Letters of credit are instructions from the paying bank to the receiving bank to make payments to individuals or legal entities of funds within a specified amount under the conditions specified in this instruction. This is the general definition of the term. It should be considered in more detail to have a complete understanding.
Basics
When it comes to establishing new partnerships between organizations and enterprises, individual entrepreneurs and individuals, a completely logical question arises: how not to face the loss of money when concluding a transaction with an unfamiliar company and subsequent settlements with it? Everyone wants to insure their business against dishonest or unscrupulous partners, especially when it comes to large sums of money or long deadlines. In this case, the answer is quite simple: you can use letters of credit. This is a convenient form of interaction, but due to its complexity, few people use it. A bank client who once took the time to carefully study this form of interaction begins to use it and rarely abandons it. So, letters of credit are a form of payment that involves the work of two banks, while non-compliance with the terms of contracts concluded earlier, both on the part of the product supplier and the buyer, is completely excluded. The result of this is security for both parties.
Character traits
Letters of credit are the safest form of mutual settlements between clients. We can give an example where the use of such a form of mutual settlements allowed all participants to benefit. In Soviet times, the majority of consumers of caustic soda switched to a letter of credit form of interaction with the enterprise, which at that time was on the verge of bankruptcy. Although the company was on the verge of bankruptcy, it still continued its activities. The bank credited funds to the current account under the letter of credit only after the supplier company provided the necessary documentation in accordance with the payers’ instructions and concluded contracts. The documents provided were thoroughly checked. It was the letter of credit that gave the parties confidence. What it is can be described in simple terms like this. Consumers receive confidence that if there is no shipment at the right time, payments will be successfully returned to their accounts, and the plant that produces the goods receives confidence that the next consumer will not be left without payment.
How it works?
Letters of credit are settlement documents on paper, on their basis the bank, which acts on behalf of the payer to open a letter of credit, undertakes obligations to make payments in favor of recipients of funds when the latter is provided with documents that comply with the terms of the concluded contract, or transfers authority to the second bank to make such payments.
In the case of using this form of mutual settlements, it is very important to choose the most suitable type. Any types of letters of credit are opened by banks in accordance with the instructions of the payers, therefore, the selected type is indicated in the draft agreement. All existing forms are prescribed by regulations of the Central Bank of the country. In the case of the Russian Federation, there is a Regulation that sets out the possibility of opening the following types of letters of credit:
- covered (deposited);
- uncovered (guaranteed);
- revocable;
- irrevocable;
- confirmed (revocable or irrevocable).
You can consider each of them separately for a better understanding of their essence.
- A covered bank letter of credit is a form in which, upon opening, the issuing bank transfers the amount at the expense of the payer to the executing financial institution for the entire term of the agreement. This type is the most common.
- Next, you can consider an uncovered letter of credit. What it is can be described in simple terms like this. When opening a letter of credit, the issuing bank does not transfer funds, but gives the executing bank the right to write off funds from the correspondent account maintained by it, within the agreed amount. The procedure for debiting funds from an account with the issuing bank is determined depending on the existing interbank agreement.
- A revocable letter of credit is a form of interaction that can be modified or canceled by the issuing bank based on a written order from the payer. In this case, no prior approval is required from the recipient of the funds, and any banking circumstances are not specified to the recipient of the funds in the event of a payment revocation.
- An irrevocable letter of credit is an agreement that can be canceled only from the moment the executing bank receives consent to change the conditions from the recipient of the funds. Partial acceptance of the terms of an irrevocable letter of credit is not permitted.
- A confirmed letter of credit is a form of interaction in which the executing bank undertakes obligations to make payment of the amount specified in it, regardless of the receipt of bank funds. The order in which confirmation is made depends on the agreement between the banks.
Additional varieties
At the moment, there are several other types of letters of credit, which are variations of those described above.
A letter of credit with a red clause is an agreement under which the issuing bank authorizes the executing bank to make an advance payment to the supplier of products in an amount specifically agreed upon before all the necessary documents are presented to them, that is, until the goods are shipped or the service will be provided.
There is also such a type as a revolving letter of credit. What this is can be described in simple language as follows. This is a letter of credit that is opened for a portion of payments from the total amount under the concluded contract, automatically renewed as payments are made for the next batch of goods or services provided. The opening of a revolving letter of credit is carried out with uniform deliveries, which are spread out over time in order to cyclically reduce the contract amount.
In one of these ways, the recipient of funds has the opportunity to refuse to use the letter of credit before its expiration, if the terms of the concluded agreement generally provide for the possibility of such a refusal. In addition, the conditions may specify acceptance by a person authorized by the payer.
Payments using letters of credit
Contracts clearly state the procedure and method of making payments for the provision of services and the supply of goods, performance of work and other activities, and also indicate the form of payment. When it comes to using a letter of credit form of mutual settlements, the agreement must necessarily reflect certain conditions: the names of the banks with which interaction is carried out are indicated; the name of the recipient of the funds is indicated; amount and type of letter of credit; the method of notifying the recipient that the letter of credit has been opened; a method of notifying the payer about the account number on which the funds will be deposited; validity; terms of payment and liability for non-fulfillment.
Often contracts contain other conditions that relate to the payment procedure. For example, partial payments may be provided. Payments are made in cashless form by transferring the agreed amount of the letter of credit to the recipient's account.
It is important to note that for violations that may be committed during the execution of the letter of credit form of mutual settlements, banks are held liable in full accordance with current legislation. If this is taken into account, then it can be understood that the executing bank will not accept unfinished documents that serve as evidence of the delivery of goods, provision of services or performance of work.
Settlement procedure
As described earlier, a letter of credit turns out to be a convenient form of interaction in many situations. The procedure is not particularly complicated. Settlements in this way can be made between legal entities, between individuals and legal entities.
Calculation algorithm for the recipient
- A letter of credit should be included as a form of payment under the terms of the concluded agreement.
- After this, you need to contact the bank office where your organization is serviced to fill out an application for opening a letter of credit. The bank must be provided with a copy of the agreement for the supply of goods or provision of certain services.
- Upon delivery of goods to the bank, you are required to provide a package of documents that confirm it. Each transaction uses its own list of documents, which must be specified in the agreement concluded when opening a letter of credit.
- If the transaction does not take place and the documents were not provided to the bank after the expiration of the letter of credit, then the entire amount is returned to the recipient’s account.
Advantages
Using any form of letter of credit, you can get a whole range of advantages, including the following. Risk reduction is ensured by the fact that after submitting a package of supporting documents to the bank, the seller will receive funds regardless of the financial condition of the seller. The terms of mutual settlements can be determined independently. The parties to the transaction have the right to change the terms of the letter of credit or completely refuse it in case of mutual agreement.
International practice
International letters of credit represent the most civilized terms of payment, which are widely used in payments at the international level. If we speak from the position of protecting the interests of the parties involved, then such conditions of interaction can be called ideal. For international settlements, there are certain rules that should be considered. So, what letters of credit are has been described in detail earlier, but how do they work in the case of international relations? At the moment, there is a list of unified rules that spell out all the features of the process.
In the system of international mutual settlements, only one form is most often used - a simple covered irrevocable documentary letter of credit. The advantages of this method of calculation were described earlier, however, in the case of such interaction, certain disadvantages can be identified.
Difficulties of the international procedure
In such a transaction there are four parties, and not two, as in ordinary mutual settlements. In addition to the customer and the supplier, the customer’s bank and the supplier’s bank are also involved. This will be difficult for a novice participant in foreign economic activity to understand.
Requirements for documents and deadlines
This form of payment always requires strict adherence to deadlines, documentation requirements, and also complicates the registration procedure. Whenever the deadline for the fulfillment of obligations by any participant in the transaction changes, documentary evidence with the signatures of all parties is always required. In addition to the contract between customers and suppliers, additional exchange of documents is required between banks. Despite the fact that now this is all done electronically and happens instantly, this requires time, as well as control of all procedures performed.
Letter of credit cost
Another disadvantage is the cost of this form of payment. From the moment the letter of credit is opened, the buyer’s funds are frozen in the bank account, and coverage of the letter of credit or a fee for a bank guarantee in the case of an uncovered letter of credit is generated. A supplier who does not have the funds to purchase materials for production has a need for borrowed funds, for which the buyer also ultimately pays. Banking fees apply for all transactions involving letters of credit.
Afterword
So, now that you have an idea of what letters of credit are, you may think that it is very complicated, but when you decide to go through the entire procedure step by step, you will understand that this form of payment is quite convenient and reliable. When you choose a reputable bank, most of the work will be done for you. When working with foreign partners, using a letter of credit will allow you to declare yourself as a specialist, which will arouse respect for your entire company.
Application letter of credit payment form parties to any transaction allows reduce your risks as much as possible: the buyer is guaranteed to receive goods (works, services), the seller is guaranteed the timely receipt of funds to his current account.
In such calculations, the bank undertakes to make payments in favor of the recipient of the funds upon presentation by the latter of documents that meet all the conditions of the letter of credit.
Thus, in settlements under a letter of credit the following parties are participants:
- buyer (payer);
- issuing bank (payer bank) - opens a letter of credit;
- seller (recipient of money);
- executing bank (seller's bank) - executes the letter of credit.
The executing bank may be the issuing bank, the recipient bank, or another bank.
JSC "NS Bank" offers preferential rates for servicing letters of credit in case of combining the functions of the issuing bank and the executing bank.
In practice, letters of credit are opened - covered, irrevocable, with or without acceptance. When opening covered letter of credit the issuing bank transfers the amount of the letter of credit (coverage) at the expense of the payer's money (or the loan provided to him) at the disposal of the executing bank for the entire validity period of the letter of credit. Irrevocable a letter of credit is recognized that cannot be canceled without the consent of the recipient of funds.
Briefly, the document flow when paying with a letter of credit can be presented as follows:
1. The buyer (payer) and the seller enter into an agreement, which states that payments under it will be carried out using a letter of credit. A letter of credit is intended for settlements with one recipient of funds. The contract concluded between the buyer and supplier must include the following details and conditions:
- name of the issuing bank;
- name of the bank serving the recipient of funds;
- name of the recipient of funds;
- letter of credit amount;
- type of letter of credit;
- method of notifying the recipient of funds about the opening of a letter of credit;
- method of notifying the organization about the account number for depositing funds opened by the executing bank;
- a complete list and precise description of the documents submitted by the recipient of funds;
- validity period of the letter of credit;
- deadline for submitting documents confirming fulfillment of the terms of the letter of credit;
- payment terms (with or without acceptance);
- liability for non-fulfillment (improper fulfillment) of obligations.
The main agreement may also include other conditions relating to the procedure for settlements under the letter of credit.
2. The payer contacts the issuing bank, with which it enters into an agreement and submits an application to open a letter of credit. The bank requests an account for settlements under the letter of credit from the nominated bank and communicates it to the payer.
3. The issuing bank transfers the cover amounts of the letter of credit to the nominated bank. The executing bank notifies the seller (recipient) of the receipt of money. The recipient cannot dispose of these funds.
4. The issuing bank informs the recipient of funds about the opening of a letter of credit and its conditions through the executing bank.
5. The next step is the opening of the letter of credit. The seller fulfills the terms of the agreement and submits to the executing bank documents confirming the fulfillment of the agreement, as well as four copies of the register of accounts, form 0401065 (Appendix 21 to Regulation 2-P). The bank checks these documents and, if everything is in order with them, credits the amount of the letter of credit to the bank account of the recipient of the money.
Payment under a letter of credit is made by bank transfer by transferring the amount of the letter of credit to the account of the recipient of the funds. Partial payments under the letter of credit are allowed.
The supplier receives the money only after he submits documents within the established time frame confirming the fulfillment of all the terms of the letter of credit.
When concluding new transactions between individuals and individual entrepreneurs, organizations and enterprises, the question often arises: “How to insure against dishonesty of counterparties and avoid loss of money or goods?” This issue is especially relevant when payment for goods is made in advance. At the same time, the risks increase if the contract is concluded for a significant amount with foreign partners. The solution is simple - use letters of credit for payments. Not everyone knows what a letter of credit is. However, having studied all the intricacies of this type of settlement, clients feel more secure and confident in carrying out large transactions.
Letter of credit: what is it in simple terms?
A letter of credit is a form of non-cash payment that is carried out under the control of two banking organizations. The bank, which protects the interests of the buyer, transfers money to the account of the seller of products (services) only if the seller provides the necessary documents to the bank. The list of documents is drawn up at the conclusion of the transaction and is stated in the contract.
The interaction between partners can become a little more complicated, it all depends on the type of letter of credit. Despite this, the banking organization acts as an intermediary who, for a fee, ensures the execution of the transaction.
Advantages of a letter of credit for the buyer
Settlements using a letter of credit, compared to other forms of payment, have advantages for the buyer:
- money is transferred to the seller only after delivery of the goods to the buyer is completed - for this it is necessary to provide the bank with the entire necessary list of documents compiled properly;
- if delivery is not made, the money is returned to the buyer within a predetermined time frame;
- the bank guarantees that the goods will be delivered in the agreed volume and assortment, as well as of proper quality, since the seller is obliged to provide bank employees with documents confirming the assortment, quality and quantity of the goods;
- the risk of negative tax consequences of the transaction is reduced - the bank guarantees the correct execution of the documents accompanying the transaction, otherwise the bank will not transfer the money to the seller’s account;
- settlements under a letter of credit can be provided by the bank on credit on favorable terms for the buyer - this allows not to withdraw a large amount of funds from circulation to pay for the transaction.
Scheme of using a letter of credit
We found out what a letter of credit is. Now let's figure out how transactions with this form of payment work in practice.
Stage 1. The seller and buyer sign a contract (purchase/sale agreement, supply of goods, provision of services), the terms of which specify the form of payment under the letter of credit, as well as the conditions for its disclosure.
Stage 2. The buyer submits an application and a copy of the contract to the bank. Based on the documents provided, the banking organization opens a letter of credit. If necessary, a letter of credit can be confirmed by the seller's bank if these requirements are provided for in the contract.
Stage 3. The coverage of the letter of credit is formed either at the expense of the client-buyer, or on the basis of a loan provided to this person by the issuing bank.
Stage 4. The seller delivers the goods and sends properly executed documents to the bank. After the bank verifies that all conditions have been met, a letter of credit is opened and the seller receives payment.
Stage 5. The buyer receives the goods and all accompanying documents.
This scheme is simple and transparent. The issued letter of credit acts as a guarantee of payment for the supplier, and for the buyer it reduces the risk of losing money, as is the case with prepayment to an unknown counterparty. At the same time, the bank accompanies the transaction, checking its purity.
Types of letters of credit
The regulations of the Central Bank of the Russian Federation stipulate the possibility of opening the following types of letters of credit:
- A covered (deposited) bank letter of credit - what it is, can be described in simple terms as follows: the buyer opens an account with the bank and transfers funds to it in the amount necessary to cover the letter of credit. The issuing bank transfers the amount to the correspondent account of the financial institution where the seller's account is opened. This is the most common type of payment under letters of credit.
- Uncovered (guaranteed) letter of credit - the issuing bank does not transfer funds to the executing bank, but provides the opportunity to write off funds from the account opened with it, within the amount specified in the contract. The procedure and timing of debiting funds from the account of the issuing bank occurs in accordance with the existing interbank agreement.
- Revocable is a documentary letter of credit that can be revoked, amended or canceled by the bank on behalf of the payer without the consent of the supplier and even without his prior notice.
- Irrevocable is a type of contract that can be canceled only after the executing bank receives consent to change the conditions from the supplier of the goods. There is no partial acceptance of the terms of an irrevocable letter of credit.
- Confirmed – a form of interaction that implies an additional guarantee of payment from a bank that is not the issuer. The financial institution undertakes to make payment for the goods (services), even if the issuing bank refuses to make the payment. This form of interaction applies only to an irrevocable letter of credit. An additional fee to the bank is required for confirmation.
Additional varieties
Today there are several other types of letters of credit. They are variations of those described above.
A documentary letter of credit with a red clause is an agreement under which the executing bank receives the authority from the issuing bank to make an advance payment to the supplier of the goods in the amount specified in the contract until the goods are fully delivered or the service is rendered in full.
Revolving type - opens when the contract provides for several deliveries of approximately equal value in parts over a certain period of time. A letter of credit is opened for an amount equal to one delivery, with the condition that after each payment, the original amount will be restored to the account. In parallel with this, the contract amount will decrease cyclically.
Transferable letter of credit – makes payments not only in favor of the seller, but also in favor of third parties (suppliers). This type is used when the seller delivers through a supplier and is not the direct shipper. The third party, having shipped the goods to the specified address, provides the necessary documents to the executive bank, after which all previously agreed payments are made in his favor.
Which type of letter of credit should I choose?
As a rule, participants must independently determine the form of the letter of credit and agree on it with the bank. The main factors influencing the choice of a letter of credit are the terms of the transaction and the interests of the parties. To do this, you need to understand exactly what a letter of credit is and which of its forms are used in our country.
At the moment, Russian legislation in matters of settling non-cash payments lags somewhat behind our Western neighbors, so you can focus on the international rules for documentary letters of credit developed by the International Chamber of Commerce.
It is worth considering that not every bank is ready to agree to non-standard terms of a letter of credit. This is due, to a large extent, to the lack of qualified specialists in this field. Therefore, before including non-standard conditions in the main agreement, you need to agree on them with the banks of the recipient and payer of funds.
Participants in mutual settlements
In order to choose this form of payment, it is not enough to know what a letter of credit is. You must also understand that, like any other form of non-cash payment, it has its drawbacks.
This transaction involves not two parties, as in ordinary mutual settlements, but four. In addition to the seller and the buyer, the seller’s bank and the buyer’s bank are involved here, where a simple letter of credit, an account is opened and all basic operations take place. This introduces certain difficulties into the transaction.
Difficulties of registration
Payment under a letter of credit implies strict requirements for documents and deadlines, as well as a complication of the registration procedure. In addition to drawing up the main contract between the buyer and seller, it is necessary to exchange documents between banks. Even though this is now done electronically, it takes time to verify all documents.
Expensive service
The cost of this type of payment is quite high. The bank charges a commission for all transactions carried out with letters of credit. In addition, from the moment the letter of credit is opened, the money in the buyer’s account is frozen, which is a guarantee that the letter of credit will be covered.
Conclusion
Despite all its shortcomings, this form of payment is reliable and convenient for all parties to the transaction. Having understood all the intricacies of the process, the client will no longer be able to refuse this type of payment.
“have passed a long time ago, but there are still situations when you want to get some guarantees that the planned transaction will end in success - the seller will receive money, and the buyer will receive goods. One possibility to achieve this is to use a letter of credit.
What is a letter of credit
A bank letter of credit, in simple terms, is a special payment procedure that guarantees that the seller will receive money only after establishing the authenticity and legal correctness of the transaction. Moreover, this guarantee is given by a bank, and not some fly-by-night company.
Types of letters of credit
Banks are ready to provide their clients with various types of letters of credit:
- Irrevocable.
This type of letter of credit cannot be revoked without the consent of the seller, and its terms also cannot be changed by him independently. - Reviewable.
When dealing with it, the possibility of withdrawal and cancellation is allowed - the buyer can change its terms without the consent of the seller. - Translated(transferable).
The seller may transfer the rights to receive funds as a result of the transaction to a third party, in part or in full, by indicating this to the executing bank. - Spare or warranty.
It is in itself a bank guarantee that payment will be made in any case, even if the buyer suddenly does not fulfill his obligations under the contract. - Renewable or revolver.
Used when it is necessary to pay for the contract in stages. The funds are written off to the seller in installments. In this case, an automatic replenishment occurs from the buyer’s account until it is paid in full. - Coated.
When settling with such a letter of credit, the seller’s debt is reimbursed by the bank where the buyer’s account is located. - Uncovered.
When settling, the seller is paid the money by the bank where his account is located. The order for this operation is made by the buyer's bank before it receives funds from its client.
Letter of credit form of payment: scheme and features
The payment scheme using a letter of credit is somewhat more complicated than a simple exchange of funds - cash, bank transfer or safe deposit box, but not much more.
So, let's look at it step by step:
1 The seller and buyer enter into an agreement in which they stipulate: payment for the transaction will be carried out through bank letter of credit.
2 The buyer submits an application to the bank for registration.
In order for the bank to issue a letter of credit, the buyer must already have an account with it or open an account before submitting the application.
What is the situation :
The bank opens a special “Letters of Credit” account in the name of the seller, notifying the owner about this and transferring funds from the buyer’s account to him.
What is the situation :
But the seller cannot yet dispose of them; they are not available to him.
What is the situation
:
If the bank approves the transaction, the money appears in the seller’s account and he can use it.
If the bank has doubts, the money is either kept until all documents are completed correctly, or returned back.
The chain of settlements is somewhat longer and more complicated when the parties have accounts not in one, but in different banks.
Video - diagram of letter of credit payment forms for international transactions:
When purchasing real estate
A typical purchase and sale transaction looks simplified like this: the buyer transfers money to the seller, who transfers the apartment to him. Everything is very simple. However, a real estate transaction is considered completed only after it is registered with Rosreestr.
Imagine the situation: the buyer and seller submit applications there, separate, and then the seller returns and takes back his application.
What should the buyer do if he has already transferred the money to the seller?
Just go to court, often long and hard.
When concluding similar transactions with fairly large risks, for example, when purchasing an apartment in a new building, the use of a letter of credit can serve additional guarantee for both parties. The seller receives a guarantee that the money will be transferred, and the buyer receives a guarantee that, having paid the money, he will not be left without an apartment.
In such calculations, the buyer signs a letter of credit agreement, transferring funds to the bank in the amount of the full cost of the apartment. The seller-developer, notified by the bank about the actual availability of funds in the account, without fear of deception, registers the transfer of ownership of the apartment.
If real estate is purchased from its owner - an individual, then using a letter of credit according to the same scheme will protect both parties from possible fraud.
Advantages and disadvantages of settlements with letters of credit
Advantages of payment by letters of credit when conducting transactions it is obvious:
- the client (buyer) receives a guarantee that services and goods will be delivered exactly in accordance with the conditions agreed in advance, of the required quality and within the time limits established in the agreement;
- the supplier (seller) is guaranteed to receive the entire amount of funds, regardless of the current financial condition of the client;
- the buyer is freed from the need to reserve money for prepayment or stage-by-stage payment of the transaction;
- the bank issuing the letter of credit is interested in monitoring the legality of the transaction, the authenticity of all documents provided and the parties’ compliance with the terms of the agreement;
- in case of force majeure, if the transaction does not take place, the buyer will return the funds in full;
- savings on interest – payments to the bank are much more profitable compared to interest on conventional loans.
Transactions using a letter of credit have flaws, but due to their insignificance they can be completely neglected:
- registration requires additional documents that are not needed for direct payments;
- the buyer bears small additional costs for paying for banking services;
- the parties need additional time for registration;
- There are some banking and legislative restrictions on registration, for example, a bank, when concluding a letter of credit agreement, must make sure of the proper financial condition of the client.
The use of a bank letter of credit when concluding various contracts becomes a worthy alternative to other payment options. When issuing it, banks are interested in the successful completion of the transaction, so they check all its stages. Such verification allows the parties to exclude deception and avoid fraud.
Video - letter of credit and other forms of payment, procedure, requirements and design features:
How does it work on a 3G network that accepts payments by bank cards.
We will consider how to transfer the rights to collect debt to a third party without the consent of the debtor or what an assignment agreement is in a separate section.
Work on prepayment or provide deferred payment? What is factoring in simple words:
Are you afraid of the risks associated with prepayment for a transaction? Do you want to be on the safe side as a first-time customer working with a new supplier? Take advantage of a letter of credit - one of the most reliable and profitable banking instruments used when concluding contracts.
The letter of credit form of payment is beneficial to both the seller and the buyer. It can be used with equal success not only in domestic Russian transactions, but also in foreign trade transactions. Today, settlement services in the form of documentary letters of credit are provided by most large Russian banks.
Letter of credit: what is it in simple terms?
In simple words, a letter of credit is a special account opened at a bank in which funds can be reserved when conducting transactions for the sale of goods or the provision of services (performing work). If both parties fully comply with the conditions specified in the contract, the bank pays the required amount to the account of the recipient (beneficiary).
Thus, the bank acts as a guarantor and assumes responsibility for making payments. The supplier is 100% sure that the product/service will be paid for, and the buyer knows that he will be able to pay for it on time and without debt.
Letter of credit form
It works according to the following scheme.
- The parties enter into a contract that stipulates the terms of the letter of credit payment.
- The buyer submits an application to his bank (issuer) to open a letter of credit account and deposits into it the amount necessary to cover the transaction (reserves funds).
- After the successful opening of a letter of credit, the issuing bank notifies the seller's bank (advising bank) about this.
- The advising bank notifies the seller about the opening of the letter of credit. The seller ships the goods and provides supporting documents to his bank.
- After checking the documents, payment is transferred to the seller’s account by the issuing bank or advising bank (depending on the terms of the agreement).
Irrevocable letter of credit
One of the main and frequently used types of documentary payments. Unlike a revocable letter of credit, a confirmed or unconfirmed irrevocable letter of credit is not revoked or amended by either party (including the bank) without the prior consent of the seller/supplier. It is considered the most reliable form of letter of credit payments, as it completely frees the trade and monetary transaction from all possible risks, primarily financial.
If during the transaction the supplier and buyer come to a mutual agreement, the terms of the irrevocable letter of credit may be changed.
Letter of credit agreement
The agreement on a transaction providing for this form of payment stipulates and strictly records any information that can subsequently be used when carrying out a trade and monetary transaction and payment for it:
- names of the supplier and recipient,
- type of letter of credit used (irrevocable/revocable, covered/uncovered),
- the amount reserved on the account to pay for the transaction,
- the duration of the obligation,
- commission size,
- payment order,
- procedure in case of non-payment of debt under a letter of credit,
- rights and obligations of all parties.
Payment by letter of credit
Payments using letters of credit provide for the transfer of funds to the seller’s account only if all the conditions specified in the contract have been met. In particular, money is transferred to the seller’s account after the goods have been fully shipped and all required documents have been submitted to the bank. If the terms of the letter of credit agreement have been violated, the payer (buyer) has the right to refuse payment and return the goods to the supplier.
A nuance: a letter of credit account is opened by the buyer with his own money or with the help of bank credit funds (if he has the right to lend).
Opening a letter of credit
To open a letter of credit account, a written application in the appropriate form is submitted to the banking organization. The statement states:
- number of the agreement under which the letter of credit is opened,
- name and details of the supplier,
- type, validity period, monetary amount of the letter of credit,
- the way to implement it,
- list of shipped (provided) goods/services,
- name of the executing bank under the letter of credit obligation,
- a list of documents that will be used as the basis for payment of funds to the supplier.
Sravni.ru advice: use a letter of credit form of payment if you need to conduct secure trade and monetary transactions with new and “problematic” business partners.
