Steps in Operation of Letter Credit

In: Business and Management

Submitted By lukepenguin
Words 2820
Pages 12

Letters of credit accomplish their purpose by substituting the credit of the bank for that of the customer, for the purpose of facilitating trade.

There are basically two types:

* Commercial * The commercial letter of credit is the primary payment mechanism for a transaction.

* Standby * The standby letter of credit is a secondary payment mechanism.

Letters of Credit have certain advantages in foreign trade transactions not only for exporters but also for importers. Letters of Credit give comfort to exporters regarding the payment. Exporters know that as long as they comply in the terms and conditions of the credit they will be paid. Exporters can demand from a bank to add its guarantee to the Credit in order to overcome various risks such as political risk. Conditions of the Credit will not be changed without the permission and consent of the exporter as long as it is irrevocable.

In Letter of credit, normally four parties are involved:

(1) The Buyer (the applicant)

(2) The Buyer's bank (the issuing)

(3) The Beneficiary (the seller/payee)

(4) The beneficiary's bank (the ADVISING BANK).

(5) The CONFIRMING BANK (often the same as the advising bank)

The LC outlines the conditions under which payment (credit) will be made to a third party (the Beneficiary). The conditions are specified by the buyer and may include insurance forms, Way Bills, Bills of Lading, Customs forms, various certificates - i.e. whatever documents the Buyer feels are necessary to safeguard the integrity of the purchased product or service upon delivery.

It is the responsibility of the issuing bank to ensure, on behalf of its client (the Buyer), that all documentary conditions have been met before the Letter of Credit funds are released.

In effect, a basic Letter of Credit is a financial contract between the…...

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