9657 03-Mar-2018, Sat
Letter of Undertaking (LoUs), Letter of Credit (LoC), Society for Worldwide Interbank Financial Telecommunication (SWIFT) system, and Core Banking System (CBS). It is important for you to understand what these terms mean, not only to get a better insight in current affairs of the nation but also to prepare for upcoming exams as current affairs based banking terms and instruments are known to be seen in the general awareness section of banking examinations topics like LoU, SWIFT, CBS, Letter of Credit (LoC) are now very important from the point of upcoming competetive Examinations.
About 'Letter Of Credit'.
A letter of credit is a letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount. In the event that the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase.
BREAKING DOWN 'Letter Of Credit'
Because a letter of credit is typically a negotiable instrument, the issuing bank pays the beneficiary or any bank nominated by the beneficiary. If a letter of credit is transferrable, the beneficiary may assign another entity, such as a corporate parent or a third party, the right to draw.
Funding a Letter of Credit
Banks typically require a pledge of securities or cash as collateral for issuing a letter of credit. Banks also collect a fee for service, typically a percentage of the size of the letter of credit. The International Chamber of Commerce Uniform Customs and Practice for Documentary Credits oversees letters of credit used in international transactions.
Example of a Letter of Credit
Citibank offers letters of credit for buyers in Latin America, Africa, Eastern Europe, Asia and the Middle East who may have difficulty obtaining international credit on their own. Citibank’s letters of credit help exporters minimize the importer’s country risk and the issuing bank’s commercial credit risk. Letters of credit are typically provided within two business days, guaranteeing payment by the confirming Citibank branch. This benefit is especially valuable when a client is located in a potentially unstable economic environment.
Types of Letters of Credit
A commercial letter of credit is a direct payment method in which the issuing bank makes the payments to the beneficiary. In contrast, a standby letter of credit is a secondary payment method in which the bank pays the beneficiary only when the holder cannot.
A revolving letter of credit lets the customer make any number of draws within a certain limit during a specific time period. A traveler’s letter of credit guarantees the issuing banks will honor drafts made at certain foreign banks.
A confirmed letter of credit involves a bank other than the issuing bank guaranteeing the letter of credit. The second bank is the confirming bank, typically the seller’s bank. The confirming bank ensures payment under the letter of credit if the holder and the issuing bank default. The issuing bank in international transactions typically requests this arrangement.
When an LoU is issued, the message of credit transfer is conveyed to overseas banks through the Society for Worldwide Interbank Financial Telecommunication (SWIFT)system. This is a significant information as it gives the bank's consent and guarantee. To issue SWIFT, an official has to log in and fill up confidential information such as the account number and SWIFT code. It generally has three layers of security - a maker, a checker and a verifier within the core banking system before it is issued.
The Society for Worldwide Interbank Financial Telecommunication (SWIFT) provides a network that enables financial institutionsworldwide to send and receive information about financial transactions in a secure, standardized and reliable environment. SWIFT also sells software and services to financial institutions, much of it for use on the SWIFTNet Network, and ISO 9362. Business Identifier Codes (BICs, previously Bank Identifier Codes) are popularly known as "SWIFT codes".
The majority of international interbank messages use the SWIFT network. As of 2015, SWIFT linked more than 11,000 financial institutions in more than 200 countries and territories, who were exchanging an average of over 15 million messages per day (compared to an average of 2.4 million daily messages in 1995). SWIFT transports financial messages in a highly secure way but does not hold accounts for its members and does not perform any form of clearing or settlement.
SWIFT does not facilitate funds transfer: rather, it sends payment orders, which must be settled by correspondent accounts that the institutions have with each other. Each financial institution, to exchange banking transactions, must have a banking relationship by either being a bank or affiliating itself with one (or more) so as to enjoy those particular business features.
SWIFT is a cooperative society under Belgian law owned by its member financial institutions with offices around the world. SWIFT headquarters, designed by Ricardo Bofill Taller de Arquitectura are in La Hulpe, Belgium, near Brussels. The chairman of SWIFT is Yawar Shah, originally from Pakistan, and its CEO is Gottfried Leibbrandt, originally from the Netherlands. SWIFT hosts an annual conference every year, called Sibos, specifically aimed at the financial services industry.
CBS refers to Core Banking System where all branches are inter-connected to ensure that the bank customers - regardless of their home branch - are able to operate their account and transact in any of the member branch located anywhere in the world.
CBS is required :
To meet the dynamically changing market & customer needs.
To improve & simplify banking processes so that bank staff can focus on sales & marketing stuff.
Convenience to customer as well as bank.
To Speed up the banking transactions.
To expand presence in rural & remote areas.
About Letter of Undertaking (LoU)
An LoU is an assurance given by one bank to another to meet a liability on behalf of a customer. The LoU is akin to a letter of credit or a guarantee. LoUs are used in international banking transactions. An LoU is issued for overseas import remittances and involves four parties — an issuing bank, a receiving bank, an importer and a beneficiary entity overseas. According to norms, the term of an LoU is 180 days, and can be rolled over once for six months. Since LoUs are a form of lending, they are typically backed by security.
A Letter of Understanding or LOU is a formal text that sums up the terms and understanding of a contract which mostly has been negotiated up to this point only in spoken form. It reviews the terms of an agreement for a service, a project or a deal and is often written as a step before a more detailed contract is issued.
The LOU may provide for example:
- Detailed summary of the work to be performed
- Tasks of the service provider and the receiver
- Milestones for the work to be done
- Work steps that have been accomplished already
In international banking system, Letter of Undertaking (LOU) is a provision of bank guarantee, under which a bank allows its customer to raise money from another Indian bank's foreign branch in the form of a short term credit. The LOU serves the purpose of a bank guarantee. However, to be able to raise the LOU, the customer is supposed to pay margin money to the bank issuing the LOU and accordingly, he is granted a credit limit.