Letter of Credit
Letter of Credit is a method of payment in international trade where the bank undertakes to pay the transaction amount on behalf of the seller by opening an account by the buyer. In most of the international transactions, where it is not possible to transfer goods and pay money at the same time due to the distance, this method will be a safe and secure solution for the parties.
Because on the one hand, the bank assures the buyer that no payment will be made to the seller before receiving the goods. On the other hand, it assures the seller that he will pay the agreed amount in full.
Advantages of Letters of Credit
1. The seller’s assurance that by presenting the goods delivery documents, he/she can receive the agreed amount from the bank.
2. The customer’s assurance that the payment to the seller will definitely happen after the goods are delivered by him/her.
3. The date of shipment and delivery of the goods can be checked.
4. It will be possible to obtain more facilities for the seller.
Beneficiary in Letters of Credit
The beneficiary is the seller, who can be a natural person or a legal entity. The seller must deliver the goods to the buyer in accordance with the laws and regulations and agreements made between him/her and the buyer, and receive the agreed amount in return. Due to the bank’s obligation to pay the amount to the seller, the correct delivery of the goods to the buyer is carefully evaluated and monitored.
Types of Letters of Credit
1. Import and Export Documentary Credit
The credit that is opened in the destination country by the buyer is called import documentary credit. The opposite point is the export letter of credit, which is related to the seller and exporter of goods.
2. Usance Letter of Credit
In this type, payment of the amount is not paid immediately after the presentation of the documents related to sending the goods. But the seller gives the buyer a deadline to pay the agreed amount after receiving the goods and selling them.
3. Revocable Letter of Credit
This type of credit will cause distrust of the beneficiary or the seller to a large extent. Because based on the terms of this type of credit, the parties can make changes to their opened account and these changes may not be favorable to the seller.
4. Irrevocable Letter of Credit
The opposite point is the previous and reliable for the parties, especially the seller. In this type of credit, it will be possible to make changes to the opened account only with the knowledge and consent of both parties.
5. At Sight Letter of Credit
It is a credit that the bank makes a payment after seeing the documents of goods shipment by the seller and verifying compliance with the stipulated conditions.
6. Confirmed Letter of Credit
It is a type of credit in which the buyer, as the exporter, must confirm the credit of the documents issued by his/her own bank to any bank that the seller is interested in. This type of credit exists because trust in the credit of the issuing bank is in a state of doubt for the seller, or it may undergo political and economic changes.
7. Unconfirmed Letter of Credit
This type of credit is usually created without the need for approval from another bank. If we come across the term Confirmed in the conditions of the credit, it means that the letter of credit has not been confirmed.
8. Back-to-Back Letter of Credit
In this type, we are faced with two credits. The initial credit related to the name of the first beneficiary is opened, but this beneficiary does not have the ability to prepare and send the goods. Therefore, relying on his/her credit, secondary credit is concluded for a seller who is able to prepare and send goods.
9. Transferable Letter of Credit
It is crediting whose nature is for the benefit of the beneficiary and is considered a privilege for him/her, because it can transfer all part of it to another.
10. Untransferable Letter of Credit
The opposite point is the previous one. In international trade, credit is non-transferable. In Iran, its transfer is also limited and requires the approve and agree of the central bank.
11. Revolving Letter of Credit
In this type, the credit is renewed after each use. In fact, we will never face a lack of credit, and we do not need to open an account again or modify it. It is also necessary to mention that credit renewal will be up to the initial credit limit.
12. Red Clause Letter of Credit
In this type of credit, the seller can demand funds under the title of advance payment from the issuing or confirming bank before sending the goods.
Up To Sum
With the increase in international business transactions, merchants are looking for more secure tools and ways to conduct their business transactions, deliver goods and make international payments. The necessity of this required the banks to take a step towards creating credits in international payment documents, and the documentary credit or LC was brought up as a custom in world trade. For this reason, today international transactions are done with more speed and confidence.