Is a Bank Letter of Credit the same as a Line of Credit?
The answer to this question is a categorical no. A Bank Letter of Credit is a financial instrument and Line of Credit is a bank loan facility. All banks, whether here in Geneva, London, New York or Singapore will confirm these two items are completely different.
Bank Letter of Credit
A Bank Letter of Credit or Documentary Letter of Credit is a financial instrument issued by a bank. It is a means of payment and is issued only upon receipt of instructions from a banks’ client.
A Documentary Letter of Credit can be either revocable or irrevocable – revocable is very rarely utilised in today’s world of finance. Irrevocable means not capable of being changed or cancelled without all the party’s agreement.
A Documentary Letter of Credit is one of the mainstays of global trade. Without a Documentary Letter of Credit world trade would not grind to a halt, but would become exceedingly slow.
A Documentary Letter of Credit is defined as a bank’s irrevocable promise to pay the seller/exporter on behalf of the buyer/importer. The bank will only pay if the seller complies with all the terms and conditions of the Documentary Letter of Credit.
How does a Documentary Letter of Credit Work?
Under a Documentary Letter of Credit (DLC), a seller may be paid a specific sum in an agreed currency by a bank. The seller must submit all the required documentation as defined by the terms and conditions contained within the DLC. A DLC is all about documents pertaining to the export of goods.
The issuing/buyers bank will transmit the DLC to the seller’s bank, who will forward a copy to the seller. The seller will then get all the documents together to present to their bank.
Once all the terms and conditions have been satisfied the bank will pay the seller. The goods will be shipped to the buyer. The seller’s bank will seek reimbursement from the buyer’s bank. The buyers bank in turn will claim the same from the buyer.
The following is an example of the types of documentation required by a DLC,
- Bill of Exchange or Draft
- Airway Bill (if air freight)
- Road Transportation Document (if road freight)
- Bill of lading
- Pro Forma or Commercial Invoice
- Insurance Policy and Certificate
- Certificate of Origin
- Inspection Certificate
- Packing List
Many of these documents will be required to be presented in quadruplicate or triplicate, sometimes even more. This is essentially how a Documentary Letter of Credit works. It is completely different to a Line of Credit.
What is a Line of Credit?
A line of credit is a loan facility offered by a bank to their clients. A line of credit is mainly offered to a bank’s corporate clients. It is seldom offered to individuals or private clients.
There are two types of lines of credit:
The first is a Secure Line of Credit. This is where the bank demands security or collateral from the client in return for a line of credit. Security can take many forms such as charge over floating and fixed assets, a charge on the company’s shares and/or personal guarantees from the directors of the company.
The second is an unsecured Line of Credit. This is where the bank takes no security whatsoever as a company will have an extraordinarily high creditworthiness. However unsecured corporate lines of credit are very rare.
How is a Line of Credit utilised?
A line of credit is not used to cover a single item loan. Typically, it will cover many facets of the business. If a company is an importer, they may need loans for Documentary Letters of Credit. If they are expanding then loans for factory expansion may be required.
Essentially a line of credit will allow a company to invest in different parts of the business. It will also allow the lender to see if the borrowings are being spent as per the agreement. It is interesting to note that a line of credit can fund a Documentary Letter of Credit. It is the only time the two will complement each other.
Please read – Important
Around the world banks are denying businesses of credit facilities, potentially limiting opportunities of expansion. Here at IntaCapital Swiss, we have been successfully offering Collateral Transfer to clients for over a decade. Our globally popular Collateral Transfer Facility utilises “leased” Demand Bank Guarantees…
Demand Bank Guarantees are the only guarantees that can be monetised. Once monetised they can be offered as collateral for lines of credit. Collateral Transfer whilst not new, offers companies access to loans and lines of credit.
If your business is suffering pandemic cash flow problems or finding itself being rejected by banks. Then please contact us today, via our online enquiry form.