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Letters of Credit & What You Need to Know

Letters of credit are fundamental components of international trade

What is a Letter of Credit (LC)?

Most of the trade in the world is carried out internationally. In order to facilitate this a business requires trade agreements with their partners and counterparts. Trust is incredibly important when agreeing payment terms. Putting this on the scale, at the riskier end, trade can be completed on open account terms, where the risk of the seller bares the risk of not being paid. A letter of credit (LC) mitigates against the risk. A letter of credit is relevant when there is an exporter and an importer requiring pre-payment or confirmation of payment in order for goods to be shipped. A letter of credit is an instrument from a bank, which guarantees buyers payment to a seller if certain criteria are met. If the buyer cannot pay for the trade received, due to the agreed contract with a letter of credit, the bank will cover the remaining price. Letters of credit are fundamental components of international trade. They are governed universally by a set of guidelines called UCP 600, which are issued by the international Chamber of Commerce. A letter of credit is a promise written on a legal document that comes from a bank with a promise to pay the holder if the holder fulfills certain obligations. Obligations include payment when the goods are shipped if certain criteria are met. A letter of credit is usually used when the buyer and seller do not have an existing relationship, which is why it is used frequently on international trade. Letters of credit are incredibly specific and a close attention to detail is required. If there is a misspelling in the contract of the name of the goods there may be a non-payment, until a new corrected letter of credit is issued and accepted.

Why Are Letters of Credit Used?

  • Safe and legally binding
  • Letters of credit offer risk reduction
  • They are efficient, as letters of credit can be raised electronically using an online trade banking service.
  • All parties are required to agree when cancelling them.
  • The exporter or payment to the seller is guaranteed payment, providing the term of the LC are met
  • Letters of credit are a focus of international trade and allow companies to trade safely in unfamiliar markets with unfamiliar suppliers.
  • They allow for safe trading
  • The details of the transaction are transparent.
  • Letters of credit offer clarity, as the goods detailed in an LC are specific and well defined.

The Advantages of Letters of Credits

  • Buyer

    Certain to receive the goods as stipulated in the letter of credit and without the requirement of paying for the goods upfront.

  • Seller

    Protected against non-payment with the risk of non-payment being transferred from the seller to the bank (or banks).

How is Payment Collected on Letters of Credit?

To receive payment the beneficiary must present documentation of completion of their part in the transaction to the issuing bank and must present documents such as; invoices, Bills of exchange or Government Documents.

There are several different types of letters of credit, each with differing purposes.

Irrevocable Letter of Credit

The irrevocable letter of credit allows cancellation or amendments to the letter of credit by the buyer. Notably the irrecobal letter of credit can only be processed the buyers bank, seller and the sellers bank agree.

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Confirmed Letter of Credit

A conformed letter of credit is a second guarantee by the sellers bank. It adds additional security for the seller. This means that if the issuing bank of the buyer fails to make a payment the sellers bank agrees a guaranteed payment.

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Transferrable Letter of Credit

A transferable letter of credit can be passed from one beneficiary to another. They are commonly used when intermediaries are involved in a transaction with others are supplying the seller in the transaction.

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Letter of Credit at Sight

Letters of credit at sight are payable as soon as the agreed documentation has been presented and verified, providing protection for the buyer and the seller.

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Usance Letters of Credit

Defferred or usance letters of credit means that the payment to the seller is delayed until an agreed period of time has passed.

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Red Clause Letter of Credit.

A red clause letter of credit permits the seller to receive partial payment from the issuing bank prior to shipping products or performing the services.

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Global Trading Can Help

At Global Trading we help companies find debt funding in the market, with various finance instructors to meet the businesses various needs. In turn this will explain debt terms to potential clients, help grow your clients and recognise future cash flow challenges.

If you need funds, Finance or Letters of Credit for Global Trade, please do not hesitate to phone us, fill in the enquiry form or message us via WhatsApp or Skype. We can assist you in opening up new avenues and help with unlocking the potential of your company on a global scale.