Letter of CreditWhat is a documentary letter of credit?
A documentary letter of credit is an irrevocable undertaking issued by a bank on behalf of a buyer (an applicant) whereby it undertakes to make payment to a named seller (a beneficiary) for the goods or a service upon presentation of the documents stipulated in the documentary credit.
Irrevocable letter of credit can neither be amended nor cancelled without the agreement of the issuing bank, the confirming bank (if any) and the beneficiary.
Currently, settlements in the form of documentary letters of credit are regulated by the Uniform Customs and Practice for Documentary Credits developed by the International Chamber of Commerce (ICC) in Paris, Publication No. 600, 2007 Revision (UCP600).
What are advantages of using a letter of credit?
For a buyer, a letter of credit is an alternative to an advance payment. Payment under a letter of credit is made by the bank provided that the documents stipulated in the documentary credit are presented by the seller to the bank and all of its terms and conditions are complied with..
For a seller, a letter of credit guarantees receipt of the payment on condition of presentation of the documents as stipulated in the documentary credit by the seller to the bank. Receipt of the payment does not depend on changes in the financial status of the buyer or fluctuations of prices on the market.
What are the categories of letters of credit according to UCP600?
Confirmed letter of credit means that the payment liabilities are borne not only by the buyer's bank, but also by a third bank. Confirming bank provides a beneficiary with an additional irrevocable and independent undertaking to honour or negotiate documents provided that they fully comply with the terms and conditions of the credit.
Confirmation of a letter of credit by a third bank removes the payment risk of the issuing bank due to possible economic, political and country risks the issuing bank can be subjected to.
Transferable letter of credit may be transferred by the transferring bank at the request of the first beneficiary in favour of the second beneficiary. When a letter of credit is transferred, the first beneficiary may only introduce changes in the following clauses of the letter of credit:
- reduce the price per unit of the goods and, correspondingly, the amount of the letter of credit;
- reduce the insurance coverage percentage;
- curtail the latest shipment date, the expiry date, the period for presentation of documents.
Standby letter of credit operates according to the guarantee principle, securing performance of the applicant’s payment liabilities to the beneficiary. Unlike a documentary letter of credit, a standby letter of credit is not a primary instrument of payment, and a beneficiary, in whose favour a standby letter of credit is issued, draws only in case of default on the transaction to which the standby letter of credit relates.
What may be used as a collateral for the issue of a letter of credit?
- a cash collateral
- a deposit
- another type of a collateral according to the credit policy of the bank
What is required to open a letter of credit?
The bank’s client must submit a completed order for opening a letter of credit and the contract, place a cash collateral on the account or agree another form of a collateral with the bank.