What is Usance Letter of Credit (LC)?

A Usance Letter of Credit (LC) is a financial instrument commonly used in international trade transactions to facilitate the purchase of goods between a buyer (importer) and a seller (exporter). Unlike a Letter of Credit at Sight, which requires immediate payment upon presentation of documents, a Usance LC allows the buyer a specified period, known as the usance period, to make payment after the goods have been delivered and the necessary documents have been presented.

Here's how a Usance LC typically works:

Agreement: The buyer and seller agree on the terms of the transaction, including the usance period (the time allowed for payment) and other relevant conditions.

LC Issuance: The buyer approaches a bank to issue a Usance LC in favor of the seller. The LC outlines the terms and conditions of the trade, including the usance period.

Shipment and Documentation: The seller ships the goods and prepares the required shipping documents, such as the bill of lading, commercial invoice, and other relevant paperwork. These documents are then presented to the buyer's bank.

Usance Period: The buyer, upon receiving the shipping documents, has a specified period (the usance period) within which to make payment to the issuing bank. The usance period is negotiated and agreed upon between the buyer and seller during the initial transaction.

Payment: Once the usance period expires, the buyer is obligated to make the payment to the issuing bank. The bank, in turn, transfers the funds to the seller's bank, and the seller receives the payment.

Key Characteristics of Usance LC:

Deferred Payment: Unlike a Sight LC, where payment is immediate, a Usance LC allows the buyer to defer payment until the agreed-upon usance period expires.

Negotiable Terms: The usance period is negotiable and can vary depending on the agreement between the buyer and seller. Usual usance periods range from 30 to 120 days.

Flexibility: Usance LCs provide flexibility to buyers by giving them time to inspect the goods before making payment.

Financing Tool: Usance LCs can be used as a financing tool for the buyer, allowing them to use the credit period to generate income from the purchased goods before making payment.

Understanding the Mechanism of a Letter of Credit at Sight

A Letter of Credit at Sight (LC) is a financial document provided by a third-party to guarantee the payment of goods in transit. This instrument outlines specific conditions for the release of funds, involving documentation such as proof of shipping and relevant bills. The designated bank is granted a stipulated period, typically not exceeding five working days, to fulfill the payment.

Step-by-Step Procedure of a Sight LC:

The importer in need of goods initiates contact with the exporter to finalize the transaction and obtain an estimate.

The importer, often having a pre-established line of credit, approaches a bank to issue a Sight LC.

Following an assessment of the importer's creditworthiness, the bank issues a Letter of Credit at Sight and forwards it to the exporter's bank.

The exporter's bank notifies the importer, providing the LC along with the terms and conditions of the trade.

Upon the exporter's satisfaction with the LC, goods are shipped, and shipping paperwork is submitted to the exporter's bank.

The bank processes the paperwork and sends it to the importer's bank.

The importer is informed by their bank that the paperwork has arrived, and full payment is required to collect the documents, necessary for product delivery.

After reviewing the paperwork, the importer pays for the LC, and their bank transfers the funds to the exporter's bank.

Significance of an LC at Sight:

A Letter of Credit at Sight offers mutual protection for both the importer and exporter in a transaction, providing various benefits:

Effective Working Capital Management for Exporters: Enables exporters to manage working capital efficiently by receiving payments as soon as the shipment is underway.

Short Payment Terms: Ensures early payment to exporters, as opposed to credit terms that may extend between 15 and 90 days.

Competitive Edge for Importers: Importers, not requiring a credit period, can negotiate favorable rates and conditions during trade, gaining a competitive advantage.

Example of LC at Sight:

Consider an international business (A) importing a million product bottles from a manufacturing business (B) in India. To mitigate risks, both parties opt for an 'LC at Sight.' The importer's bank issues the LC, and the transaction proceeds smoothly following the agreed-upon terms.

Format of LC at Sight:

Key details included in an LC at Sight encompass the importer's bank details, exporter details, issuance date, particulars of the importer, and specifics of the trade transaction, all authenticated with the signature of a bank official.

Distinguishing LC at Sight from Usance LC:

While a Sight LC necessitates immediate payment, a Usance LC allows the importer a predetermined grace period post-delivery, typically between 30 to 120 days.