How a letter of credit helps the business to grow
banking services

The Ultimate Guide to Letters of Credit

A letter of credit is merely a promise from the bank side to make the payment while assuming that all the conditions are met. There are many complications while using LOC.

The buyers (importers) and the sellers (exporters) usually need intermediaries like banks, Business Finance Services, alternate financiers, and others to guarantee the payment and the delivery of goods to each other. There is a trust relationship between buyers and sellers. They both look for securely receiving the payments and goods. Around 80% of international trade takes place on open account terms, which means buy now and pay later. So, the exporters fear for the full payment of their goods. Thus, through Letter of credit, the goods and the payment of buyers and sellers can be protected by the bank.

LOC is a trade finance instrument which is used to ensure the securely delivery of goods and payment. The International Chamber of Commerce defines the rules of this instrument through UCP 600, which are followed by the producers, traders, and the exporters throughout the world.

Letter of Credit for Import

Assume that, an importer is going to buy goods from an exporter. Letter of credit for import can be used here for this transaction, which is standby LOC. This letter of credit is used in the US for several services like building projects, electrical services, and others. Suppose, the exporter is an electric utility company which sells power, and the importer is a customer who is going to buy power from it.

  1. There is a contract between both to buy and sell the power on the agreed price, quantity, and time using LOC. Here, it would be best if you learned that sales agreement between the buyer and the seller is not a part of LOC. LOC is a different document issued by the bank to secure the payment and supply of goods.
  2. The buyer will contact the bank to get LOC. The bank needs some information regarding the sales agreement for issuing the letter of credit. By issuing the LOC, the bank financial services promise the seller to make the payment on behalf of the buyer. If everything is correct, then the seller moves to produce the goods and ship them to the buyer.
  3. To get the payment, the seller has to ship the goods. Also, he will submit the documents of shipping to the bank on a particular date. As he will meet all the requirements of LOC, he will get paid by the bank. Now, the buyer has nothing to do with the seller because the bank will pay him from its side.
  4. The bank will verify the documents and will pay the seller for his goods.

Elements of Letter of Credit

  1. It is a payment undertaking which is issued by a bank
  2. It is the document on behalf of the buyer
  3. The document to pay the seller on behalf of the buyer for a given amount
  4. The amount is paid on presenting the specified documents representing the supply of goods
  5. The amount is paid within the specified time limits
  6. Documents are presented at the specified place and time.

Types of Letter of Credit

There are different types of LOC’s issued by the bank, depending upon the kind of business and transaction. Businesspeople should be aware of all terms and conditions related to different types of letter of credit.

  1. Irrevocable: In this type of LOC, the buyer can cancel or amend the original LOC if the other parties agree. The buyers do so is he purchases some more goods which were earlier not purchased.
  2. Confirmed: This LOC is issued for the more security to the seller in case if the buyer’s bank does not pay the seller, then the seller’s bank will pay him.
  3. Transferable: This LOC is used where there are many intermediaries are involved in a business transaction or if there are more parties included in the letter of credit.

How a letter of credit helps the business to grow?

The use of Letter of credit can be beneficial for the business, and it doesn’t matter if you are a seller or buyer. The trading tool, letter of credit is legally binding for almost all countries of the world. This tool provides better transparency and creates trust in the business. One can do business with any company or business in the world using the letter of credit. The person will be ensured that all the agreed goods and the payments will be received on time.

Letter of credit is secured access for any company or business to the global market. It means providing better goods and services at lower prices in the worldwide market. The seller can securely and safely offer its goods and services to the buyer in the world at the very low risk of payments.

Conclusion

The use of the letter of credit services as the tool for reducing the risk of payment has been growing continuously from the past decades. Its purpose is to substitute the credit of the bank for the purpose to facilitate the trade of goods and services. Business people should be familiar with the types of letter of credit, which are commercial and standby. On the receipt of the LOC, the person should check all the items carefully to ensure that everything is going right, and then he can comply with the terms and conditions of the LOC.

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