The letter of credit is an international means of payment issued by a commercial bank.
Letters of credit are documents issued by commercial banks to guarantee the payment of merchandise. This indicates to the seller or exporter that, in compliance with the conditions of the contract, the issuing bank is responsible for the disbursement of money.
Characteristics of the letter of credit
Some of the characteristics of the letters of credit are:
- It is one of the most widely used payment methods internationally.
- It allows to guarantee purchase and sale operations with a high level of reliability. For both the seller and the buyer.
- The seller insures the payment for his goods or services, after having fulfilled the specifications.
- The buyer makes sure to pay for what he really needs or specifies in the document. That is, it guarantees the contract under the terms and conditions agreed in the negotiation process.
- It must contain all the relevant information regarding the purchase sale agreement. As well as identification of the agreement participants.
- It represents a binding payment commitment by the issuing bank.
- Failure to comply with what was agreed in a letter of credit entails legal measures.
Types of Letter of Credit
There are several ways to classify letters of credit. Some type of letter of credit are the following:
- Transferable Letter of Credit: It is a document that allows the seller to transfer part of the payment. In this case, it can be used to guarantee the supply of raw Materials, for example.
- Letter of credit confirmed: In this case, a bank other than the issuer is involved as guarantor of the contract implied in the document. Generally, it is the bank of the seller who fulfills this function. In this case, it is also called confirming bank.
- Letter of credit with advance payment: For this type of contract, there is usually a prior relationship between buyer and seller. In the document, an advance payment is established to the seller, prior to the delivery of the merchandise.
- Deferred Letter of Credit: In this case, the payment date is established after the delivery of the merchandise with a specific time. It may be the case of contracts in which the buyer requires an inspection of the purchased merchandise.
When to request a letter of credit?
In principle, there must be a negotiation process prior to the issuance of the letter of credit. This agreement must include a contract for the sale of merchandise.
After the negotiation, the seller, to guarantee the payment of their products, asks the buyer for a letter of credit. This, goes to your bank to issue it, after giving you the details of the transaction. If approved, the seller is notified and proceeds to produce or ship the merchandise. Finally, once the conditions established in the letter of credit have been met, the bank makes the payment.