Letter of Credit
What Is a Letter of Credit?
A letter of credit, or "credit letter," is a letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the right amount. If the buyer can't make a payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase. It very well might be offered as a facility.
Due to the idea of international dealings, including factors like distance, varying laws in every country, and difficulty in knowing each party personally, the utilization of letters of credit has turned into a vital part of international trade.
How a Letter of Credit Works
Since a letter of credit is commonly a negotiable instrument, the responsible bank pays the beneficiary or any bank nominated by the beneficiary. In the event that a letter of credit is transferable, the beneficiary might assign another entity, for example, a corporate parent or an outsider, the right to draw.
Banks commonly require a pledge of securities or cash as collateral for giving a letter of credit.
Banks likewise collect a fee for service, regularly a percentage of the size of the letter of credit. The International Chamber of Commerce Uniform Customs and Practice for Documentary Credits directs letters of credit utilized in international transactions. There are several types of letters of credit accessible.
Types of Letters of Credit
Commercial Letter of Credit
This is a direct payment method where the responsible bank makes the payments to the beneficiary. Conversely, a standby letter of credit is a secondary payment method where the bank pays the beneficiary just when the holder can't.
Revolving Letter of Credit
This sort of letter permits a customer to make quite a few draws inside a certain limit during a specific time span.
Explorer's Letter of Credit
For those traveling to another country, this letter will guarantee that responsible banks will respect drafts made at certain foreign banks.
Confirmed Letter of Credit
A confirmed letter of credit includes a bank other than the responsible bank guaranteeing the letter of credit. The subsequent bank is the affirming bank, commonly the seller's bank. The affirming bank guarantees payment under the letter of credit on the off chance that the holder and the responsible bank default. The responsible bank in international transactions commonly demands this arrangement.
Genuine Example of a Letter of Credit
Citibank offers letters of credit for buyers in Latin America, Africa, Eastern Europe, Asia, and the Middle East who might experience issues acquiring international credit all alone. Citibank's letters of credit assist exporters with limiting the merchant's country risk and the responsible bank's commercial credit risk.
Letters of credit are ordinarily given inside two business days, guaranteeing payment by the affirming Citibank branch. This benefit is particularly significant when a client is situated in a possibly unsteady economic environment.
Features
- A letter of credit is a document sent from a bank or financial institute that guarantees that a seller will receive a buyer's payment on time and for the full amount.
- Letters of credit are in many cases utilized inside the international trade industry.
- There are various letters of credit including one called a revolving letter of credit.
- Banks collect a fee for giving a letter of credit.
FAQ
What Is an Example of a Letter of Credit?
Think about an exporter in an unsound economic climate, where credit might be more hard to get. The Bank of America would offer this buyer a letter of credit, accessible inside two business days, in which the purchase would be guaranteed by a Bank of America branch. Since the bank and the exporter have an existing relationship, the bank is learned of the buyer's creditworthiness, assets, and financial status.
How Does a Letter of Credit Work?
Frequently in international trade, a letter of credit is utilized to imply that a payment will be made to the seller on time, and in full, as guaranteed by a bank or financial institution. In the wake of sending a letter of credit, the bank will charge a fee, ordinarily a percentage of the letter of credit, as well as requiring collateral from the buyer. Among the different forms of letters of credit are a revolving letter of credit, a commercial letter of credit, and a confirmed letter of credit.
What Is the Difference Between a Commercial Letter of Credit and a Revolving Letter of Credit?
As one of the most common forms of letters of credit, commercial letters of credit are the point at which the bank makes payment directly to the beneficiary or seller. Revolving letters of credit, on the other hand, can be utilized for different payments inside a specific time span. Regularly, these are utilized for businesses that have a continuous relationship, with the time limit of the arrangement as a rule spreading over one year.
