What Is a Usance Letter of Credit and How Does It Work?

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A Usance Letter of Credit (LC), also known as a deferred payment LC, is a trade finance instrument that allows the buyer (importer) to pay the seller (exporter) after an agreed-upon credit period. Unlike a Sight LC, which requires immediate payment upon document verification, a Usance LC provides a delay, typically 30, 60, 90, or 180 days, giving the buyer time to generate funds or sell the goods before settling the payment.

Key Features of a Usance Letter of Credit

  1. Deferred Payment: Payment is made after the credit period specified in the LC.
  2. Document-Based: Payment depends on the presentation of compliant trade documents.
  3. Bank Guarantee: The issuing bank guarantees payment to the seller after the deferred period.
  4. Predefined Credit Period: The time frame for payment is agreed upon in advance between the buyer and seller.

How Does a Usance Letter of Credit Work?

Here’s the step-by-step process:

  1. Trade Agreement:
    • The buyer and seller agree to use a Usance LC as the payment method.
    • The seller grants the buyer a credit period, allowing deferred payment.
  2. Issuance of Usance LC:
    • The buyer requests their bank (issuing bank) to issue a Usance LC in favor of the seller.
    • The LC specifies the credit period and required documents (e.g., bill of lading, invoice, packing list).
  3. Notification to the Seller:
    • The issuing bank transmits the Usance LC to the seller’s bank (advising bank), which informs the seller.
  4. Shipment and Documentation:
    • The seller ships the goods and submits the required documents to the advising bank.
  5. Document Verification:
    • The advising bank and issuing bank verify that the documents comply with the LC terms.
  6. Acceptance by Issuing Bank:
    • The issuing bank provides an acceptance notice to the seller, confirming that payment will be made after the credit period.
  7. Payment at Maturity:
    • At the end of the agreed credit period (e.g., 60 days), the issuing bank pays the seller, and the buyer reimburses the bank.

Example of a Usance LC Transaction

  • Scenario:
    A machinery supplier in Germany ships equipment to a construction company in India. The Indian buyer requests a 90-day Usance LC to manage their cash flow.
  • Process:
    • The German supplier ships the machinery and submits the documents to their bank.
    • The Indian buyer’s bank guarantees payment after 90 days, allowing the buyer to generate revenue from the project before making the payment.

When Should Usance Letters of Credit Be Used?

  1. Buyers Requiring Extended Payment Terms:
    • Buyers with cash flow constraints or longer sales cycles benefit from deferred payment.
  2. Large-Value Transactions:
    • Usance LCs are ideal for high-value goods where immediate payment may be challenging for the buyer.
  3. Trusted Trade Relationships:
    • Often used when the seller trusts the buyer or has confidence in the issuing bank’s guarantee.
  4. Exporters Seeking Payment Security:
    • Sellers get a bank’s commitment for future payment, reducing their risk.

Advantages of Usance Letters of Credit

For Buyers (Importers):

  1. Flexible Cash Flow:
    • Allows buyers to sell the goods and generate revenue before payment.
  2. Improved Liquidity:
    • Reduces the immediate burden of payment, especially for large transactions.
  3. Risk Mitigation:
    • Ensures goods are shipped before any payment commitment.

For Sellers (Exporters):

  1. Guaranteed Payment:
    • Bank guarantees payment at the end of the credit period.
  2. Supports Larger Orders:
    • Encourages buyers to place larger orders due to deferred payment terms.
  3. Option to Discount Receivables:
    • Sellers can use the accepted LC to obtain early payment by discounting it with their bank.

Potential Disadvantages

  1. For Buyers:
    • Interest or fees may apply for the deferred payment period, increasing costs.
    • Requires trust in the issuing bank’s reliability.
  2. For Sellers:
    • Delayed payment can impact cash flow if not discounted.
    • Risk of discrepancies in documents leading to delays.

Comparison: Usance LC vs. Sight LC

FeatureUsance LCSight LC
Payment TimingDeferred after a credit periodImmediate upon document approval
Buyer’s BenefitTime to arrange funds or sell goodsNone
Seller’s BenefitGuaranteed payment at a future dateImmediate payment certainty
CostMay involve interest/charges for deferralHigher processing fees

Documents Required for a Usance LC

  • Commercial Invoice.
  • Bill of Lading or Airway Bill.
  • Packing List.
  • Certificate of Origin.
  • Inspection Certificate (if required).
  • Insurance Certificate (if applicable).

A Usance Letter of Credit is a powerful trade finance tool that balances the needs of both buyers and sellers. Buyers benefit from deferred payment, giving them flexibility to manage their cash flow, while sellers gain security through a bank’s guarantee of future payment. By facilitating smooth and secure trade transactions, Usance LCs play a critical role in international commerce.

What Are Sight Letters of Credit, and When Should They Be Used?

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