Non-Bank Issued Letters of Credit

Though, the letter of credits are defined by UCP-600 only issued by banks, however there are circumstances where a non-bank issuer can issue the letter of credit, The risk involvement is as high as it is in other similar payment method (where no undertaking issued by bank), reason being that there is no undertaking of banks, wherein a commercial letter of credit provides comfort to the applicant that the payment will only be made once we receive the credit compliance documents and beneficiary get the assurance of payment upon presentation of the same credit compliance documents.

The beneficiary should exercise caution before shipping the goods and placing reliance on the documentary credit as its guarantee of payment, if a credit is issued by an individual or a corporate field “50b” of the MT700 will come into the picture.

The requirement by the seller for a letter of credit is two-fold: first that he has a guarantee of payment, and second that he can use the credit to raise pre-shipment finance from his banker.

In the case of the corporate issued credit as we understand it, the guarantee of payment is not normally by an independent third party, and, as such, the credit risk is that of the corporate entity issuing the credit.

Similarly when documents are presented under the credit for negotiation, that negotiation if any, is based on the risk of the issuing entity, i.e. is corporate, not bank risk.

Even if letter of credit is issued by a non-bank, the non-bank issuer should be held to the same obligation and standard of care as would a bank. In either case, the obligation is to pay against the presentation of documents that comply with the terms and conditions of the credit and that determination is to be made based solely on the documentary presentation and not on the status of reimbursement obligations or the underlying transaction, and local law should apply the same principles to an independent undertaking regardless of who makes it.

A credit can be issued subject to the UCP-600 by a non-bank, however, it does not mean that it is necessary for a beneficiary to accept such a credit. Issuance through an advising bank does mitigate the issue of whether the credit is authentic and presentation of documents to a bank does reduce some operational risks. There is, the risk of the creditworthiness of the issuer and country risk. These risks apply equally whether the issuer is or is not a bank and a beneficiary should always assess whether it is prepared to accept the credit and country risk associated with the issuer. If not, it should require confirmation by an entity with which it is comfortable.

An additional risk that may not be apparent to beneficiaries, namely the risk of neutrality of the issuer. This risk is somewhat more intangible but is very important. It is the risk that, when presented with documents, the issuer may be influenced by factors other than whether they comply on their face with the terms and conditions of the credit and may exercise certain discretionary judgments in examining documents against the beneficiary where it would not otherwise do so if external factors were different. While this risk is not confined to non-banks, the reputation of individual banks for integrity is well known in the letter of credit community and one which most banks that regularly engage in letter of credit practice work hard to maintain. It is less apparent that when faced with a poor credit decision, an insurance company will approach the problem in the same way as would a letter of credit banker rather than as an insurer, which may be inclined to reject all arguable claims and engage in litigation to settle any colourable dispute.

For these reasons, advising/exporters banks generally inform corporate letter of credit users of the advantages of having a bank's obligation, either as the issuer of a credit or as the confirmer of a credit issued by a non-bank. There would be no objection under standard international letter of credit practice to informing specifically the beneficiary of such a credit as to the nature of the issuer in addition to emphasizing that the advising bank assumes no liability, although in the absence of agreed standards such a decision depends with the individual bank involved. Where the manner of issuance misleads the beneficiary into believing that the issuer is a bank, the advising bank may expose itself to liability. Ultimately, however, the decision as to whether or not to accept the risks associated with a non-bank issuance rests with the beneficiary.

Following risks may occur:

·        No assurance of payment by a bank upon complying presentation.

·        Fraud – there is the risk that the documentary credit itself may be fraudulently issued. This might induce a beneficiary to ship goods or perform a service against an apparent bank undertaking to pay that does not in fact exist. In this event, the beneficiary will have no enforceable claim against the named     bank because either that bank did not issue the documentary credit or the bank does not exist.

·        Workability check may not be done as banks are just acting as an agent (though it is not a responsibility of an advising bank but most of the banks do it at issuance stage)

·        Non-bank/corporate/ individual issuer may not be well known of UCP and ISBP rules. In above scenario, there could be the reason that the prospective of a letter of credit is not being fulfilled, that is why it not defined in UCP as well and more riskier than a normal commercial letter of credit.

·        Foreign exchange risk – if the currency of the credit is not the beneficiary’s operating currency, there may be a difference in exchange rates between the time when the documentary credit is issued (or the time of the underlying agreement) and the time at which settlement is made. If the movement is unfavourable to the beneficiary, it may receive less than the anticipated price, reducing its profit margin or incurring a loss. A beneficiary can protect against this risk by entering into a forward foreign exchange contract or by buying an option. A forward has the effect of fixing the future exchange rate.