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Restricted Letter of Credit

Restricted Letter of Credit

A Letter of Credit (LC) or the Credit Letter is a letter issued by a financial institution – like a bank – guaranteeing on-time payment of the correct amount from the buyer to the seller; in cases where the buyer fails to make the payment of the purchase, the bank stands liable to pay the entire or the remaining amount of the purchase. In a letter of credit, where the bank which issued the LC, lets the customer redeem the LC from a particular bank, it refers to a Restricted Letter of Credit.

The restricted letter of credit restricts negotiation with the bank nominated by the issuing bank in credit. The restricted negotiable letter of credit states that the issuing bank’s authorization of payment to the beneficiary is restricted to a specific nominated bank.

Restricted Letter of Credit vs Freely Negotiable Letter of Credit

In common terms, a freely negotiable letter of credit refers to the LC which mentions no condition or negotiation of documents. Letter of credit of this type can be negotiated with any willing bank of the beneficiary's choice.

On the other hand, restricted letter of credit specifies a particular bank for negotiation and in such cases if the bank named for negotiation refuses to negotiate, the opening bank is liable to pay as per the terms of credit.

Course of action of beneficiary bank in cases of restricted letter of credit

If there is a restricted letter of credit, the beneficiary bank might ask the payee submit documents to the negotiating bank, along with instructions. The documents being presented, the negotiating bank is then requested to accept them and process payment to the beneficiary as outlined by the letter of credit. This process is considered to be cost and time saving, since both the beneficiary and negotiating bank are familiar with each other’s process of handling the documents.

In other cases, the beneficiary’s bank are liable to send the documents through a banking channel – which charges an extra amount for the document examination service for the beneficiary. This process is not much suggestible, considering the fact that non-nominated banks have no extra security or protection. If banks, as such, offer a document examination service and have not included any such examinations, it will result in a ‘silent’ confirmation, leaving the beneficiary with limited recourse against the bank.

Potential problems in dealing with non-nominated banks without a restricted letter of credit may include:

  • Dishonor by the nominated bank
  • Prospects of documents getting lost after being sent from the beneficiary’s bank
  • Zero protection under Uniform Customs and Practice under Documentary Credits (UCP)

However, even while the non-nominated banks don’t come under the protection of UCP, they are eligible to get paid on the maturity date if the documents meet in accordance to the rules.

Bank can directly send the documents to the issuing bank rather than going through the negotiating bank

According to UCP 600 - an official publication issued by the International Chamber of Commerce (ICC), which are applicable on financial institutions which issue Letter of Credits – this is authorized.

Article 6a of UCP 600 states, “A credit must state the bank with which it is available or whether it is available with any bank. A credit available with a nominated bank is also available with the issuing bank.”

And, the publication’s article 6d (II) states, “The place of the bank with which the credit is available is the place for presentation. The place for presentation under a credit available with any bank is that of any bank. A place for presentation other than that of the issuing bank is in addition to the place of the issuing bank.”

Therefore, beneficiaries are authorized to do without the services of additional agents and directly deal with the issuing bank.

Examples of restricted letter of credits

  • In some cases, the issuing bank may provide a letter of credit which will restrict presentation to client’s bank and may also outline that the issuing bank is allowed to first confirm before any presentation made.
  • In a case, where a customer might prefer a different bank as the confirming bank due to better offered rates, the letter of credit may be restricted to a bank whose offshore office is the drawee and the financing and issuing bank and the beneficiary would not maintain an account there, despite having financial dealing with it.
  • A restricted letter of credit might also be preferred because of issuing bank and country risks with infancy of banking networks. This is mostly applicable when a client – belonging from a developed country, without the knowledge of who the letter of credit will be advised through – awaits a LC from a developing country with inherent transaction risks

Problems that might occur with restricted letter of credit

Though advantageous in certain aspects, problems with the restricted letter of credit may arise in cases were the beneficiary’s bank does not have a swift authentication process with the opening bank. To avoid such complications, opening banks usually prefer to send the letter of credit to their correspondent in the beneficiary’s country. In such cases, the opening bank also restricts the letter of credit to the correspondent.