What is a letter of credit? This is an issued obligation of the bank on behalf of the buyer, aimed at paying for all documents provided by the seller, if all the conditions of the contract are met. An irrevocable letter of credit is a non-cash form of payment, which is a guarantee of payment. All documents of the seller are checked in accordance with international standards. Letters of credit is an agreement between the seller and the buyer, designed to ensure a balance between them in the case of the enterprise conducting a foreign trade operation for the first time or developing a new sales market.
Features
The main difference of letters of credit from any other calculation methods is that only documents are used in circulation, and not the goods that these papers provide. Banks only consider the documents mentioned in the conditions of the letter of credit, they do not pay attention to other agreements (contracts and any other agreements between the buyer and seller). This is not only an obligation, but also the conditions defined by the buyer and provided in writing to the bank along with an application for opening a letter of credit.
Letter of credit - what is it? Clauses
The documentation should indicate:
- number and date;
- Amount
- type of letter of credit;
- details of the recipient, payer, issuing bank, as well as the executing organization;
- way of execution;
- validity;
- deadline for submission of documents;
- purpose of payment ;
- need for confirmation;
- list of documents and requirements for them;
- procedure for paying a commission of banks.
A letter of credit can solve the problem when the seller refuses to send the goods without a guarantee of payment, and the buyer does not want to give the money back until he is sure that everything is delivered in accordance with the terms of the contract.
Kinds
We have already found out that letters of credit are the bank’s obligations aimed at paying for all the documents provided by the seller, and we also sorted out what should be indicated in them. Now consider the types of letters of credit :
- Revocable . The conditions are subject to change, it is easy to cancel without notifying the seller.
- Irrevocable . It is impossible to cancel, and any of its conditions is changed solely with the consent of all parties.
- Transferable . The seller, not the supplier of the entire batch of goods, transfers his own rights to receive funds in whole or in part to third parties and accompanies the executing bank with the necessary instructions.
- Stand-by letters of credit is a guarantee of payment security in the event that the buyer does not fulfill its own obligations specified in the contract.
- Revolving . Used in regular deliveries of products. The amount of the letter of credit is replenished automatically as payments are made within the established limit and its validity period.
Pros and cons
Letters of credit - it is guaranteed to receive absolutely the entire amount from the buyer, careful monitoring of compliance with all conditions of the contract, a full refund upon cancellation of the transaction, as well as the legal responsibility of banks for the legality of operations where the letter of credit is applied. The disadvantages include difficulties with documentation and the high cost of this form of settlement for a foreign trade transaction.