Usance Letter of Credit

A Usance Letter of Credit (Usance LC), also known as a Deferred Payment Letter of Credit or Time Letter of Credit, is a trade finance instrument that facilitates international and domestic trade by allowing deferred payment to the exporter after shipment of goods. Unlike a sight letter of credit, where payment is made immediately upon presentation of compliant documents, a usance LC provides a specified credit period—such as 30, 60, 90, or 180 days—after the date of shipment or acceptance. This mechanism plays a crucial role in balancing liquidity needs, risk management, and trust between trading parties, with significant implications for banking, finance, and the Indian economy.

Concept and Basic Structure

A usance letter of credit is issued by a bank on behalf of an importer (applicant) in favour of an exporter (beneficiary), undertaking to make payment at a future date, subject to the terms and conditions of the credit. The payment obligation arises only after the exporter presents documents that strictly comply with the LC terms, such as the bill of lading, invoice, insurance certificate, and inspection reports.
The defining feature of a usance LC is the time gap between document acceptance and actual payment. This deferred payment period effectively provides short-term credit to the importer while assuring the exporter of payment backed by the issuing bank’s creditworthiness.

Legal and Regulatory Framework

Usance letters of credit are governed internationally by the Uniform Customs and Practice for Documentary Credits (UCP), issued by the International Chamber of Commerce (ICC). In India, their usage is regulated within the broader foreign exchange and trade finance framework prescribed by the Reserve Bank of India.
RBI guidelines govern aspects such as permissible usance periods, reporting requirements, and the linkage of usance LCs with trade credit norms under foreign exchange management regulations. These rules ensure that usance LCs support genuine trade transactions and do not become channels for speculative or unregulated credit.

Operational Mechanism of a Usance LC

The operational process of a usance letter of credit involves several stages. The importer requests the issuing bank to open a usance LC in favour of the exporter, specifying the credit period and other terms. Once issued and advised through the exporter’s bank, the exporter ships the goods and submits the required documents.
After document scrutiny, the issuing bank accepts the documents and undertakes to pay at maturity. On the due date, payment is made to the exporter or the negotiating bank. During the usance period, the importer can sell the goods, generate cash flows, and arrange funds for settlement, improving working capital management.

Role in the Banking Sector

For banks, usance letters of credit are an important component of trade finance portfolios. They generate fee-based income through issuance, confirmation, and negotiation charges, while also creating opportunities for short-term lending and discounting.
Banks assess the creditworthiness of the importer before issuing a usance LC, as the deferred payment represents a funded exposure at maturity. Risk management practices such as credit limits, collateral requirements, and confirmation by reputable foreign banks are commonly employed to mitigate default risk.

Impact on Trade Finance and Corporate Finance

Usance LCs are particularly valuable for importers who require time to convert inventory into sales proceeds. By providing deferred payment terms, they reduce immediate cash outflows and improve liquidity. Exporters benefit from reduced counterparty risk, as the payment obligation rests with a bank rather than the importer.
In many cases, exporters may opt for discounting or forfaiting of usance bills to receive immediate funds at a discount. This flexibility enhances cash flow management and supports smoother trade operations.

Significance for the Indian Economy

At the macroeconomic level, usance letters of credit facilitate domestic and international trade by reducing financing constraints and fostering trust between trading partners. They support India’s import of capital goods, raw materials, and intermediate inputs, which are essential for industrial production and economic growth.
By enabling exporters to access assured payments and importers to manage working capital efficiently, usance LCs contribute to trade expansion, employment generation, and integration into global value chains. They also promote formal trade channels, improving transparency and regulatory oversight.

Advantages of Usance Letters of Credit

The key advantages of usance LCs include:

• Working Capital Support: Deferred payment eases liquidity pressure on importers.
• Risk Mitigation: Bank-backed payment assurance reduces counterparty risk for exporters.
• Trade Facilitation: Encourages cross-border trade by bridging trust gaps.
• Financial Flexibility: Options for bill discounting and structured trade finance.