LC at Sight - Quick Payment Under a Letter of Credit
An LC at sight is a letter of credit (LC) that is payable immediately – within five to ten days – after the seller meets the requirements of the letter of credit. This type of LC is the quickest form of payment for sellers, who are often selling to overseas buyers.
Letters of Credit
All letters of credit, including sight letters of credit, depend on documents. To get paid, the beneficiary (again, often an exporter or service provider) needs to submit documents to the bank. Those documents typically include the letter of credit itself and any documents proving that the exporter has met his obligations.
Letters of credit are tools for payment, separate from a purchase or sales agreement. LCs are used to ensure that the person on the other side of the deal performs certain actions. Banks guarantee payment and hold onto the money until it can be proven that certain requirements are met. To set up a documentary letter of credit, the party making the payment will apply for a letter of credit with a local bank.
If you’re selling something (to a buyer overseas, for example), you can gain confidence by using a letter of credit: with a properly designed agreement, you’ll get paid as long as you ship the goods as agreed.
Payment is typically guaranteed by a well-established bank, so you’re not relying on the credit (or willingness) of a buyer that you may be unfamiliar with.
If you’re buying something, a letter of credit can help you avoid paying for something that never arrives. Instead of sending money and hoping for the best, your funds are held in escrow until the seller can produce documents proving that a shipment to you was made. For example, the seller might need to provide a bill of lading and other documents.
All that said, you can’t completely eliminate risk using a letter of credit – the seller could ship low-quality goods or even commit fraud and ship a box of rocks – but you can certainly reduce your risk. Banks will release funds as long as they receive the documents listed in the letter of credit. The bank will not ensure that the order was fulfilled exactly as specified in the purchase agreement. You can for the letter of credit, which gives somebody the opportunity to review the contents of the shipment before your payment is released.
What Does "Immediately" Mean?
Although payment with a sight LC is relatively quick, it is not necessarily instant. The seller’s bank (which might be the negotiating or advising bank) will review the documents submitted and make sure they meet the requirements in the letter of credit. This process may take several business days.
In some cases, the documents must be forwarded to another bank for review. Once the bank verifies compliance, payment is made – but that almost never happens immediately. Finally, although wire transfers are a quick form of payment, it can take a day or two for funds to end up in a beneficiary's account (especially if the transfer comes from overseas).
It's probably reasonable to expect about five business days for each bank to review documentation and another one to two business days for the funds to transfer.
Alternative Letters of Credit
To understand how an LC at sight works, it might help to review how it doesn’t work. An alternative form of LC is a deferred payment letter of credit or a usance letter of credit.
With those instruments, payment happens at some future point in time – long after the documents have been submitted (perhaps 30, 90, or 180 days after).
Deferred payment gives the buyer more time to come up with funds. As a result, it can serve as a form of seller-financing, which would help to attract buyers that otherwise have to pay more quickly. The buyer also has a chance to sell the imported goods and generate revenue before the payment is due, making it easier to fund the payment (or shortening the amount of time that the buyer has to borrow from a bank).
Letters of credit can have a variety of features. For example, irrevocable letters of credit are harder to unilaterally cancel. Confirmed letters of credit add even more security because a trusted bank can guarantee the payment (in addition to the unknown bank in the buyer’s country).
To learn about other alternatives, read about the different types of letters of credit.
Why Use a Sight LC?
A letter of credit that pays at sight is beneficial for sellers. Payment arrives more quickly than it would with a deferred payment letter of credit. Exporters spend money to produce and ship goods, so getting funds back quickly helps them avoid a crunch.
Quick payment is also preferable if you have concerns about the solvency of your buyer or any of the banks involved.
Plus, if you're dealing with a buyer (and bank) in a volatile nation, you might prefer to get paid as quickly as possible. Political unrest could lead to financial turmoil, resulting in currency changes – or you might just end up waiting forever.