The word ‘Usance’ has different meanings in different contexts. Usually, it refers to the credit period allowed to the buyer between the purchase of goods and the payment for them.
It only relates to credit transactions that take place between debtors and creditors in regular business with each other. It works efficiently when the buyer makes bulk purchases in the ordinary course of his business.
Understanding the meaning of Usance
Usance is also used as a synonym for ‘usage,’ and so, it is symbolic of different things in different industries. In financing, it refers to the interest charged to the creditor on borrowed funds. It refers to the interest earned by the bank on loans.
The term ‘Usance’ is very commonly referred to in International Trade. It is the time period allowed by law between the date of the Bill and the date of payment for the imported goods. It is widely used in foreign transactions. The buyer and seller mutually agree on the date of payment. The time period differs from country to country and can range from weeks to months.
Basically, Usance is referred to as the concept of deferred payment. This idea facilitates the buyer to gain more time for payments of goods. The buyer can ensure the quality and quantity of goods. It also enables him to have more working capital. It encourages wholesale transactions and also encourages the buyer who is starting a new business.
Usance Letter of Credit
Usance Letter of Credit, also known as Deferred or Time or Term LC, is a type of LC where payment is to be done on a pre-decided date on the receipt of all documents. A Letter of Credit is a document that guarantees payment to the exporter by the Importer. It is a trade finance tool that aims to reduce the risks associated with international trades.
In international trades, the buyers and sellers i.e., importers and exporters, are uncertain about whether they can trust the other party with their side of the contract. Both of them want to ensure that their contract is not breached, and they get a fair trade.
An LC is among various mechanisms that enable them to have trustworthy and successful transactions. An LC allows the Importer to make payments on a date decided by both the parties after receiving the goods and all documents.
There are many types of LCs, such as Commercial LC, Revocable and Irrevocable LC, Sight LC, etc. and Usance LC is one of them. It has different elements from all other types, which makes it unique. It gives the Importer extra time ranging from 30 to 180 days, during which he can make adequate arrangements for paying the exporter.
How Usance LC works
When the Importer and exporter both agree on a contract, they then move forward with an LC. In this process, one of the parties, usually the Importer, approaches the bank in their country and applies for a Usance Letter of Credit in the exporter’s name.
The bank serves as an intermediary and ensures that the payment is made and the services are delivered according to the contract. The Issuing Bank acts as a guarantor for the Importer, and so his credit needs to be good. This bank shall correspond with the Advising bank of the exporter and forward the Usance LC to them after verifying it.
The exporter will then export the goods to the buyer and send all necessary documents to the Advising bank. These documents include an invoice, shipping details, bill of lading, etc. These documents are forwarded to the Issuing bank, which then verifies and forwards them to the Importer.
The Importer shall make the payments within the time period agreed upon in the LC. This time period shall be mutually decided by both parties and signed by them. An LC includes all the information and details about the transaction. It is legally binding.
A Letter of Credit is regulated by the International Chamber of Commerce through Uniform Customs and Practice for Documentary Credits (UCP 600).
Types of Usance LCs
Usance LCs can be classified into two types based on the time period.
- The first type is when the Importer has a period of 90 days after the date of the Bill of Lading for the payment of goods.
- The second type is when the Importer has a period of 30 days from the date of receipt of all documents by the Issuing bank for the payment.
Benefits of Usance LC
- A Usance LC allows the Importer to defer payments so he can ensure that the goods are effectively and safely delivered before making the full payment. It also gives the exporter the guarantee of payment for his goods.
- Both the Advising and the Issuing banks charge certain charges for their services, and so these transactions contribute to their earnings as well.
- This mechanism assists in reducing risks, and so it promotes international trades.
- It paves the way for a reliable and wholesome relationship between the exporters and importers.
- The deferred payment makes it easier for the Importer to have better working capital management.
Usance Payable at Sight LC (UPAS LC)
UPAS LC consists of elements from both Usance LC and Sight LC. A Sight LC is a type of LC that ensures the payment for goods or services as soon as all the documents are presented to the Importer along with it. A Sight LC contains conditions that need to be fulfilled in order for the payment to be made.
Once those conditions are fulfilled, payment is made. If documents are required to be presented, then all necessary documents shall be presented to the Advising bank, and then immediate payment shall be made.
UPAS LC is a trade finance tool in which payment to the exporter is made on the basis of Sight, and the Importer shall make the payment to the Issuing bank on Usance terms. The exporter is paid immediately on the presentation of documents by the Issuing bank.
The Importer is given the time period as per Usance for making payments to the bank. It works effectively when the exporter asks for immediate payment, but the Importer is unable to facilitate it due to any reason. UPAS LC is preferable for both parties.
- Exporters receive their payments immediately from the bank, thus eliminating the debt period.
- Importers gain more time for payments without having to pay immediately, as in the case of Sight LC.
- This method works effectively when either of the parties does not agree on any other methods. This proves to be convenient for both parties.
- Importers do not have to worry about the quality of goods as the sellers are assured about their payment.
A Bill of Exchange is a negotiable instrument wherein one party promises the other party to pay a certain sum of money to them. It is called Bills Payable and Bills Receivables. It is mostly used in international trades.
Usance Bills are the bills for which the due date comes on a future date. Therefore, it is a document in which one party promises to pay money to the other party on a future date. The seller of goods draws the Bill, and so he comes to the drawer, and the buyer becomes the drawee. This instrument is useful in credit transactions.
The drawer also has the option of discounting the Bill with the bank before the due date. He can trade the Usance bill with the bank for money lesser than the amount of the Bill.
This difference in the amounts is called the discount. The discount is calculated by the bank. This mechanism gives the drawer benefit of immediate payment, and the drawee can make settlements with the bank on or before the due date. The bank takes into account the creditworthiness of the drawee.
Summing it up
Usance is generally more preferred by the buyer of goods as he can get instant delivery without having to pay for them at the time. The seller has to observe a debt period and has to manage with his scarce working capital through it.
So, the concept of Usance is more feasible in a buyer’s market. The seller can promote wholesale transactions by giving a credit period to his buyers. In the long run, it increases sales for the buyer, and it is also beneficial to the buyer if he is commencing a new business.
In international trade, the concept of Usance has been prevalent. With its many benefits to both exporters and importers, Letters of Credit are used and acknowledged by 175 countries worldwide.
Usance LCs are very useful for businesses that engage in large volume trades. They can also be useful to E-Commerce businesses that trade overseas and prevent disputes. It encourages prosperous relationships between countries trading overseas and improves their business partnerships.
Usance can prove to be helpful to Small or Medium Enterprises (SMEs) as well. Businesses have grown worldwide because of the trust and risk management that instruments like Usance provide to them.