A Letter of Credit (LC) is a financial document that financial institutions provide as a guarantee for their clients. These clients are businesses that want to purchases goods, usually from foreign businesses.
However, it can also facilitate domestic transactions. Usually, foreign transactions for physical goods require LCs or else these transactions cannot take place. In transactions that involve an LC, there are usually four parties.
These parties are the applicant or the buyer, the beneficiary or the seller, the issuing bank or the buyer’s bank, and the advising bank or the seller’s bank.
There are many different types of LC facilities that financial institutions provide. These may include commercial LCs, export/import LCs, transferable or untransferable LCs, standby LCs, etc. One particular type of LC is known as a Sight LC.
What is a Sight Letter of Credit?
Sight Letter of Credit is a special type of LC. A Sight LC refers to the document that verifies the payment of any goods or services involved.
In a Sight LC, as soon as the beneficiary presents the necessary documents that confirm the transaction, the issuing bank will issue a payment to them.
Unlike a traditional LC, in a Sight LC, there are only three parties involved. The only missing party in Sight LC is the advisory bank, also known as the seller’s bank.
This is because, in this type of LC, the seller gets paid directly by the issuing bank. However, the issuing bank will need the documents necessary to release the payment.
These documents will contain a list of all the requirements that the seller must fulfil to be eligible for a payment. For example, the issuing bank will require proof of shipment of the goods involved in the transaction.
Some banks will also specify a time limit after which they will not pay the seller. However, the terms and deadlines are agreed in advance by all parties to avoid any conflicts in the future.
While Sight LC may be faster than other types of LCs, they are not immediate. The issuing bank will still require some time to review the documents submitted by the seller.
The review process is vital as it ensures that the seller meets all the requirements of clearance, thus, protecting the buyer up to a certain extent.
Usually, the bank may take several days to review the documents and clear the payment. Once the bank clears the funds, the transfer of money to another country will also require some time.
Sight Letter of Credit vs Other Types
A Sight Letter of Credit, while still an LC and can facilitate foreign transactions, is different from other types of LCs. A Sight LC is usually requested by sellers, as they benefit the most from it.
This is mainly because there is no advising bank involved in this type of LC, which can speed up the time in which the seller gets the payment.
This can be particularly useful for small companies or companies that want to have better control over their cash flows.
Similarly, if the seller suspects that the buyer may not be able to pay at a later date for any reason, they will prefer to get paid as soon as possible.
This could be helpful in times where there are external factors that may affect the receipt of cash for the seller.
Some sellers may also limit the number of transactions at a time with one buyer. Therefore, earlier clearance of payments will be beneficial for both the seller and the buyer.
Advantages and Disadvantages
As mentioned above, the main advantage of a Sight LC is for the seller as it allows them to receive their compensation much earlier. This can reduce any risks involved with defaults or late receival for the sellers.
For example, by receiving their payment earlier, sellers can mitigate the risk of default from the buyer. Similarly, by receiving earlier compensation, sellers can manage their cashflows better. For the buyer, it does not have any significant advantages.
On the other hand, Sight LC may also have some disadvantages. These disadvantages mainly apply to the buyer.
First of all, when the seller receives earlier compensation, the buyer may not get enough time to check the quality of the goods as the issuing bank releases the payment based on documentation.
Similarly, the buyer gets a lower credit period in this type of LC. Finally, if sellers request a Sight LC, then they may have to compromise on some aspects of the deal, which may not be ideal.
Conclusion
Sight Letter of Credit is a type of LC in which the seller gets compensation quicker because there is no advising bank involved in the transaction.
In a Sight LC, the seller has to meet some predetermined requirements and provide documentation proving they have met those requirements to the issuing bank.
The issuing bank will carry out some checks on the provided documentation and then pay the seller directly. Sight LCs are quicker as compared to other types of LCs, which may bring some advantages to the seller.
