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Guide to understanding Usance Letter of Credit

A Usance Letter of Credit offers a predetermined credit period to the importer for hassle-free exports. In this blog, learn more about the need, process and format of a Usance LC.

Financial transactions are a critical part of any import-export process and agreement. As international payment might take long to be completed, it can delay the entire transportation process incurring losses to traders. Therefore, most importers request a bank to act as a trusted intermediary between the two parties to ensure transaction are fulfilled. Importers request the respective bank to guarantee payment through a Letter of Credit to the supplier to ensure that the shipment is not delayed. In such cases, the exporter’s bank verifies the LC before the goods are shipped.

As there is a substantial gap between document submission from importers and payment processing, importers receive a grace period of 30, 60 or 90 days as per the terms in the LC. To reduce this payment waiting period of 30-90 days, a Usance LC or Sight LC is used. It provides a predetermined credit period to the importer.

What is a Usance LC?

A Usance Letter of Credit is used in trade finance process, where the issuing bank (importer’s bank) guarantees the confirming bank (exporter’s bank) to make the payment by a present date. Once the importer and exporter agree on a sale contract, importer usually requests the issuing bank to provide them with a Usance Letter of Credit to secure the transaction. The exporter also nominates a bank (confirming bank) to receive and approve the term of Usance LC sent by the issuing bank.

The importer and exporter negotiate terms of trade such as description of sold goods and delivery date. If the confirming bank approves Usance LC, the issuing bank then pays to the confirming bank on the decided date once the importer presents the relevant documents¹.

What is the need for a Usance LC?

In international trade, the supplier or shipper receives the payment and proceeds to ship the cargo. In that case, the importer must pay the exporter before receiving the shipment. Unlike other Letters of Credit, a Usance LC offers a deferred payment option to the importer. The importer receives interest-free capital and goods before paying the exporter. The Usance Letter gives the importer a grace period to make the payment².

How does a Usance LC work?

There are four parties involved when a Usance LC is used – importer, exporter, issuing bank and confirming bank. Here is the commonly preferred step-by-step process of how a Usance LC works:

1. The importer contacts an exporter, receives a quotation for goods and confirms the deal.
2. The importer then contacts the issuance bank (usually, a bank that has already offered them a line of credit) and requests for a Usance LC.
3. After verifying the importer’s creditworthiness, the bank issues a Usance LC and sends it to the exporter’s bank.
4. The exporter’s confirming bank informs the exporter and sends the Usance LC with trade terms and conditions.
5. The exporter verifies the terms and if he agrees with them, ships the goods to the importer and submits the necessary shipping documents to the confirming bank.
6. The confirming bank then verifies the documents and transfers them to the issuing bank of the importer.
7. The issuing bank notifies the importer about the received documents and asks them for the full payment to receive shipment delivery.
8. The importer verifies documents and makes payments. Then, the issuing bank sends payment to the exporter’s bank and the exporter receives the payment.

Example of Usance LC

Importer 'A' residing in the UK plans to buy goods worth $65,000 from 'B', an exporter based in India. B wants to use Letter of Credit for payment as he wants to reduce risks. A requests a Usance Letter of Credit as he wants a credit period of 60 days to make the payment for the goods. B agrees and A applies for a Usance LC of $65,000 in the name of B. Similarly, B nominates a bank in India as his advising bank.

Following is the sequence of transaction between the two parties:
On April 1 2019, as per A’s application, the issuing bank issues a Usance LC $65,000 towards B and sends it to the confirming bank. The terms of the Usance Letter mention ‘payment of $65,000, 60 days from the date of Bill of Lading.’

The confirming bank forwards it to B to verify and accept the terms. On June 1 2019, B manufactures and ships goods worth $65,000 to A. A receives the BOL on June 2 2019. On June 10 2019, B submits the shipping documents like packing list, BOL and invoice with the original LC from the confirming bank. The bank verifies documents and sends them to the issuing bank, which receives and verifies the document and forwards it to A, who accepts the documents on June 17, 2019.

Despite receiving the document, he still has 60 days from the BOL date to make the payment (60 days from June 2, 2019). A receives the shipment on July 5 and checks the quality. On July 28, A makes the payment of $65,000 to the issuing bank. The bank transfers the payment to the confirming bank in India. The bank deducts their advising charges and transfers the money to B.

The above-mentioned example is fictional and has been used for illustration purpose only*.

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More blogs on Letter of Credit

1. Letter of Credit at Sight: Meaning, process and its benefits

2. What is a Transferable Letter of Credit?

3. Irrevocable Letter of Credit: Meaning, process and benefits

4. Green Clause Letter of Credit: Definition, example and features

5. Documentary Letter of Credit: Overview and working

6. Revocable Letter of Credit: Everything you need to know about its uses

7. Red Clause Letter of Credit: Meaning, example and types

8. Standby Letter of Credit (SBLC): Overview, process and types

9. What is Letter of Credit?

10. Revolving Letter of Credit: Overview, meaning and process

11. Back to Back Letter of Credit: Overview, meaning and process

Published on October 29, 2022.

Sources:
1. https://www.tradefinanceglobal.com/posts/usance-letters-of-credit-what-are-they/
2. https://efinancemanagement.com/working-capital-financing/usance-letter-of-credit
3. https://www.dripcapital.com/en-in/resources/blog/sight-lc-letter-of-credit

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*Map not to scale. The map has been used for design and representational purpose only, it does not depict the geographical boundaries of the country. These do not conform to the external boundaries of India recognized by the Survey of India.

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