A Green Clause Letter of Credit is an advance payment offered by the issuing bank to guarantee exporters with payment. Learn about its features and benefits.
International trade between importers and exporters requires mutual trust, especially for payments. More often than not, a trade transaction (from agreement to delivery) might span across a few months. Hence, it is important to plan and agree upon a payment method that suits both the parties. This is where a Letter of Credit helps.
A Letter of Credit is a legal document provided by a bank or a financial institution, that guarantees that the exporter will be paid the full and correct amount on time. The issuing bank acts as a mediator between the parties and provides the exporter with an advance payment or guarantee of payment from the importer.
What is a Green Clause Letter of Credit?
A Green Clause Letter of Credit is an advance payment offered by the issuing bank to guarantee exporters with payment. As the Green Clause LC is an extension of a Red Clause LC, it is essential to understand the relevance between the two.
A Red Clause Letter of Credit acts as an advance payment. Under this LC, the issuing bank makes an advance payment to the exporter to support by providing working capital (indirectly) to buy raw materials and pay for the processing and packaging of goods to be exported. On the other hand, a Green Clause Letter of Credit not only pays for processing, packaging and raw materials, but also ensures payment for pre-shipment warehousing at the origin port and other insurance expenses. This type of LCs is only granted after the purchased goods are securely stored in the bonded warehouses at the origin port. These Letters of Credit are commonly used for trade transactions of consumables like rice, wheat, gold, etc1.
Features of a Green Clause Letter of Credit
Following are some of the features of Green Clause LC:
• Extends offering of Red Clause LC with additional benefits like coverage of insurance costs and pre-shipment warehousing. • Offers 70 - 80% of the original credit amount, which is significantly more than Red Clause LC, which offers only 20 - 25%. • Empowers exporters and manufacturers by boosting their working capital. • Involves collateral – if the exporter defaults on payment, the collateral will be collected by the banks to compensate for the credit amount. • Enables importers to receive better offers and discounts from exporters.
What are the documents required for a Green Clause Letter of Credit?
Some of the documents involved in a Green Clause Letter of Credit are:
Once the agreement is finalized, the exporter requests for payment from the importer, who then approaches the issuing bank to issue a Green Clause Letter of Credit that mentions the terms and conditions mentioned in the trade agreement between the parties. According to the Green Clause LC, goods to be exported must be stored in a bonded warehouse. Once the bank receives the documentation that ensures goods are stored in the warehouse, it issues a Letter of Credit. Then, the bank pays advance payment to the exporter.
Example of a Green Clause Letter of Credit
Here is an example of a Green Clause LC: Business A is buying premium wheat worth $100 from Business B in India. B requests A to issue a Green Clause LC with an advance payment of $75 (75% of LC value). A agrees and applies for a Green Clause Letter with its bank.
The above-mentioned example is fictional and has been used to explain the concept.
Advantages and disadvantages of Green Clause LC
• Exporters receive cash flow solutions through advance payment. • Importers can be assured of goods as the facilitator issues a confirmation receipt of goods in the warehouse. • It allows importers to determine the portion of advance payment and nature of the payment series. • The documentary credit and advance payment provide exporters with a financial guarantee. • As the LC covers on-port warehousing, it relieves the exporters from problems involved in pre-shipment storage. • It helps create long-term and trustworthy relationships between exporters and importers.
• They are more expensive than other LCs. • Importers need to hire a collateral manager if a new trade deal involves a Green Clause LC. • Once advance payments are approved, there cannot be changes even if exporters need more funds. Hence, they lack the flexibility required for international trade. • Exporters may need to offer discounts.
A Green Clause Letter of Credit benefits both exporters and importers – as it provides financial guarantee to an exporter, and allows the importer to negotiate better trade terms to get discounts.
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What is the difference between Red and Green Clause Letters of Credit?
Two major differences between a Red Clause LC and Green Clause LC are: • Green Clause LC extends offering of Red Clause LC with additional benefits like coverage of insurance costs and pre-shipment warehousing. • It also offers 70 - 80% of the original credit amount, which is significantly more than Red Clause LC, which offers only 20 - 25%.
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