Letter of credit is a transaction in which the buyer instructs the bank to pay the agreed amount of money from his account to the seller within a certain time period, after they have provided the documents indicated by the agreement.
Concept and essence of a letter of credit
In case of letters of credit, three groups of participants can be distinguished. These are applicants - payers of the letter of credit, beneficiaries - recipients of payment under the letter of credit, the bank itself, which acts as the guarantor of the transaction between the parties. This form of settlement is practiced in foreign and domestic trade.
How does a letter of credit work in practice? For example, the seller and the buyer entered into a supply agreement, but they are not ready to work on an advance payment due to the high risks of non-delivery or non-payment of the goods. Then the buyer applies to the bank to open a letter of credit for the amount of the contract. The conditions under which the money are to be debited to the seller's account are negotiated. This, for example, the provision of shipping documents (bill of lading, invoice). The less trust between companies, the wider the list of documents. The application for a letter of credit also contains the name of the beneficiary, type of letter of credit, opening date and other parameters.
The seller, having received notification of the received letter of credit, provides the bank with the document stipulated by the agreement and receives his money for the goods.
Such services are not provided by banks free of charge. The commission for opening a letter of credit is paid by the buyer, it varies depending on the bank.
The advantages of the letter of credit form of settlements lie in additional guarantees of payment for the supplier, control over the fulfillment of the terms of delivery by banks. Disadvantages - in the complicated workflow and high commissions of banks.
Classification of letters of credit
Today, there are many types of letters of credit, among which the payer can choose the best one for himself.
In Russia, letters of credit are divided into the following groups:
- revocable and irrevocable - today all letters of credit are irrevocable;
- confirmed and unconfirmed;
- covered (deposited) and guaranteed.
According to the confirmed letter of credit, another bank (other than the issuer) is obliged to pay the entire amount in favor of the beneficiary upon presentation of documents that meet the conditions of the letter of credit, regardless of the transfer of money to him. If there is no obligation of another bank, then the letter of credit is unconfirmed.
Under a covered letter of credit, the entire amount is transferred by the bank to the coverage account in the beneficiary's bank at the expense of the payer or the loan.
Most of the letters of credit are uncovered. According to them, the bank does not transfer money to the beneficiary's account, but provides him with the opportunity to write off the required amount from his correspondent account.
There are also other types of letters of credit. Under a letter of credit with a red clause, the supplier can receive an advance payment before the presentation of the shipping documents. Revolving L / C is used for regular deliveries and has the ability to automatically renew.
A transferable letter of credit allows transfers of part of a letter of credit to other beneficiaries.
