Letter of credit - what is it? This is the obligation of the bank to make, on behalf of the client and at his expense, payments to individuals and legal entities within the indicated amounts and on the conditions specified in the instruction. The main feature in the calculation of letters of credit is that banks deal only with documents, and not at all with the goods that these securities represent.
What are the main advantages of a letter of credit?
The advantages of a letter of credit are, as a rule, in the following:
- Guaranteed receipt of the amount to the supplier from the buyer.
- Monitoring compliance by the bank with the terms of delivery and a letter of credit.
- Non-diversion of funds from economic turnover.
- Providing a full and guaranteed refund to the buyer upon cancellation of the transaction.
- The presence of legal liability of credit organizations for the legality of the transaction in which the letter of credit is applied.
What are the disadvantages of the letter of credit settlement scheme?
disadvantages
The list of shortcomings is small, and it is difficult to call them significant. They are as follows:
- The presence of some difficulties associated with a large number of documents at various stages of processing a letter of credit.
- Some additional costs that go to the bank commission.
Features
The application of the letter of credit settlement scheme should be spelled out in the agreement between the seller and the buyer. The calculation scheme is set in the main contract, which reflect:
- Name of the issuing bank and the structure serving the payee.
- Indication of the name of the recipient of funds and amount, as well as the type of letter of credit.
- Variant of notification to the recipient regarding the opening of the letter of credit.
- Message to the payer of the account number for the deposit of funds, which is opened by the executing bank.
- A complete list along with an accurate description of the documents that are provided by the recipient.
- Period of validity of a letter of credit and requirements for paperwork.
- Payment terms along with liability for default.
In addition, the contract may reflect conditions that relate to the settlement procedure.
Types of letters of credit opened by banks:
- covered, or deposited, at the opening of which the amount of the letter of credit is transferred to the executing bank;
- uncovered, or guaranteed, while the amount of the letter of credit can be written off by the performing bank from the main correspondent term;
- revocable, which can be canceled or changed based on the order of the payer; cancellation of a letter of credit or approval of preliminary changes with the recipient of funds will not be needed. When the letter of credit is canceled, the bank that is the issuer does not bear any obligations to the recipient;
- irrevocable letters of credit can be changed or canceled only after agreement with the executing bank and the recipient of funds.
Settlements under a letter of credit: scheme
The procedure for calculating letters of credit, as a rule, is as follows:
- Conclusion of a contract for the supply of goods.
- Providing a buyer's order to open a letter of credit to the issuer and the procedure for its launch.
- Notification of opening from the issuer to the advising bank.
- Conducting shipment of goods.
- The process of transferring shipping documents to an advising agency from a seller.
- Forwarding of documentation and requirements from the advising financial institution to the issuer.
- Write-off of funds from the customer account.
- Transfer of finance from the issuer to the performing bank.
- Transfer of papers to the buyer.
- Crediting funds to the seller’s account.
Letter of credit of Sberbank when buying real estate
You can never be completely confident in an outsider, especially when it comes to transactions for a large amount. Sberbank offers its customers to take responsibility for the outcome of important transactions and guarantees security for each side. Buyers are confident that they will receive the goods, and sellers do not doubt the payment. A letter of credit of Sberbank when buying real estate is considered a unique opportunity to avoid numerous risks and not be a victim of dishonest customers.
This is one of the frequent services that this financial institution provides. Its essence is to provide additional guarantees to citizens participating in the transaction. This type of calculation is appropriate and very beneficial in a number of the following cases:
- As part of the sale and purchase of real estate, including mortgage lending.
- Against the background of the exchange of real estate.
- When conducting a sale or purchase of valuable property, whether it is a vehicle, jewelry, securities, a share in the business and more.
- To pay for expensive services.
The principles of interaction of each of the parties to the transaction, which prefer a bank letter of credit as a method of payment, is as follows:
- They draw up a contract in which they stipulate the rights with the obligations of the parties, the subject of the agreement, the timing of the fulfillment of obligations, as well as the price of the issue.
- The agreement is signed in writing by both parties (or their official representatives).
- Further, the buyer makes a money transfer to a special open savings account for these purposes with Sberbank in the amounts referred to in the contract.
- After the seller fulfills his obligations according to the signed agreement, and the buyer transfers the required amount to the account, Sberbank will transfer the funds to the seller.
Often, a letter of credit is used by citizens who are directly involved in transactions with a particular property. The acquisition of this type of property is a rather large purchase, and, as a rule, a considerable sum of money is at stake. In order for the transaction to succeed and all obligations to be fulfilled, the parties apply to Sberbank within the deadlines established by the agreement for the purpose of issuing a letter of credit.
What is the essence of letters of credit for individuals?
They can be used to perform the following operations:
- Real estate transactions.
- The implementation of the purchase and sale of goods.
- Performing all kinds of work and services.
Distinguished covered letters of credit, in which the financial institution transfers the amount at the disposal of the executing bank. In addition, there is an uncovered type, in which the issuer does not transfer funds, but makes it possible to write off money from a correspondent account within the established amount.
Sales contract: basic concepts
A purchase and sale agreement with a letter of credit formalizes the transaction using a safe and convenient way from the point of view of having an additional guarantee for the parties regarding the fulfillment of their obligations by the scheme.
When settling, the issuer, on behalf of the payer and in accordance with his instructions, assumes a unilateral obligation to transfer money to the recipient, provided that the latter submits to the financial institution appropriate documentation that meets the requirements.
The contract of sale, in which the letter of credit is indicated as a form of settlement, is made in accordance with the existing requirements. This letter of credit payment strategy can be applied to any trade transaction. For example, the practice of using a letter of credit in real estate transactions and the supply of goods is very common.
How to open this account?
In order to apply the forms of settlements under the letter of credit between the parties to the transaction, it is required to draw up an appropriate agreement. It is compiled on a documentary basis, and the form of settlements is mandatory indicated. The agreement usually includes the following clauses:
- Name of each party to the transaction (supplier and buyer).
- Types of settlements and their variety (for example, an uncovered irrevocable letter of credit).
- The amount of funds that will be transferred to the supplier as part of the terms of the agreement.
- The terms for which the contract is concluded and the amount of the commission.
- The procedure for making payments (immediately the whole amount or advance payments).
- Actions of the parties in case of failure to fulfill the conditions for which the payment letter of credit was applied.
- The rights of participants along with their responsibilities.
Statement
How to open a letter of credit, it is important to find out in advance. In order for the signed agreement to enter into force, the buyer must contact the bank and draw up a statement indicating the letter of credit settlement form. The statement also indicates:
- A reference to the agreement according to which a letter of credit will be used between the parties.
- The name of the institution of the supplier, as well as its details of the register.
- Indication of the type of transaction and the amount due to the seller.
- The terms of the agreement and the method of realization of the letter of credit (whether it is an advance or all the money, as well as under what conditions they can be relied upon).
- The name and number of goods whose supply is indicated in the contract (or maybe it is about services or some kind of work).
- The name of the banking institution that will fulfill the obligations.
- A list of documentation that will be accepted by the bank as part of the confirmation of the agreement.
From the moment of registration and signing of the application, the letter of credit enters into legal force. The completed type may be extended for new terms by mutual agreement of each of the parties.
What is the difference between letters of credit and a bank cell?
Many customers often ask this question. The following must be considered:
- A bank cell is the best option to guarantee the security of the transaction as part of the settlement between the parties to the agreement using cash.
- The letter of credit acts as an additional guarantee for the parties to the transaction, provided that a non-cash transaction is performed between them. Funds upon fulfillment by the parties of the obligations stipulated in the agreement are saved in non-cash form in a savings account, which the client opens specially for these purposes. After the seller successfully fulfills all the terms of the transaction, the bank transfers the buyer’s funds to the seller.
Thus, the difference is that the latter involves cashless payments, rather than cash.
We examined the scheme of settlements under the letter of credit.