Letter Of Credit
A documentary letter of credit is a pecuniary liability of the confirming bank to pay a certain amount stipulated by the agreement to the seller for the goods upon presentation of the documents confirming dispatch of the goods and compliance with the mutual agreement between the seller and the buyer. The confirming bank issuing such a liability must make the payment to the exporter or secure the payment by another bank.
To perform a letter of credit transaction, the client, as a rule, has to secure the letter of credit with the help of a cash deposit or other collateral.
For a buyer, documentary letters of credit are beneficial due to the fact that the buyer can set the terms to the seller and reduce the risk of non-performance of the goods supply liabilities by the supplier to the minimum. Besides, the buyer acquires goods using the extensive experience of the confirming bank in such transactions. The seller can also be sure that upon dispatch of the goods and presentation of all documents in accordance with the letter of credit terms the seller will receive the payment regardless of the buyer, because the bank pays in this case.
Letters of credit are divided into the following categories:
Revocable / irrevocable LC;
Confirmed / non-confirmed LC;
Transferable / non-transferable LC
Irrevocable letter of credit cannot be annulled prior to its expiry without the consent of the seller.
Revocable letter of credit can be annulled even without notifying the seller. However, in practice, such letters of credit are very rare, as they do not provide guarantees to the seller.
Confirmed letter of credit means the payment liabilities are borne not only by the buyer’s bank, but also by the seller’s bank or a third bank which adds confirmation.
Transferable letter of credit means the order of an intermediary (the first beneficiary) can be transferred by the confirming bank in favour of the supplier (the second beneficiary). When a letter of credit is transferred, the first beneficiary can only introduce changes in the following clauses of the letter of credit:
The price and the corresponding amount of the letter of credit (downwards)
The dispatch terms and the letter of credit expiry (downwards)
Non-transferable letter of credit cannot be transferred.
In international settlements, the application of documentary letters of credit is regulated by a special document – Uniform Customs and Practice for Documentary Credits UCP-600, developed by the International Chamber of Commerce (ICC) in Paris.
The confirming bank secures the performance of both export (when the client is a seller) and import (when the client is a buyer) letters of credit for selling and buying goods from a business partner abroad.