A Letter of Credit or Credit Letter is a document used for financial institution especially in trade finance. It provides inalterable payment undertaking.
It can also be used for transaction payment, that is, redeeming the letter of credit pays an exporter. Credit letter are mostly used in international trade transactions while dealing with a supplier in a foreign country as a customer.
These letters are usually beneficial for the people who want to receive Money from a bank. They are inalterable and cannot be canceled without prior agreement of the right holder or confirming bank.
These letters that have to be presented by beneficiaries so as to receive payment contain a commercial invoice, bill of lading and documents providing the shipment was guaranteed against loss or damage while shipping.
Letters of credit do not deal in goods, they deal in documents. They can only be altered if both buyer and seller agree with each other.
Their use will go on to increase as the global economy evolves. The International Chamber of Commerce Uniform Customs and Practice for Documentary Credits govern the letters of credit used in international transactions.
A letter of credit is a contractual agreement between a bank and and another bank (on behalf of the customer) to make payment.
Elements of a Credit Letter:
- A payment undertaking given by a bank
- An applicant (on behalf of the buyer)
- To pay a beneficiary for an amount of Money that was given before.
- On presentation of documents that are specified and representing the supply of goods.
- Within time limits specified before.
- Documents must conform to conditions and terms that were set out in a credit letter.
- Documents to be presented at a specified place.
The process:
- Buyer and seller agree to make business and the seller wants a credit letter to guarantee the payment.
- Buyer applies to her or his bank for a credit letter.
- The bank of buyer approves the risk of credit and then sends it to its confirming bank.
- Advising bank will authenticate the credit and send it to the beneficiary.
- Seller sends the goods and verifies the requirements to support his or her letter. Documentary requirements can vary according to the perceived risk while dealing with a particular company.
- Seller sends the goods and verifies the requirements to support his or her letter. Documentary requirements can vary according to the perceived risk while dealing with a particular company.
- Confirming bank examines the letter.
- If the documents are correct, the bank will claim the funds.
- Advising bank will send the letter to the issuing bank.
- Issuing bank examines the letter for compliance and then forwards it to the buyer.
Thanks to this process, the risk can be reduced.
