LC margin Definition ,How it calculation? -by corporate practice bd
LC margin, also known as Letter of Credit margin or LC margin requirement, refers to the percentage of the total value of a Letter of Credit (LC) that the buyer or importer must deposit with their bank as collateral or security. It serves as a guarantee to the issuing bank that the buyer has the financial capacity to fulfill their obligations under the LC.
Here's how LC margin works:
Letter of Credit (LC) Issuance:
The buyer and seller agree to use a Letter of Credit as the payment method for their international trade transaction. The buyer applies for an LC from their bank (the issuing bank), which acts as a guarantee of payment to the seller.
Margin Requirement:
The issuing bank requires the buyer to deposit a certain percentage of the total LC value as margin or collateral. This margin serves as security for the bank in case the buyer fails to fulfill their payment obligations under the LC.
Calculation of Margin:
The margin requirement is typically expressed as a percentage of the total LC value. For example, if the LC value is $100,000 and the margin requirement is 5%, the buyer would need to deposit $5,000 as margin with their bank.
Use of Margin:
The margin deposited by the buyer remains with their bank until the LC is fully utilized or expired. It cannot be accessed or withdrawn by the buyer during this period unless authorized by the bank.
Release of Margin:
Once the buyer fulfills their payment obligations under the LC, the margin is released back to the buyer by their bank. If the buyer defaults on payment, the issuing bank may utilize the margin to cover the payment to the seller.
Risk Mitigation:
The margin requirement helps mitigate the risk for the issuing bank by ensuring that the buyer has a financial stake in the transaction. It provides assurance to the seller that payment will be made, even if the buyer defaults, as the bank can use the margin to fulfill the payment obligation.
In Finally:
Overall, LC margin serves as a mechanism to mitigate risk and ensure the smooth execution of international trade transactions involving Letters of Credit. The specific margin requirement may vary depending on factors such as the creditworthiness of the buyer and the nature of the transaction.