Letter of Credit Discounting :

What is Letter Of Credit Discounting? 

Letter of Credit discounting is a primary method of financing in international trade and is also known as a documentary credit. Fundamentally, it is a guarantee provided by a financial institution to pay sellers on behalf of buyers in case of default on their part. Letter of Credit discounting serves as financial security for businesses involved in either export or import or both. 

LC discounting is considered to be a typical funding option as financial institutions follow a mandatory verification process to confirm the authenticity of both the parties. Also, the chance of manipulating the discounting rate is minimal as only the prevailing rates apply to a Letter of Credit. 

Types Of Letter of Credit: 

In a broader sense, there are 5 types of Letter of Credit   –

1. Revocable:

   It is considered to be an uncommon Letter of Credit as it can be changed or cancelled by a banking institution at any time and for any reason. It cannot be transferred to a third party.

2. Irrevocable: 

   This Letter of Credit can only be changed or cancelled if all concerned parties agree to it. Typically, an irrevocable Letter of Credit is considered to be more secure than revocable ones.

3. Transferable: 

   A transferable Letter of Credit can be transferred from one beneficiary to another. Such an LC is used when intermediaries partake in a transaction. 

4. Confirmed:

   When an advising financial institution trusted by the seller guarantees payment from the buyer, a Letter of Credit is confirmed. A confirmed irrevocable Letter of Credit is more secure than the unconfirmed ones as it is backed and guaranteed by both the issuing and confirming bank.

5. Unconfirmed: 

    In the case when a letter of credit reaches the beneficiary with only the issuing bank's payment undertaking, without any confirmation added by another financial institution is known as an unconfirmed letter of credit.

   Besides these, other Letters of Credit include – standby Letter of Credit, revolving Letter of Credit and back-to-back Letter of Credit. 

How Does The Letter of Credit Discounting Work?

The pointers mentioned below offer a fair idea about how an LC discounting works –

• On agreeing to the terms of trade, the seller requests a buyer to provide a Letter of Credit before the goods are delivered to guarantee the financial security of the trade.
• The buyer approaches an issuing bank to obtain a Letter of Credit.
• To discount an LC, the seller submits required export documents to his/her bank.
• LC advice is issued to the exporter by his/her bank.
• The money availed is used to process the order and deliver goods or services as per the terms.
• The collected export documents are forwarded to the LC issuing bank.
• On receiving the document, the issuing bank verifies them and notifies about the acceptance of bills under LC.
• The institution disburses payment to the seller's account.

When Can A LC Be Discounted? 

It must be noted that exporters can get the LC discounted in any of these situations –

• To fulfil financial requirements, an exporter may request for discounting of the bills backed by a received Letter of Credit. The exporter's financial institution proceeds to discount the bill and make a net payment after deducting applicable LC discounting charges.

1. When an importer wants to extend the payment term, but the exporter requires immediate payment.
2. In case an importer fails to pay the money on the due date.

Benefits Of LC Discounting:

LC discounting services in India provide quick and assured access to funding in times of need, making it a preferred financial tool among business entities. 

These are key benefits of LC discounting –

• It puts exporters at ease by eliminating credit risk and assuring payment.

• The advance payment helps to access working capital, which in turn results in seamless cash flow and enhanced operations.
• On receiving the payment before a bill's maturity date, the beneficiary can pay off exporters, use the money in the production process or meet other production-oriented requirements.
• It enables beneficiaries to provide extended repayment tenure to their trading partner, which helps them to negotiate a better deal.

Though there are several benefits of LC discounting, exporters need to become familiar with its limitations as well. If they do not find LC discounting a feasible option, they may consider alternative funding options to keep their operations active until the importer pays off. 

KredX helps businesses raise funds to meet their working capital requirements within 24-72 hours*against attractive terms.

LC Discounting vs Invoice Discounting: 

The table below highlights the significant differences between LC discount and bill discount.

With this understanding of LC discounting and its alternative funding options, individuals can make an informed decision when resorting to raising finance for their export/import business.