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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. Learn more about its process and need in the blog.

Financial transactions are a critical part of any import-export process. To protect against non-payment or non-delivery, traders often utilize a letter of credit — a legally binding financial instrument issued by banks to ensure that timely payment is made for shipped goods. Under this arrangement, if the importer is unable to complete the payment, the importer’s bank (also known as the issuing bank) will pay the exporter the full or remaining amount on behalf of the importer.¹

A usance letter of credit is a specific type of letter of credit often used in trade finance to extend a predetermined credit period to the importer.²It serves a specific function in international trade and is different from a sight letter of credit.

What is a Usance LC?

A usance letter of credit, also known as a deferred letter of credit is used in the trade finance process, where the issuing bank (importer’s bank) guarantees the confirming bank (exporter’s bank) that the payment will be made by the preset date. Once the importer and exporter agree on a sale contract, the importer usually requests the issuing bank to provide them with a usance LC to secure the transaction.³The exporter also nominates a bank (confirming bank) to receive and approve the terms of the usance LC sent by the issuing bank.

The importer and exporter negotiate terms of trade, such as the description of sold goods and the delivery date. If the confirming bank approves the usance LC, the issuing bank pays the confirming bank on the decided date once the importer presents the relevant documents.⁴

What is the need for a Usance LC?

Letters of credit are used to build trust among trading partners and guarantee payment to the exporter upon shipment of goods. Unlike other letters of credit, a usance LC offers a deferred payment option to the importer. A usance LC will specify the maturity period and the actual payment date. The tenor is typically set at a certain number of days after the bill of lading date or after sight. This means that the importer does not have to pay the exporter immediately for a transaction, which makes cash flow management easier and frees up working capital that the importer can use in other aspects of their business. In certain cases, a usance LC may also allow the buyer to receive delivery of the goods and evaluate its condition before making payment.⁵

How does a Usance LC work?

Here is a step-by-step process of how a usance LC works:

1. The importer and the exporter agree upon a sale contract and decide to use a letter of credit to secure the transaction.
2. The importer nominates a bank (issuing bank) and the exporter nominates their own bank (confirming bank).
3. The importer and the exporter negotiate the terms of the deal, including delivery date and description of goods.
4. If the importer requests for a usance letter of credit, both parties will determine a preset date for payment. The payment due date is usually after the bills of lading are confirmed after shipment, or when the issuing bank receives confirming documents.
5. Once the goods are shipped, the exporter sends the letter of credit to the confirming bank.
6. The confirming bank verifies the documents and sends them to the issuing bank.
7. The importer and the issuing bank verify and confirm the documents.
8. The issuing bank must pay the confirming bank within the time period mentioned in the usance letter of credit. The issuing bank also deducts an advising fee for itself.
9. The exporter will receive the payment as per the due date. If they wish to receive the payment sooner, they can choose to negotiate payment discounting. In this case, the confirming bank releases the payment to the exporter ahead of the payment due date after deducting a greater percentage fee for itself.⁶

Example of Usance LC

Importer A, residing in the UK, plans to buy goods worth $xxx from B, an exporter based in India. B wants to use a 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 $xxx in the name of B. Similarly, B nominates a bank in India as his advising bank.

Following is the sequence of transactions between the two parties:

1. On April 1, 2019, as per A’s application, the issuing bank issued a usance LC of $xxx towards B and sent it to the confirming bank. The terms of the usance letter mention ‘payment of $xxx, 60 days from the date of bill of lading.’The confirming bank forwards it to B to verify and accept the terms.
2. On June 1, 2019, B manufactured and shipped goods worth $xxx to A.
3. A received the BOL on June 2, 2019.
4. On June 10, 2019, B submitted the shipping documents, including the packing list, BOL, and invoice with the original LC from the confirming bank.
5. The bank verifies the 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).
6. A received the shipment on July 5, 2019 and checked the quality.
7. On July 28, A made the payment of $xxx to the issuing bank. The bank transferred the payment to the confirming bank in India. The bank deducted their advising charges and transferred the money to B.⁷

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

Difference between usance LC and sight LC

A usance LC allows the importer to make the payment at a predetermined date after the conditions of the sale are fulfilled and the confirming documents are presented. This is different from a sight LC where payment needs to be made immediately after the confirming documents are submitted.⁸

Conclusion

In conclusion, a usance letter of credit is an important financial instrument in international trade. It offers exporters a guaranteed payment mechanism and provides importers with a deferred payment option that enhances their cash flow and reduces transaction risk.

It is crucial to note that any error or noncompliance with the terms of a usance letter of credit might result in payment disputes and delays. This may be particularly disruptive for e-commerce exporters whose business models depend on swift and reliable transactions. To avoid complications and receive expert assistance with export compliance and documentation, exporters can leverage the tools and services offered by e-commerce export programs like Amazon Global Selling.

Amazon Global Selling: Easy e-commerce exports from India

Amazon Global Selling is an e-commerce export program that helps Indian exporters expand their businesses to 18+ international marketplaces like the USA, the UAE, the UK, Australia, and more. Without having to set up a physical store or warehouse abroad, Amazon’s simple registration process and hassle-free logistic support help you reach global customers in a seamless manner.

Frequently Asked Questions

How long is the repayment grace period for a usance letter of credit?

The payment period for a usance letter of credit varies and could be anywhere between one to four months.⁹

When is a usance letter of credit used?

A usance letter of credit is used in international trade transactions when the importer and exporter agree on a deferred payment arrangement. A usance LC provides the importer with a specific credit period (usually 30, 60, or 90 days) to make the payment, provided that all documentary requirements are met. In such situations, the issuing bank (the bank of the importer) assures the confirming bank (the bank of the exporter) that the payment will be made by a specific, mutually agreed-upon date.¹⁰

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://cleartax.in/s/letters-of-credit
2. https://khatabook.com/blog/usance-letters-of-credit-what-are-they/
3. https://www.tradefinanceglobal.com/posts/usance-letters-of-credit-what-are-they/
4. https://www.tradefinanceglobal.com/posts/usance-letters-of-credit-what-are-they/
5. https://efinancemanagement.com/working-capital-financing/usance-letter-of-credit
6. https://www.tradefinanceglobal.com/posts/usance-letters-of-credit-what-are-they/
7. https://efinancemanagement.com/working-capital-financing/usance-letter-of-credit
8. https://www.tradefinanceglobal.com/posts/usance-letters-of-credit-what-are-they/
9. https://khatabook.com/blog/usance-letters-of-credit-what-are-they/#
10. https://www.tradefinanceglobal.com/posts/usance-letters-of-credit-what-are-they/

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