Understanding Letter Of Credit
A letter of credit is a letter from a bank guaranteeing that a buyer's payment to a Seller will be received on time and for the correct amount. In the event that the buyer is unable to make payment on the purchase, the bank will be required to cover the full or remaining amount of the purchase.
In a Brief
Instance of Letter Of Credit
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Because a letter of credit is typically a negotiable instrument, the issuing bank pays the beneficiary or any bank nominated by the beneficiary. If a letter of credit is transferable, the beneficiary may assign another entity, such as a corporate parent or a third party, the right to draw. Note: Financial Institution typically require a pledge of securities or cash as collateral for issuing a letter of credit. Banks also collect a fee for service, typically a percentage of the size of the letter of credit. The International Chamber of Commerce Uniform Customs and Practice for Documentary Credits oversees letters of credit used in international transactions. There are several types of letters of credit available.
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Due to the nature of international dealings, including factors such as distance, differing laws in each country, and difficulty in knowing each party personally, the use of letters of credit has become a very important aspect of international trade.
Various Classifications of Letters of Credit
Commercial Letter of Credit
The issuing bank makes the payments to the beneficiary in this direct payment method. In contrast, a Standby Letter of Credit a secondary payment method in which the bank pays the beneficiary only when the holder cannot.
Standby Letter of Credit
This kind of letter allows a customer to make any number of draws within a certain limit during a specific period.
Traveller's Letter of Credit
For those going abroad, this letter will guarantee that issuing banks will honour drafts made at certain foreign banks.
Confirmed Letter of Credit
A confirmed letter of credit involves a bank other than the issuing bank guaranteeing the letter of credit. The second bank is the confirming bank, typically the seller's bank. The confirming bank ensures payment under the letter of credit if the holder and the issuing bank default. The issuing bank in international transactions typically requests this arrangement.
Sample of a Letter of Credit
First Group Capital offers letters of credit for buyers in Latin America, Africa, Eastern Europe, Asia, and the Middle East who may have difficulty obtaining international credit on their own. Our letters of credit help exporters minimize the importer's country risk and the issuing bank's commercial credit risk.
Letters of credit are typically provided within five business days, guaranteeing payment by our confirming issuing bank branch. This benefit is especially valuable when a client is located in a potentially unstable economic environment.
- A letter of credit is a letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount.
- There are many kinds of letters of credit, including one for travellers.
- Banks collect a fee for a letter of credit service, typically a percentage of the size of the letter of credit.
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