Letter of credit payment is a commonly used payment method in the financial world. Today, this method is frequently preferred in foreign trade. In international trade, insecurity may arise if the importer and exporter do not know each other very well. The exporter wants to collect the price of the products he sells. On the other hand, the importer aims to receive the goods on time. This is where the letter of credit comes into play.
This method is a type of payment that provides assurance to both parties. Thus, communication difficulties due to different time zones and long distances are eliminated. In the letter of credit, the payment is secured by the bank. You can safely use a letter of credit in your foreign trade transactions. If you have questions about the letter of credit, you will find the answers you are looking for in this article.
A letter of credit is a contract in which the foreign buyer’s bank undertakes to pay after the exporter sends the goods and submits the necessary documents to the exporter’s bank as proof. Banks or other financial institutions mediate letters of credit transactions.
Exporters and importers are protected by letters of credit. They can assist you in gaining new business in overseas markets. This means that the exporter is guaranteed payment while the importer is given the proper payment conditions.
Let’s say you are an importer. If you use a letter of credit, you can only pay for goods after the supplier has proven that the goods have been shipped. You also do not need to pay any advances or deposits to the exporter. So, you can protect your cash flow as well. Moreover, a letter of credit shows your creditworthiness. Therefore, it provides instant credibility for you.
For exporters, on the other hand, a letter of credit is like insurance. If the price of the goods sent by the exporter has not been paid by the buyer, the letter of credit payment works like insurance. In such a case, the financial institution will cover the amount. Therefore, a letter of credit is like a shield against legal risks. Because as long as the exporter meets the delivery conditions, his payment is guaranteed. Letter of credit provides another important advantage to exporters. It can be shown as collateral in working capital loans for exporters.
Parties in Letter of Credit Payment
The beneficiary is an exporter. In other words, it is the party that supplies or sells the goods.
The applicant is the buyer. It is the party that requests the bank to create a letter of credit.
The issuing bank is the bank that creates the letter of credit upon the request of the buyer.
The advising bank is located in the exporter’s country and notifies the exporter of the letter of credit.
How Does It Work?
The International Chamber of Commerce‘s (ICC) UCP 600 and ISBP 745 regulations have determined how letters of credit will work. ISBP 745 gives certain details and implementing directives, while UCP 600 outlines the rules.
The payment is made by the issuing bank to the beneficiary or to the bank he designates. The beneficiary may give the right to draw to another entity if the letter of credit is transferable. Banks charge a fee for the service, which is a percentage of the size of the letter of credit.
Letter of Credit Costs
There is no predetermined charge for this service. The fees will be determined by the bank you use. A percentage of the amount covered by the letter of credit is likely to be collected. This fee normally does not exceed a few percentage points. However, it varies depending on factors like your credit history.
Types of Letter of Credit
Revocable Letter of Credit
In the case of a revocable letter of credit, the buyer or the issuing bank may change or cancel the letter without formal notice.
Irrevocable Letter of Credit
An irrevocable letter of credit is the opposite of a revocable letter of credit. It cannot be canceled or altered in any way unless the buyer, seller, and issuing bank have an explicit agreement.
Confirmed Letter of Credit
The exporter has a payment guarantee from a second bank or confirming bank in a confirmed letter of credit.
Unconfirmed Letter of Credit
Only the issuing bank can guarantee an unconfirmed letter of credit. An unconfirmed letter of credit is a common type, but in areas of economic distress and political uncertainty, payment may be at risk.
Transferrable Letter of Credit
This type is a letter of credit that allows the primary beneficiary to transfer the credit to another party. Thus, in this type, a second beneficiary arises.
Straight Letter of Credit
A limited engagement clause is included in this sort of letter of credit. The issuing bank agrees to pay the beneficiary upon submission of the required documents at its own counters or at its own counters of the named bank, according to the clause.
Restricted Letter of Credit
Only one authorized bank can be used for negotiations in this category. As a result, the issuing bank’s ability to pay the beneficiary is restricted to a single, specified bank.
Unrestricted Letter of Payment
Unlike the restricted letter of payment, in this type, the bank is not specified. As a result, the beneficiary’s chosen bank can be used to negotiate the letter of credit.
Usance Letter of Credit
The usance letter of credit may delay the payment by allowing time for the buyer to inspect or sell the goods.
Sight Letter of Credit
A sight letter of credit is a document confirming payment for goods and services. Payment can be made when this document is presented along with the required documents.
How to Get a Letter of Credit?
In short, if you want to get a letter of credit, you need to contact your bank. Not every institution has a letter of credit opportunity, but the bank you contact may also direct you to other institutions. You should present the necessary information to the bank in detail. Then the bank will explain whether it considers you suitable for the letter of credit.