Letters of Credit & What You Need to Know
Letters of credit are fundamental components of international tradeWhat is a Letter of Credit (LC)?
Most of the trade in the world is carried out internationally. In order to facilitate this a business requires trade agreements with their partners and counterparts. Trust is incredibly important when agreeing payment terms. Putting this on the scale, at the riskier end, trade can be completed on open account terms, where the risk of the seller bares the risk of not being paid. A letter of credit (LC) mitigates against the risk.
A letter of credit is relevant when there is an exporter and an importer requiring pre-payment or confirmation of payment in order for goods to be shipped.
A letter of credit is an instrument from a bank, which guarantees buyers payment to a seller if certain criteria are met. If the buyer cannot pay for the trade received, due to the agreed contract with a letter of credit, the bank will cover the remaining price.
Letters of credit are fundamental components of international trade. They are governed universally by a set of guidelines called UCP 600, which are issued by the international Chamber of Commerce.
A letter of credit is a promise written on a legal document that comes from a bank with a promise to pay the holder if the holder fulfills certain obligations. Obligations include payment when the goods are shipped if certain criteria are met. A letter of credit is usually used when the buyer and seller do not have an existing relationship, which is why it is used frequently on international trade.
Letters of credit are incredibly specific and a close attention to detail is required. If there is a misspelling in the contract of the name of the goods there may be a non-payment, until a new corrected letter of credit is issued and accepted.
Why Are Letters of Credit Used?
The Advantages of Letters of Credits
Buyer
Certain to receive the goods as stipulated in the letter of credit and without the requirement of paying for the goods upfront.
Seller
Protected against non-payment with the risk of non-payment being transferred from the seller to the bank (or banks).
How is Payment Collected on Letters of Credit?
To receive payment the beneficiary must present documentation of completion of their part in the transaction to the issuing bank and must present documents such as; invoices, Bills of exchange or Government Documents.There are several different types of letters of credit, each with differing purposes.
Irrevocable Letter of Credit
The irrevocable letter of credit allows cancellation or amendments to the letter of credit by the buyer. Notably the irrevocable letter of credit can only be processed the buyers bank, seller and the sellers bank agree.
Confirmed Letter of Credit
A confirmed letter of credit, is a second letter obtained by the borrower, from a second bank. The second bank promises to pay the seller if the first bank fails to do so.
Transferable Letter of Credit
A transferable letter of credit allows the first beneficiary to transfer some or all of the credit to another party, which creates a secondary beneficiary. ... an alternative option to advance payments.
Letter of Credit at Sight
Letters of credit at sight are payable as soon as the agreed documentation has been presented and verified, providing protection for the buyer and the seller.
Usance Letters of Credit
Defferred or usance letters of credit means that the payment to the seller is delayed until an agreed period of time has passed.
Red Clause Letter of Credit
A red clause letter of credit permits the seller to receive partial payment from the issuing bank prior to shipping products or performing the services.