International trade always includes some uncertainty and risk due to several factors like distance between parties, political instability, country laws, etc. These possibly issues can be avoided when the two parties use a letter of credit, or L/C. An L/C can allow for a smooth deal because they are usually fixed.
When two parties want to make a deal, their banks use these letters to represent their interests and the terms of the negotiations. This way, the guarantees presented in the deal can be fulfilled correctly. Banks will use the letters to make sure all shipping documents are provided for payment to be made. There are also many types of credit letters, which depends on the deal itself. Parties can agree to sight, non-performing, standby, confirmed, and even revocable letters.
The buyer of the two parties will usually request a note through the local bank, which is considered the issuing bank. The issuing bank will note the seller or supplier of the goods as the beneficiary, and will send the L/C to the beneficiary’s advising bank. The advising bank is then tasked to authenticate the letter and provide all the necessary documents the beneficiary provides to it to the issuing bank. These are all documents and proof of terms fulfilled, including shipping confirmations of the goods.
The issuing bank of the buyer will authenticate the documents that prove that the terms and conditions were met, and will transfer the agreed upon sum of money to the advising bank. Once the money is received by the advising bank, it is transferred to the beneficiary. Since credit letters are negotiable to begin with, it’s possible to transfer the title to someone else. In this case, whoever is listed on the note will be the one who receives the money. For whatever reason the issuing bank does not send the money to the advising bank, the advising bank has no obligation to pay the beneficiary.
Sight letter types are payable when the documents are all submitted to the issuing bank. Non-performing or standby letters pose as a fallback for the supplier or beneficiary if for any reason the buyer refuses to pay the specified amount by the due date, even when the goods were delivered. This is a good way to protect the interests of the beneficiary, and is fulfilled or cancelled once the sums are paid.
With confirmed credit letters, the beneficiary will be paid either by the issuing or advising banks. Normally, the advising bank doesn’t have any obligations to pay the beneficiary if the issuing bank doesn’t transfer any funds. However with this note, the beneficiary will be paid by the advising bank as long as the terms of the letter were met.
The revocable letter is the last of the types. Usually, credit note are unchangeable. However, if there is a revocable note in place, the issuing bank can modify or even cancel the transaction or deal after it has been issued.
There are fees the beneficiary must pay. The fees include general payment, advising, reimbursement, communication, and discrepancy. The buyer also is required to pay a fee, but only to open the initial letter. The amount of this fee varies based on the sum of the payments, type of note, and country.
Read more about The Importance Of Letter Of Credit Uses.