What is a letter of credit? This is a bank promise issued in the name of the buyer, with which all documents provided by the seller are to be paid, provided all contractual conditions are met. Irrevocable letter of credit – cashless payment that represents a payment guarantee. All documents of the seller are checked according to international standards. Letters of credit are an agreement between the seller and the buyer intended to ensure a balance between them when a company first conducts a foreign trade transaction or dominates a new market.
The main difference between letters of credit from all other calculation methods – only documents in circulation are used, not the goods that these papers deliver. The banks only take into account the documents mentioned in the letter of credit and do not observe any other contracts (contracts and other agreements between buyer and seller). This is not only an obligation, but also the conditions laid down by the buyer and given to the bank in writing, as well as an application for the opening of a letter of credit.
What is a letter of credit? Points of the agreement
The documentation should state the following:
- Number and date;
- Type of letter of credit;
- Information on the recipient, the payer, the issuing bank and the executing organization;
- the duration of the documents;
- Purpose of payment;
- the need for confirmation;
- List of documents and requirements for this;
- Procedure for paying commission fees from banks.
A letter of credit can solve a problem if the seller refuses to ship the goods without a payment guarantee and the buyer does not want to give any money until he has confidence in the delivery of the delivery in accordance with the terms of the contract.
We have already found that letters of credit are the bank’s payment obligations for all documents provided by the seller and the dismantling of the information contained therein. Now consider the types of letters of credit:
- Revocable. The terms can be changed, it is easy to cancel them without notifying the seller.
- Irrevocably. This cannot be overturned and their terms will only change with the consent of all parties.
- Transferable. The seller, not the supplier of the entire consignment, transfers all or part of his own rights to money to third parties and is accompanied by the executing bank.
- Standby letters of credit – it is a guarantee of payment security if the buyer does not meet his own contractual obligations.
- Spinning. Used for regular deliveries of products. The amount of the letter of credit is automatically replenished if payments are made within the specified limit and its validity period.
Letters of credit are a guaranteed document
Absolutely the entire amount paid by the buyer, careful monitoring of compliance with all contractual terms, full reimbursement in the event of cancellation of the transaction, and the banks’ legal liability for the legality of the transactions in which the letter of credit is used. The disadvantages include complexity the documentation and the high cost of this payment method for a foreign trade business.