Usance Letter of Credit

A usance letter of credit is a letter of credit under which payment is due on a fixed future date, rather than when compliant documents are presented. The delay, called the usance or tenor, is typically 30, 60, 90 or 180 days, counted from sight of the documents, from the bill of lading date or from another stated event. It is also called a time credit or term credit.

A usance credit gives the importer time to receive and sell the goods before paying, while the exporter still has a bank's promise to pay at maturity. Under UCP 600 it takes one of two forms: a deferred payment credit or an acceptance credit. Its opposite is the sight letter of credit, which pays once the documents are found compliant.

Think of buying furniture on "pay in 90 days" terms, but with the shop's bank, not the shop, guaranteeing that the bill will be paid on day 90. The shop knows exactly when it will be paid and by whom. The buyer gets the sofa now and pays later.

A usance credit does this between countries. The exporter ships and hands over the paperwork. If the paperwork is in order, the importer's bank promises to pay on a fixed future date. The importer can collect the goods, sell them and use that money to pay the bank. If the exporter cannot wait, it can usually sell the bank's promise to its own bank for cash today, accepting a little less than the full amount.

• Acceptance credit. The beneficiary presents documents with a time draft (a bill of exchange) drawn on the issuing or nominated bank. The bank "accepts" it by signing, creating a banker's acceptance: a negotiable instrument that can be sold in the money market.
• Deferred payment credit. No draft is used. The bank gives a deferred payment undertaking, a commitment to pay at maturity. This avoids stamp duties some countries charge on bills of exchange, but there is no negotiable paper to trade.

Either way, once compliant documents are presented, the issuing bank is irrevocably bound to pay at maturity even if the importer becomes insolvent in the meantime. An unaccepted time draft between the trading parties alone, by contrast, is a trade acceptance and carries only the buyer's credit.

Exporters often want cash before maturity. Article 12(b) of UCP 600 says that by nominating a bank to accept a draft or incur a deferred payment undertaking, the issuing bank also authorizes it to prepay or purchase that accepted draft or undertaking. This made export bill discounting under credits more secure after UCP 600 took effect in July 2007. Longer receivables of this kind can also be sold through forfaiting.

Discount is usually calculated on a simple-interest basis:

• $F$ is the face value of the accepted draft or deferred payment undertaking.
• $r$ is the annual discount rate as a decimal, usually a reference rate such as SOFR plus a margin reflecting the issuing bank's risk.
• $d$ is the number of days from the discount date to maturity; 360 is the day-count basis common for US dollars (365 is used for sterling).

Example: an exporter holds an accepted USD 200,000 draft maturing in 90 days, and its bank discounts at 7 percent a year. The discount is $200{,}000 \times 0.07 \times 90 \div 360 = 3{,}500$, so the exporter receives USD 196,500 today. The bank collects USD 200,000 from the issuing bank at maturity.

A common variant is the usance payable at sight (UPAS) credit. The beneficiary is paid at sight as under a sight credit, but the importer reimburses the issuing bank only at the end of the usance period. A bank, often the issuing bank's correspondent, funds the gap, and the interest is for the importer's account. UPAS credits are widely used in Indian and other South Asian import trade, where they give importers cheaper foreign-currency credit than local borrowing, sometimes alongside buyer credit. For the exporter the economics resemble a sight credit; for the importer they resemble a loan.

Usance credits suit buyers who need time to sell before paying, such as distributors and manufacturers turning imported inputs into products, and help their working capital and days payable. Sellers agree to them to win business while keeping bank security, often building the financing cost into the price. Compared with open-account trade on the same terms, the seller is protected against the buyer's default, but remains exposed to the issuing bank and its country. Exporters manage that by asking a bank in their own country to confirm the credit, or by insuring the risk through export credit insurance.

• International Chamber of Commerce