Types of Letters of Credit - Essay Example

Letter of Credit LETTER OF CREDIT Letter of credit is a document from a bank guaranteeing the seller that payment would be made available to the seller by the specified time. This guarantee is usually given on behalf of the buyer because the buyer requests his bank to do so. Letter of credit, in simple terms, is a type of assurance that is given to the seller that he will surely get the remuneration for the goods that he has delivered. In simple words it means that the bank on the behalf of its customer provides the person or enterprise, with which the customer has made some dealing, with the letter that make it certain to him that he will be given the cash for the services or goods that he has provided. To get the payment from the bank, seller has to provide the bank with some of the necessary documents which is a sort of confirmation that the goods have been delivered to the buyer during the specified time duration. Letter of credit is usually used when there is an international export in order to avoid the trading risk that commonly includes not being aware of the host country, the customs and the political condition of that country. This helps the buyer in many different cases and gives him the security for his payment (Warner, 2011). THE PARTIES OF LETTER OF CREDIT The parties that are involved in the letter of credit are same but they usually differ on the basis of their accounts or titles. Buyer or the applicant The first and the primary one is the applicant generally known as the buyer. Letter of credit is given when the buyer or the applicant requests the bank though the buyer does not owe to one of the credit party; this is due to the fact that letter of credit is the different transaction from the sales or any other sort of contracts. It is the type of a security to the seller (Warner, 2011). Seller or the beneficiary Then, it is the beneficiary that is commonly known as the seller, the one who provides the services and goods to the buyer or applicant. The seller gets the favor of the bank and the letter of credit initiates. Issuing bank Issuing bank, as per the name represents, is the bank that issues the letter of credit to the applicant on his request. It agrees to credit the given amount to the beneficiary. Nominee bank The next party to the letter of credit is the nominee bank or the opening bank. It is the party that has the credit for the seller. Advising bank Another party to the letter of credit is the advising bank, also known as the agent for the opening bank. It is the one that gives advice of the credit on the request of the issuing bank. It means that it verifies that the opening bank is reliable. Conforming bank Conforming bank is the one that forwards its conformation that there is an availability of credit on the request of the issuing bank. It is not necessary that the confirming bank always puts in its conformation to the issuing bank. But, in case it puts in its conformation then the letter of credit becomes irrevocable. This also means that if the issuing bank is not able to pay to the seller then the conformation bank pays to the seller. Reimbursing bank or the payee Reimbursing bank is another party that is the party that reimburses the amount issued by the first issuing bank. TYPES OF LETTERS OF CREDIT There are different types of letter of credits following are some of the types of letter of credits. Revolving letter of credit The first type is the revolving letter of credit. It is opened when the goods or services are not given in one i.e. the goods are delivered at separate intervals in time. The payment is also not given at one single time but is given when the goods or services are provided to the buyer. There is no time limit for this type of letter of credit it continues for a long time period. Both the parties are given the new order as the delivery of goods and services is made (Sercu,2009; Wang, 2009) . Back to back letters of credit The next type of letter of credit is back to back. This is considered as the most secure and safe method for transactions. Two Letters of credit are used in order to assist the seller in paying for the purchase of goods or services from an agent. One of the letter of credit remains intact with the buyer’s bank; the seller gets another Letter of credit issued from his own bank, keeping the agent as a beneficiary. This ensures that the agent would receive his payment as soon as he performs the terms of the contract (Sercu,2009; Wang, 2009). Revocable letter of credit As per the name, this letter of credit can be revoked by the bank that issued it. The buyer, at any time, can make changes to it or can cancel the deal without the permission of seller. The payment for this type of letter is not a guarantee so this type of letter is not used frequently. Irrevocable letter of credit This type of letter of credit can not be changed or cancelled by the buyer. The seller has the guarantee that he will get the payments for his goods in response to all the rules and regulations that are given in the letter of credit. Such Letter of Credit is usually used when there is an international trading. The payment here is sure so the sellers some time also take loans for the shorter time duration from banks that have low interest rates (Sercu,2009; Wang, 2009). DOCUMENTS THAT ARE COMMONLY USED The buyers usually provide the list of documents to the seller that he needs to get the goods into his country at the lowest rate possible. Not all of them but some of them are those that are needed for Customs clearance. Documents that are commonly used for the transactions usually include the following; Transport document This document covers two types of transports that are multimodal and combined. They include the bill of lading, non-negotiable sea bill, charter party bills, transport for air documents, documents for road ways, railways documents required for sea travel (Sercu,2009; Wang, 2009). Insurance documents These include insurance policy (UCP, article 34, 35, 36), insurance certificate and the open cover (given by the entire exporter). Financial documents These include the bill of exchange (UCP, article 9) that is also known as a draft. It is presented by every company. The draft holds the name of bank as the one who will pay. Commercial documents These include commercial invoice (UCP, article 37) which is actually a declaration that buyer is obliged to pay. Besides the commercial invoice the other documents include a list of packaging (UCP, article 20, 21), weight list (UCP, article 20, 21, 38), inspection certificate, and the certificate of analysis. Official documents These include certificate of origin (UCP, article 20, 21) which holds the information about the good’s organization and it is usually given by a third party. Another document is the Consular invoice (UCP, article 20, 21) which is important as some of the countries do not allow the goods to enter their country for security reasons until the certificate is attached. Export documents Different countries import different goods depending upon the type of goods that are being traded and the type of transactions they will occur. Two documents are required, the first one is the invoice and the second one is the transport document. Buyer and seller need to make sure that all the documents should conform to the terms and conditions as follows: A. Conform to all the terms and conditions of the letter of credit. B. Comply with the UCP 500. C. Agree to the data of each and every document. Certificates Certificates that are required must be signed. These certificates vary from country to country and product to product. Usually these certificates are to be given by some trustworthy third party. These certificates usually increase the cost of goods that are sold. Few other common types of certificates include; inspection certificates (UCP, article 20, 21) this tells that the product that is being shipped and is up to the set standards mentioned within the letter of credit. Others are USAD inspection certificate (UCP, article 20, 21) it is given by the US agriculture department (Wunnicke et al, 2000). Other types of documents that are mentioned include the authentication document (UCP, article 20), copy of document (UCP, article 20), conformation document (UCP, article 14), performance document (UCP, article 4), discrepancy document (UCP, article 14), date document (UCP, article 22), examination document (UCP, article 13), issuer document (UCP, article 20), lost document (UCP, article 16), fake document (UCP, article 15), original document (UCP, article 20), non-stipulated documents (UCP, article 13), requirement documents (UCP, article 5), signed documents (UCP, article 20), stale documents (UCP, article 43). All these documents are used on the basis of the country demands and the type of merchandise that is being exported or shipped (Wunnicke et al, 2000). References Sercu, P. (2009). International finance: Theory into practice. Princeton, N.J: Princeton University Press. Wang, P. (2009). The economics of foreign exchange and global finance. Berlin: Springer-Verlag. Warner, S. . (2011). A Letter of Credit. Project Gutenberg. Wunnicke, B., Wunnicke, D. B., & Turner, P. S. (2000).Standby and commercial letters of credit. New York (N.Y.: Aspen Law & Business. Read More