At the very first step as an importer I need to find myself a supplier. Then I need to sign a sales contract with my supplier. On the sales contract I should be indication terms and conditions of the sale including all import and export procedures such as delivery term, FOB New York Port Incoterms 2010, description of goods, delivery date, price and quantity of the goods, package type, insurance coverage, legal details etc.. Remember I can use a proforma invoice instead of a sales contract. 

PS : Some practicer think that letter of credit is a kind of sales contract. But this is false. Letter of credit is not a sales contract. Actually, letter of credit is an independent structure from the sale or other contract on which they may be based. Therefore, it should be keep in mind that a good sales contract protects the party, which behaves in goodwill against various kinds of risks. 

Step 2 : After I sign the sale contract with my supplier, as an importer (remember importer is the applicant of the lc transaction) I have to apply to my bank to have the letter of credit opened in favour of my supplier. I have to make sure that letter of credit application must be in accordance with the terms of the sales agreement. 

Step 3 : Now I am at the bank. I am telling my customer service representative that I would like to open a letter of credit. She informs me that I need to fill an application form which is called "Letter of Credit Application Form" or "Documentary Letter of Credit – Application From". She told me that some banks use electronic lc application forms whereas some of them still using hard copies. But she also informs me that all these lc application forms are similar to each other whether they are offline or online. Because they follow the swift message body of issuance of letter of credit. Banks use MT 700 - Issue of a Documentary Credit swift messages when issuing a letter of credit. 

After filling the letter of credit application form my customer representative request me attach proforma invoice or sales contract. I think they demand such these documents just to make sure that my letter of credit application form reflects the correct data stated on the proforma invoice. Sometimes banks also make reference to proforma invoice number on the letter of credit texts as well. But this is not a good banking practice according to lc rules.

Step 4 : At this stage banks will evaluate my letter of credit application. If they decide to issue a letter of credit on my behalf than they would like to secure their payment obligation from myself. My bank will be checking my line of credit and compare it to the amount of my letter of credit application total. If my line of credit is above the letter of credit amount than my bank will issue the lc without any additional assurance.  On the other hand if my bank finds me untrustworthy than they may demand %100 letter of credit amount plus lc issuance charges to be put into my account with them as a security. 

Step 5 : On this stage it would be a good idea to have a draft l/c from my bank. Draft lc will be in swift message format and reflects every detail of final lc. The good thing is that I can send draft lc to my supplier and have it checked before it will be issued. Once draft lc will be confirmed by my supplier I can give final approval to my bank for the issuance of the lc. 
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How to open a letter of credit?
We discuss how to open a letter of credit | lc application process on this page in detail. Also you can find related terms in regards to letter of credit application process such as letter of credit application form, draft lc, mt 700 issue of a documentary credit swift message.

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