Letter of credit is a form of payment secured by a bank's credit. For international trade, letters of credit have been created to reduce the risk of stagnation of funds and to protect the rights of both the seller (i.e., the supplier) and the buyer (i.e., the purchaser). We will then introduce the letter of credit process, its role and the more commonly used irrevocable letters of credit in international trade.

The Operational Process of Letter of Credit

So how exactly does the use of Letter of credit work? The process of bank letter of credit is as follows:

1. You, as the purchaser, and the supplier mutually agree to pay by letter of credit in the order.

2. The purchaser applies to the local bank to open the L/C. The letter of credit is opened with a deposit of a certain amount or with a guarantee from a qualified third-party company

3. The issuing bank issues letter of credit with the supplier as the beneficiary in accordance with the contents of the application, and then forwards the letter of credit to the supplier through the correspondent bank at the supplier's location. After receiving the letter of credit, the supplier confirms that the letter of credit is in accordance with the terms of the contract and confirms that the letter of credit is eligible for shipment.

4. After delivery, the supplier obtains the relevant documents for the shipment of the goods and can negotiate the payment to the local bank in accordance with the L/C.

5. After verifying that the letter of credit and the relevant documents are satisfactory, the negotiating bank advances the payment to the supplier in accordance with the amount of the bill of exchange, less interest and handling charges.

6. The negotiating bank sends the bill of exchange and freight bill to the issuing bank for collection. Upon receipt of the bill of exchange and the relevant documents, the issuing bank notifies the purchaser of the payment (the purchase of the beneficiary's documents and bill of exchange by the negotiating bank is based on the issuing bank's guarantee of reimbursement.)

7. The purchaser pays the issuing bank to redeem the bill upon receipt of the notice from the issuing bank. A redemption is the delivery to the issuing bank of the balance of the letter of credit in addition to the deposit paid in advance for the issuance of the letter.

*Note: The letter of credit will generally specify the latest date of shipment, the latest time of delivery, the port of departure/discharge, the delivery documents, and the provisions for delivery of the documents. The data in the delivery documents must be carefully checked and any incorrect company name or inconsistency with the bill of lading will invalidate the letter of credit.

The role of bank letters of credit

There are many roles for bank letter of credit, the three main ones are as follows:

1. Guarantee payment

As the supplier may not know the creditworthiness and payment ability of the foreign purchaser when exporting, the goods will only be shipped if the payment is made first, or under the condition of a bank letter of credit, as the credit of the purchaser's bank provides the guarantee.

2. Financing role

The supplier can pledge the letter of credit to obtain a loan from a third party (or a bank) when it is urgently needed before the letter of credit expires. The purchaser can also apply for an advance from the bank to raise the credit.

3. Convenience

In addition to securing payment and providing financing, letters of credit provide convenience for both the supplier and the purchaser. The credit checks of both parties, the registration of guarantees or pledges for processing and the arrangement of payments are simplified by the letter of credit.

Irrevocable letters of credit

There are many types of letters of credit, such as revocable credit, irrevocable credit, documentary credit and sight letters of credit. Among them, irrevocable letters of credit are more commonly used in international trade.

Irrevocable letter of credit is a letter of credit that is issued by the issuing bank and cannot be amended or cancelled at will during its validity without the consent of the beneficiary or the negotiating bank and other parties concerned. The issuing bank (or its designated bank) guarantees payment for the goods as long as the beneficiary provides the relevant documents in accordance with the provisions of the letter. Where such a letter of credit is used, it must bear the wording "irrevocable" and contain the text of the issuing bank's guarantee of payment.

After the irrevocable letter of credit has been opened, the bank must release the money to the beneficiary of the letter of credit provided that the documents submitted by the supplier meet the requirements of the letter of credit on paper and that they are in conformity with the documents. Therefore, when a letter of credit is received from or to be issued to a foreign party, it is important to carefully review the relevant terms of the letter of credit.

*Features

The irrevocable letter of credit has two main characteristics:

1. There is a firm commitment to pay by the issuing bank.

In the case of irrevocable documentary letter of credit, when all the documents specified therein are submitted to the designated bank or issuing bank in accordance with the terms and conditions of the letter of credit, it constitutes a firm commitment by the issuing bank to pay in accordance with the time fixed in the letter of credit.

2. Having irrevocability.

This refers to the fact that the issuing bank is bound by the terms and conditions of the letter of credit from the date of its opening. In the event of revocation or amendment, the terms of the original letter of credit remain valid for the beneficiary until the beneficiary has indicated to the bank notifying the amendment that it accepts the amendment.

* Of course, even irrevocable letters of credit can be cancelled and amended with the unanimity of the issuing bank, the confirming bank and the beneficiary of the letter of credit.

I believe that through the above introduction, you must have a certain understanding of letters of credit. If you have any questions or would like to enquire, please feel free to contact us or visit our website: www.hbsocket.com