Letter of Credit
Posted on 8th December 2021 at 11:19
A letter of credit is a document issued by a bank on behalf of the importer and for the benefit of the exporter. It is an undertaking to pay the exporter the amount specified in the letter of credit once the conditions of the letter of credit have been met. If the buyer is unable to make payment on the purchase, then the bank will be required to make the full or remaining payment. It is a secured method of settlement. It reduces the risk of non-payment for the delivery of goods. It is legally binding.
Letter of credit is an indispensable document in international trade where the buyer and seller are separated by distance, located in different countries, governed by different laws, and performing different trade practices which are not known to both parties. The letter of credit provides increased assurance to both importer and the exporter of fulfilment of their obligations to deliver the goods and to pay for those goods within a specified time frame. It protects the traders against losses in case the parties fail to fulfil their obligations and encourages them to transact with unknown partners and expand their trade in new geographical regions.
These letters are highly customisable, and both trading partners can put in terms and conditions as per their requirements and arrive at a mutual list of clauses. Letter of credit helps an exporter's financial planning. Letter of credit is easy to obtain provided both the parties are considered creditworthy. Banks do not provide this service free and usually charge a percentage of the transaction outlined in the letter of credit.
There are different kinds of letters of credit; however, the main types are mentioned below:
Recoverable / Irrevocable: A revocable letter of credit can be altered at any time by the bank or buyer without the knowledge of the seller. However, an irrevocable letter of credit can be altered with the mutual consent of both parties.
Confirmed / Unconfirmed: An unconfirmed letter of credit is assured only by the issuing bank, while in case of a confirmed letter of credit, the bank in the exporter’s own country also assures to make the payment even if the first bank fails to do so.
Transferable: Transferable letter of credit is transferable to another beneficiary.
Standby: This type of letter of credit gives an assurance to the exporter that the buyer can meet his commitment.
Revolving: This type of letter of credit is used for any payments between the same seller, thus there is no need to issue a new letter of credit every time.
Back-to-Back: This type of letter of credit is issued when an intermediary is part of the transaction, and a transfer letter of credit is not considered to be the best option.
The letter of credit also has some disadvantages: Strict terms often apply to result in delays. It can be expensive and not suitable for everyone.
If you need any help obtaining credit reports or help recovering any overdue debts please contact us on +44 121 442 5330.
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