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July 28, 2007
July 27, 2007
Banking System in Jordan
The banking system is comprised of 13 commercial banks (of which five are branches of foreign banks), five investment banks, two Islamic banks and one industrial development bank, in addition to a number of specialized credit institutions. The Central Bank of Jordan (CBJ) is the banking system’s regulatory agency. The banking law, which aims at enhancing competition within the banking sector, was inaugurated back in 1999. The new law was intended to protect depositors’ interests and diminishes money market risk, while allowing free market forces greater influence. In addition, the CBJ has set a deposit insurance scheme, which is currently in force.
Jordanian banks rely heavily on traditional banking activities, namely, the extension of direct credit facilities, as their main source of income. Although the central bank distinguishes between “investment banks” and “commercial banks”, there is no significant difference in operations between the two. Further, Jordanian banks have adopted modern banking practices such as automated check clearing, and use magnetic check processors, unified reporting forms and electronic data-transmission networks.
Credit facilities offered by banks include loans, discounted bills, and overdraft facilities. Investment banks are not permitted to extend overdraft facilities. The corporate bond market remains under-developed, and continues to be over-shadowed by traditional direct lending. One reason is rigid interest rates; another relates to poor incentives related to the marketing of corporate bonds.
The central bank permits banks to extend loans and credit facilities in foreign currency. In such cases, it requires debt repayment to be in foreign currency.
The CBJ is considering raising the minimum capital requirement for Jordanian banks to JD 50m, which will likely promote further consolidation within the banking system.
The Arab Bank and the Housing Bank are the two largest banks in Jordan, with an asset-base of JD 15.46 billion and JD 1.42 billion, respectively, as of the end of 1998. The difference between their asset bases owes to the vast difference in their scope of operations; the Arab Bank has a worldwide presence, while the Housing Bank’s prime focus is the local market.
An analysis of the credit market shows that over the last three years, 26% went to finance trading activities. Portfolio investors are the second largest recipients of credit at 20% of the total, while the construction sector ranks third at a 19% average share. Industry’s share out of the total is 13%.There are no restrictions on the flow of foreign currency for all commercial and capital transactions. (see chapter vii “conversion and transfer policies”).
General financing availability, terms of payment and insurance
To obtain project financing, banks require a comprehensive feasibility study, including a detailed cash flow analysis. Where larger projects are concerned, banks generally prefer to spread credit risk by syndicating the loan. The CBJ has stepped up its role as banking sector overseer, and has given greater attention to banks’ assets quality, particularly with respect to loan portfolios.
Conventional financing methods include overdrafts, one-year discounted loans, three-year loans with interest payable monthly, and syndicated loans for periods of one to seven years.
The United States Eximbank and the CBJ signed an agreement in 1996 allowing the private sector to import U.S. goods using Eximbank short- or medium-term credit guarantees. To date, this program has been under-utilized. More information on this program can be obtained at Eximbank’s web page at: http://www.exim.gov/country/ebd-y-35.htmlBanks with correspondent U.S. banking arrangements
All of the country’s banks maintain direct correspondence with U.S.-based banks. Each local Jordanian bank deals with at least two to three New York-based banks.(see list of licensed banks.)
IX. Business travelJordan has excellent air connections with other middle eastern countries, Europe and Asia. The national airline, Royal Jordanian, flies to several major cities in the U.S. major European airlines also have frequent connections to Jordan.
Most major hotels have business service offices with fax machines, Internet and e-mail. U.S.-based telephone calling cards such as AT&T, MCI and Sprint do not have local access numbers, and therefore do not function in Jordan. International calls must be made through the Jordan Telecommunications Company, which recently lowered its tariffs. Car rental facilities and airport-to-hotel shuttle buses are available. The climate is Mediterranean, relatively mild and very favorable compared to the gulf region and north Africa.
All rights reserved, J. Sifri Consulting Services, Banking Consultants www.graincon.comJuly 18, 2007
Standby Letters of Credit
Under Standby letters of credit, the beneficiary often receives payment by merely presenting a simple claim and a draft – prepared by the beneficiary himself - to the issuing or nominated bank that accepted to act in accordance with its nomination. In developed countries this is acceptable because even if the beneficiary’s claim is a fraudulent one, the efficient legal systems they have constantly provide the protection for the applicant; they can pursue the fraudsters quickly and efficiently. Unfortunately, the case is not so in most of the world’s countries where legal procedures are often lengthy, expensive and hardly efficient.
Standby Letters of Credit can never be quite as safe as commercial Letters of Credit and practically are not so popular in many parts of the world when it comes to import/export deals. Nevertheless, Standby letters of credit can effectively be used in a wider range of transactions that does not involve import/export deals. Frequently it is used as security for commercial lines of credit granted, for example a TV manufacturer may need to purchase on credit large quantities of electrical devices from another electrical devices manufacturer. The seller would agree to grant the TV manufacturer a line of credit if the later provides adequate security. The best security in this case is a standby letter of credit issued by a reliable bank on behalf of the TV manufacturer in favour of the electrical devices manufacturer (beneficiary) by which the beneficiary can regain the value of the goods supplied if and when the TV manufacturer fails to pay on due date.
While they can be structured in many different ways, standbys are typically used in situations like the TV manufacturer's: a bank promises to pay the seller of a good in the event that the buyer does not meet its payment obligations as defined in the original purchase contract. In exchange, the bank usually receives from the buyer a fee. In essence, the bank guarantees that the seller will be paid whenever the buyer defaults to pay.
Standby Letters of Credit can also be used as a secondary means of payment, or as a guarantee for performance, or as collateral in lieu of cash. Direct Pay standby letters of credit can also be used to make regular payments of interest or principal.
The standby letters of credit are used at vast scales in the western world. There is some $950 billion outstanding in standby Letters of Credit, of which $570 billion were issued by non-U.S. banks for the U.S. market; These figure exceed the exposure in the commercial LC market.
Often standby Letters of Credit are issued subject only to the Uniform Customs and Practice for Documentary Credits (UCP600) rules, which were developed specifically for commercial Letters of credit. More than half the UCP articles, however, do not apply to standby Letters of Credit. Hence, it is much more secured to issue standby letters of credit subject to the ISP98.
The ISP is a complete set of rules that represent the practice of international banks in handling standby LCs. It has been drafted by group of experts and sanctioned by the ICC, hence, it is globally recognized by all banks. Same as the new UCP600, the ISP98 includes definitions of terms. In addition, the ISP98 sets clear rules on procedures to follow when a standby LC requires presentation of documents by a certain day, and that day happens to fall on a non-banking day. Under Article 29 of the UCP600, this could cause confusion and even problems for many companies. The trouble arises when a standby LC is used to guarantee a monthly payment, say, on the 27th of every month. Sometimes, of course, the 27th will fall on a weekend, and according to the UCP, if the beneficiary waits until the following Monday to draw he not only loses the right to that installment but his entire right to draw on the LC -- the UCP only allows extending the last date for presentation for the first following banking day.
The ISP sets clear rules for use of standby LCs issued to secure repayment of an installment note that extends over a long period of time. Under the UCP, issuers have been known to deny payment of a standby LC if the buyer has already made a number of installment payments up to that point. Also, the ISP defines rules for transfer of beneficiaries.
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July 13, 2007
Standby LCs
In general, a standby letter of credit is a legal promise (undertaking), made by a bank (issuer) on behalf of one of its customers (applicant), to pay on demand a fixed sum of money, in parts or in whole, to a named beneficiary if and when the applicant fails to carry out a certain duty he owes to the beneficiary (defaults).
In other words, a bank that issues a standby letter of credit guarantees to cover the beneficiary for losses incurred as a result of the failure of applicant to perform his part of an agreement with the beneficiary (failure to perform one’s part in an underlying stand by agreement is normally referred to as a default situation. Ofcourse a standby does not necessarily have to depict a default situation, but for simplification purposes at this stage we will assume that it does).Hence, it can be argued that a standby LC in essence is a bank guarantee. This would have been true if it wasn’t for the following two major differences that distinguish one instrument from the other:
1. Unlike the guarantees, there is a special type of standby letter of Credit called Direct Pay which does not normally involve a default situation, although it may do so as we will see later on. A Direct Pay Standby LC bounds the issuer to pay, merely on demand, within the letter of credit’s validity period, a sum certain in money to the order of a specified beneficiary.
2. The standby letter of credit has evolved into a complex instrument that encompasses a much wider range of uses than that covered by the guarantees. On this point, it is worthwhile noting the following comment in the ICC Publication 511 Documentary Credits UCP500 and 400 Compared:
“…It was agreed unanimously that the Standby letter of credit is not to be merged with the bank guarantee rules regulated by the ICC’s Uniform Rules for Demand Guarantees (URDG), ICC Publication No. 458. While the Standby Credit is, from a legal point of view, equal to the demand guarantee, there are important differences between the two. The standby credit has developed into an all purposes financial support instrument embracing a much wider range of uses than the normal demand guarantee. For this reason, and since the UCP is the most suitable and compatible set of rules with the basic character of the standby credit, the link between the Standby Credit and UCP was maintained.”
Before we start interpreting the articles of the ISP98, going through the following hypothetical example on standby letters of credit will help the reader to form an over view of this important financial tool and assist him in understanding its mechanisms. A quick note; in real life cases, the text of Performance Standby LCs normally differs from the following one in that it contains more specifications as to the different phases required to consummate an underlying project and allows partial drawings.
Example
“Happy Seasons Supermarket” decided to move into larger premises. They chose to construct their own building to suit their specific storing requirements. To do so, they signed an agreement with “Solid Steel Building Contractors” to construct the desired new building. Amongst other terms, the agreement included the following condition:-
“Prior to the commencement of the construction of the building in question, “Solid Steel Building Contractors” must arrange for the issuance of a standby LC for the value of the contract i.e. USD 5,240,000.00 through a reputable bank allowing “Happy Seasons Supermarket” to draw said value if, and only if, “Solid Steel Building Contractors” fails to deliver the building ready for use on or before 20April2010, and/or fails to deliver the building in accordance with the specifications and terms of the signed agreement between them bearing reference JSCS 279 GTI.
Specifying the terms, “Solid Steel Building Contractors” instructed their bank “National Bank of Azaro” to issue a standby LC in favor of “Happy Seasons Supermarket”. National Bank of Azaro in turn issued the
following LC:
Issuer: National Bank of Azaro
Happy Seasons Supermarket
38 floor, Miami Square
Pierre Ducos Place
Yerevan – Armenia
2March2006
Dear Sirs,
We hereby issue our irrevocable standby letter of credit No. ANSBC7 by order of Solid Steel Building Contractors Ltd., Rasha Street - Terra Sancta Area, Armenia, for an amount of USD5,240,000.00 (five million two hundred forty thousand US Dollars only), which expires at out counter on 20April2010.
This credit is available by payment against presentation to us of the following documents:-
1. Your sight draft drawn on us (National Bank of Azaro) for the amount of your drawing.
2. Your certificate stating that you have effected payment to Solid Steel Building Contractor Ltd. in accordance with agreement number JSCS 279 GTI and were not delivered the building on 20April2010 per said agreement.
Partial drawings not allowed.
All charges under this standby letter of credit are for the account of beneficiary.
Except where otherwise expressly stated, this standby letter of credit is subject to the Uniform Customs and Practice for Documentary Credits (1993 Revision) ICC Publication No. 500. Please quote our reference number on any future correspondence.
Yours faithfully,
National Bank of Azaro – Armenia
From this example, we can deduce that Happy Seasons Supermarket were willing to grant their big project to the building contractors only if they received a reliable and legal assurance that the contractor will deliver the building in accordance with the contract agreement. This assurance was in the form of a standby LC by which a reliable bank, National Bank of Azaro in this case, undertook (legally promised) to honor (pay) any claim Happy Seasons make if the contractor fails to deliver what has been agreed upon (default situation).
Note here that the Happy Seasons Supermarket (beneficiary) need not prove that the contractor failed to deliver, all they need to do is to present a simple direct claim and a demand draft, the two documents are adequate to oblige the issuing bank to honor.
There are vast varieties of other uses for standby LCs. It may be issued by an importer in favor of an exporter to secure the latter’s right for payment if funds were not received directly from the importer. It may also be issued in favor of a bank in another country as a form of security for issuing a counter guarantee or a standby LC, or it may be issued as a form of securing a loan granted by a bank to a borrower. A seller can also issue a standby in favor of the buyer.
Now that we have generally introduced the subject, let us move to interpreting the provisions of each of the ISP98 articles:-
Read Rule 1.01 of the ISP98
This first provision of the ISP98 indicates the situations at which the rules apply (scope). Although the rules were specifically legislated for all types of Standby LCs, they may govern any other similar undertaking, however named or described, provided of course, an express reference to the rules is made in the text of the undertaking. Since we are examining the rules from a strictly banking perspective, this article will only discuss their use in situations related to standby letters of credit.
So subrule (a) states that the ISP98 is intended to apply to standby letters of credit. Subrule (b) clarifies that application of the rules to any standby letter of credit must be made clear by expressly referring to them in the text of the LC. Subrule (b) also allows subjecting undertakings similar to standby LCs to ISP98 – for example it is possible to issue a bank guarantee subject to ISP98, although demand guarantees have a separate set of official rules (URDG – Uniform Rules for Demand Guarantees). Such similar undertakings are called “standbys”, hence, there is a difference between a “standby letter of credit” and a standby.
Same as in all official DCs rules, it is possible to modify or exclude the application of any provisions in these rules by expressly demanding so in the text of the undertaking; subrule c so states.
Subrule a segregated standby LCs into three different types; performance standby letters of credit, financial standby letters of credit and direct pay standby letters of credit. Performance standby LCs are those under which the applicant is required to perform a non-monetary obligation, same as the building contractor in the example explained above. Conversely, the standby letters of credit that require the applicant to pay a financial debt owed are named financial standby LCs.
Direct Pay Standbys are those obligating the issuer to pay principal, interest or both when a financial instrument becomes due. These standbys can also cover a default situation. They are commonly used in issuing financial instruments like treasury bonds and other securities. The default coverage is meant to protect against insolvencies of the issuer of the securities.
Subrule (b) uses the words “however named or described” indicating that the name/designation of a standby LC is irrelevant. It is only the nature of the undertaking that determines its function as a standby LC. This rule was initiated to cover situations where terms such as “Letter of Credit”, “Documentary Letter of Credit”, “Commercial Letter of Credit” or “guarantee” are used to describe a standby LC, which is common in some places.
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