Public Information

28 Jan 2019

Understanding the Role of Banks as Providers of L/C in Trade

A Letter of Credit (L/C) is a letter issued by a bank to guarantee that a buyer's payment to a seller will be received in the correct amount according to an agreed set of conditions. L/Cs are only valid in international trade, namely, for importers as debtors and exporters from abroad as recipients of money or beneficiaries. 
The following is a brief explanation on how L/Cs are issued.

• The buyer and the supplier sign and enter into an agreement contract, where it must be explicitly stated that payment will be processed through a bank-issued L/C.
• The seller request the issuance of L/C to the bank.
• The issuing bank examines and verifies the required documents and guarantees provided by the buyer.
• If all required documents have been submitted, the bank will issue a L/C through an advising  bank or a branch of the Bank in the exporting country.
• After the goods have been transported by the seller and after receiving a Bill of Lading (BoL) for the shipment of the aforementioned goods, the BoL is submitted to the advising bank, after which payment will be processed.
• After the buyer pays the exact amount according to the contract with the Bank, the buyer receives the BoL from the bank, and may  to collect goods. 

L/Cs issued by banks will guarantee payment to the seller on the condition that all requirements are met. A L/C also functions as a bank’s tangible commitment in completing international commercial transactions.

It is worth noting that not all international trade transactions require the issuance of a L/C. However, the Indonesian government  has recently released a new policy where several export commodities must utilize a L/C in international transactions. The policy entered into effect in October 2018 along with the signing of the Regulation of the Ministry of Trade No. 94/2018 regarding the use of L/C for several exported goods, September 7th, 2018. The policy aims to ensure that  DHE (export proceeds) will return to Indonesia. According to the current Minister of Trade, Dr. Enggartiasto Lukita, the policy would allow at least 50% of proceeds from exported goods to settle in domestic national banks for at least 6 months, where they will be converted to Indonesian Rupiah.

The following are several exported commodities required to use a L/C:

• Minerals;
• Coal;
• Palm oil.

Crude oil and gas were once included as L/C-requiring export commodities. However, since these commodities have a different export system where bank guarantees or a Standby Letter of Credit (SLBC) are generally used, exports involving crude oil and gas are no longer obliged to use L/Cs.

The Indonesian government has actually applied similar regulations prior to this policy, all requiring the use of L/Cs for several commodities, though they have not been effectively enforced due to several constraints. For example, many sellers are concerned that buyers will refuse a transaction processed through a bank-issued L/C.

Nevertheless, the Ministry of Trade appears to be optimistic that the regulations issued this year regarding L/Cs will be well-executed and will yield favorable results. Though requiring L/Cs may slow down export earnings, this method is considered especially effective to increase the supply of US dollars and returning DHE to the country.

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