Back to Back Letter of Credit

Back to Back Letter of Credit:

Opening, Amendment as per GFET Chapter-7 Section iii, Accounting Procedure Including Voucher Preparation

Mohammad Abdullah Al-Mamun

Assistant Vice President & Export In charge

Social Islami Bank Ltd

Principal Branch

Generally Back to Back Letter of Credit is one kind of non-funded working capital facility provided by the seller’s (Exporter) or beneficiary’s bank, because the beneficiary of the export letter of credit may not be in a position to export the goods within stipulated period to the buyer without the facility. Exporter has to purchase the raw materials from another suppliers or manufacturer after making payment to them. In such situation Back to Back letter of credit is issued or opened.

The Government of Bangladesh has advised a special procedure under which the export oriented garments units are allowed to import their raw materials free of duty under bonded warehouse arrangements. Back to Back LC is used to import the inputs generally on credit term up to 180 days against the foreign LC received from overseas buyer.

      Back to Back LC Means What?

Back to Back LC is issued on behalf of a customer (Exporter or Seller) against the security of Export LCs (under lien) for procurement of raw materials either locally or from abroad and makes the goods against export order timely and ship the goods within stipulated period. Virtually Back to Back LC is one kind of import LC which is opened against lien of valid Export LCs.

The customer is entitled to open a BTB LC 75% out of 100% of FOB Value of the Export LC. More than one BTB import LC can be issued against one or more Export LCs.

      Different types of Back to Back LC:

1.      Inland (Local) Back to Back LC: Inland back to back LCs denominated in foreign exchange may be opened in favor of local manufacturer-cum-supplier against Master Export LCs received by export oriented manufacturing units. IMP/LCAF is not applicable in such cases.

2.      Foreign Back to Back LC:  Foreign back to back LC is opened in favor of foreign manufacturer cum supplier against master export LCs to procure fabrics/yarn or accessories as per buyer requirements. IMP/LCAF is applicable while opening of Foreign Back to Back LC

3.      EPZ Back to Back LC:  EPZ Back to Back LC is opened in favor of manufacturing units under Export Processing Zone (EPZ) in Bangladesh. IMP/LCAF is applicable in such cases. EPZ BBLC is treated as Foreign back to back LC.

4.      EDF (Export Development Fund) LC: EDF loan/investment facility provided to the importer to meet import obligations at maturity. Sometimes importer has to be purchased raw materials at sight basis instead of usance LC. In such cases EDF facility is needed.

5.      BTB import LC against Inland BTB LC: Back to Back LC may in turn to be opened for importing of necessary inputs, against inland back to back LC in favor of local manufacturer-cum-supplier operating under bonded warehouse system.

6.      Opening of LC in FC by exporters operating without bond licence: As per decision of the National Board of Revenue, a manufacturer-cum-exporter operating without bonded warehouse licence, may open usance LC and sight LC (against advance receipts of export proceeds) denominated in foreign exchange favoring packaging industries, manufacturers of hanger and plastic goods operating under bonded warehouse licence against all types of export contracts (sales contract, purchase order, proforma invoice, etc.) received from abroad.

7.      Opening LC in local currency: Hundred percent export oriented industries/direct exporters shall open and settle inland LC in foreign currency favoring manufacturer-cum-suppliers in the above cases only. For procuring inputs from local traders/suppliers, LC shall be opened in local currency only.

     Opening Procedure of Back to Back Import LC (Under GFET Chapter -7 Section iii Revised Edition 2018):

The ADs may open back to back (BTB) import LCs against export LCs received by export oriented industrial units operating under the bonded warehouse system. The following instructions should be complied with while opening back to back import LCs:

(i)                 Only recognized export oriented industrial units operating under bonded warehouse system    will be allowed the back to back LC facility. The unit requesting for this facility should possess valid registration with the CCI&E and valid bonded warehouse license.

(ii)               The master export LC (against which opening of back to back LC is requested) should have validity period adequate to cover the time needed for importation of inputs, manufacture of merchandise and shipment to consignee.

(iii)             The back to back LC value shall not exceed the admissible percentage of net FOB value of the relative master export LC (as per prescribed value addition requirement) and the price of goods to be imported must be competitive. For computation of net FOB value of a master export LC in respect of CIF basis, the freight charge, insurance cost and commission (foreign) if payable by the exporter shall be deducted from the LC value. If the freight element is not shown separately, a certificate from the shipping company or the shipping agent should be asked for.

(iv)             The back to back import LCs shall be opened on usance basis for a period not exceeding 180(one hundred eighty) days.

(v)               All amendments of the master export LC should be noted down carefully to rule out chances of excess obligation under the back to- back import LC.

(vi)              Back to back import LC should not be opened against LCs received for export under Barter/STA, without prior approval of Bangladesh Bank.

Moreover before lien of Export LC ADs should collect credit report of the buyer through an internationally reputed firm/company.

      Accounting Procedure:

While LC is opened, bank accepts whole liability on behalf of the importer/customer to make payment against the credit if shipment is made within the period and that the stipulated documents are presented and other terms and conditions as per LC are complied with. In order to maintain books of accounts and to show LCs liability bank has to pass an entry on LC liability ledger as well as in the general ledger. This liability is treated as contingent liability. A liability voucher as follows:

Ø  Contingent liability voucher:

o   Dr. Customer’s Liability on LC

o   Cr. Banker’s Liability on LC

Ø  Commission, charges and fees (as per Schedule of chares provided by H/O)

Commission, charges and other fees are recovered from the customer/party by passing following entries:

o   Dr. Customer’s Account

o   Cr. Commission on LC o   Cr. Stationery charges o   Cr. SWIFT charge o   Cr. Stamp in hand

NB: Dr. and Cr. entries must be agreed with equal.

      Lodgment of Documents:

After shipment of goods against LC, the supplier prepares shipping documents and presents these to negotiating bank. The documents are order in term of letter of credit, the negotiating bank sends the document to LC issuing/reimbursing bank. On receipt of the shipping documents from the negotiating bank, LC opening bank should carefully scrutiny/examine these to ensure that they conform to the terms of letter of credit.

If there be any discrepancy(s) in the documents the bank should immediately advise the importer to seek his acceptance of the documents despite of the discrepancy(s). If the importer refuses to accept the documents, the bank should advise the negotiating bank by SWIFT for instruction with regards to disposal of the goods and the documents.

If the documents are found in order and these are acceptable to the importer or the discrepancy(s) accepted by the importer, the bank lodges the accepted bills on BBLC, the bank also might be issue a letter of acceptance and send it to the negotiating bank through SWIFT. The message of acceptance is internationally recognized payment undertaking at the maturity date conform to the LC terms.

      Accounting Procedures at the time of Lodgment:

Bank will reverse the LC liability through creation of another contingent liability.

Ø  Contingent liability reverse voucher:

o   Dr. Banker’s Liability on LC

o   Cr. Customers  Liability on LC

Ø  Voucher on Bills Liability:

o   Dr. Customer’s Liability on BB Bills

o   Cr. Banker’s Liability on BB Bills

Ø  Voucher on acceptance commission and fees.

Commission and other fees are recovered from the customer/party by passing following entries:

o   Dr. Customer’s Account

o   Cr. Commission from acceptance o   Cr. SWIFT charge

NB: Dr. and Cr. entries must be agreed with equal.

      Why does require amendments?

Letter of credit requires amendment while the terms of trade have not been needed by the importer or exporter at the time of opening/establishing LC. 

If the supplier finds that the term of credit could not be fully complied with the LC, he would request for necessary amendment by the applicant before the goods shipped. These amendments must be advised by the opening bank to the seller/supplier through advising bank.

Sometimes the applicant may also like to amend the credit after it has been advised. Reasons for amendment are as follows:

a.       To increase or decrease in amount of LC

b.      Changes in the dates of shipment

c.       Changes in the dates of negotiation

d.      Changes in merchandise and other terms of the credit

The amendment must also be advised by the LC opening bank to the seller/supplier through advising bank before shipments of goods. Besides, the bank would need a written request from the importer. Such amendments will obviously be agreed in all parties to the letter of credit i.e. the LC opening bank, the advising bank and the supplier/seller.

The message of amendment must be sent to all concern through SWIFT. Each and every amendment of LC must be noted in the LC file in chronological order.

Amendment commission and other charges and fees are to be realized by debiting customer’s account. If the amount of LC is increased, the contingent liability voucher is to be passed.

      Accounting Procedure at the time of LC amendment:

Ø  Contingent Liability Voucher

o   Dr. Customer’s liability on LC

o   Cr. Banker’s Liability on LC

Commission and SWIFT charges recovered from the customer/party by passing following entries:

o   Dr. Customer’s Account

o   Cr. Commission on LC o   Cr. Amendment  charges o   Cr. SWIFT charge

NB: Dr. and Cr. entries must be agreed with equal.

If the amount of LC is decreased then the contingent liability voucher is to be passed.

Ø  Contingent Liability Reversal Voucher

o   Dr. Banker’s Liability on LC

o   Cr. Customers  Liability on LC

And the party account to be debited for realization of amendment charges and SWIFT charges.

 

 

References:

1.        GEFT volume 1 revised edition 2018

2.        Charles W.L. Hill, International Business 7^th edition, MC Graw Hill New York

3.       L. R Chowdhury, A text Book on Foreign Exchange 1^st Edition 2000

4.       UCP -600 2007  revision