A Usance Letter of Credit, also referred to as a deferred payment letter of credit, is a financial instrument commonly used in international trade transactions. It serves as a guarantee of payment from a buyer’s bank to a seller, providing assurance that payment will be made at a specified future date.
The Usance Letter of Credit is a specialized type of letter of credit that allows for a deferred payment term. Unlike a sight letter of credit, where payment is made upon presentation of documents, a usance letter of credit allows the buyer to defer payment for a certain period of time, typically ranging from 30 to 180 days, depending on the agreed-upon terms.
This financial instrument is especially beneficial for buyers, as it provides them with additional time to receive and inspect the goods or services before making payment. It also enables them to manage their cash flow more effectively, as they can delay the settlement of the transaction while still maintaining a good relationship with the seller.
To initiate a Usance Letter of Credit, the buyer applies to their bank, known as the issuing bank, and provides the necessary documentation, including details of the transaction, such as the amount, shipping terms, and the agreed-upon usance period. The issuing bank assesses the creditworthiness of the buyer and, if approved, issues the letter of credit to the seller or their bank, known as the beneficiary.
Upon shipment of the goods or completion of the agreed-upon services, the seller presents the required documents, such as the commercial invoice, packing list, and bill of lading, to the issuing bank or another nominated bank. The bank checks the documents for compliance with the letter of credit terms and, if all requirements are met, makes payment to the seller at the expiration of the usance period.
It is important to note that the Usance Letter of Credit is a negotiable instrument, meaning it can be assigned or transferred to a third party, such as a financial institution or another supplier. This flexibility allows the seller to utilize the letter of credit as collateral to secure financing, known as usance financing or discounting, while waiting for the payment.
Usance Letters of Credit are subject to strict international rules and guidelines, primarily governed by the International Chamber of Commerce (ICC) through their publication, Uniform Customs and Practice for Documentary Credits (UCP 600). These rules provide a standardized framework for the issuance, presentation, and examination of documents under the letter of credit, ensuring a smooth and efficient process for all parties involved.
In summary, a Usance Letter of Credit is a financial instrument that provides flexibility and a deferred payment term for buyers in international trade transactions. It offers them the opportunity to inspect the goods or services before making payment, while also allowing sellers to secure financing using the letter of credit as collateral. By adhering to the rules and practices outlined by the ICC, the Usance Letter of Credit facilitates secure and efficient trade finance operations.
