Settlements under a letter of credit are a guarantee of legal security of any transaction. What is a letter of credit from a bank when buying an apartment? Conditions for disclosing a letter of credit

Hello! In this article we will talk about the system of payments using letters of credit.

Today you will learn:

Where can a letter of credit come in handy?
What types of letters of credit are most common;
How to draw up an agreement using a letter of credit;
How to use a letter of credit.

Letter of credit: the essence of the concept

The business sphere is full of not only conscientious companies that operate in accordance with the law and the terms of the contract. There are also scammers whose main goal is to leave the counterparty with nothing. You give them a product or money for it, but as a result you are left without both.

However, expanding the production volume of an enterprise implies that it will cooperate with new business partners, whose integrity is not always possible to verify.

What to do if you enter into an agreement with a company unknown to you and are worried about the outcome of the transaction? What should you do if the other party is late in payment or if goods are not shipped in response to your advance? Such issues and resulting problems are easily resolved with the help of a letter of credit.

Letter of Credit is a special settlement system that guarantees both parties to the transaction a positive outcome. This is a banking product with the participation of two banks: in the first an account is opened for the seller, and in the second for the buyer. The credit institution transfers funds from the account only if the terms of the agreement between the parties to the transaction are fulfilled and supporting documents are provided.

A letter of credit implies the presence of two participants in addition to banks:

Applicant (or buyer);
Beneficiary (seller).

The initiator of the contract is the buyer. It is he who is interested in receiving the object of the transaction, and therefore applies to the bank with an application to open a letter of credit.

This service is provided on a fee basis: banks charge commissions, which in some cases are quite impressive. However, a letter of credit is a guarantee of contract performance, which plays an important role for both parties to the agreement.

The buyer's bank will transfer funds to the seller's account only if the terms of the signed agreement are fulfilled (for example, when goods are shipped). If the seller violates the terms of the agreement, the bank will return the funds to the buyer’s account.

A letter of credit is a rather complicated operation that requires complex processing. However, it is very popular, as it is the key to successful cooperation between participants in various transactions.

For which payments is a letter of credit used?

A letter of credit is a fairly universal concept that can be used in transactions between:

Individuals.

Legal entities are the main users of such banking services. Often, transactions involve companies whose names are not well known, and therefore one of the parties to the transaction tries to hedge their bets.

One company supplies the goods, and the second acquires them. A letter of credit allows them to avoid controversial situations when making payments. The same applies to the provision of various services or performance of work.

Individual entrepreneurs can also offer the counterparty to issue a letter of credit if they doubt its reliability. When planning to ship goods for a large amount, it is better to fix the settlement process in a very clear agreement so as not to lose your own funds.

The use of letters of credit is also common among individuals. Most often it accompanies large purchases. For example, you. A seller has been found, however, for some reason you doubt that he will fulfill his obligations under the contract.

To be sure of his integrity and accurately receive funds from the sale, you should contact the bank and conclude an agreement on the terms of a letter of credit. Most often, scammers immediately disappear with such offers, since the bank will require them to deposit the full amount into their account.

If the buyer is a decent person, then no problems arise in the process of issuing a letter of credit.

The essence of a letter of credit is the same for different parties to transactions: the fulfillment of obligations under it is insured. The use of this banking service is relevant to any items of purchase and sale: from small goods to expensive real estate.

Types of letters of credit

Letters of credit are a payment instrument used not only for domestic trade.

Based on this, there are two types of it:

International (applied for transactions involving export or import);
Domestic (used exclusively for purchase and sale within the country).

Letters of credit can also be distinguished:

Revocable. You can cancel an already opened letter of credit at any time by one of the parties to the transaction. However, this type of calculation is extremely unreliable and does not inspire confidence among market participants. Therefore, in our country their use is limited by regulations. This is done in order to avoid fraudulent actions by one of the parties to the agreement;
Irrevocable. Once a letter of credit has been signed, it cannot be cancelled. This type of calculation gives confidence to the parties to the transaction in its successful outcome.

Depending on the terms of the transaction, letters of credit are divided into:

Confirmed. In this case, the executing bank (the one that transfers funds to the seller’s account) offsets the money to the second party to the transaction, even if there is no money in the account. In other words, the bank is looking for a third party to the transaction as a credit institution that will transfer the required amount upon fulfillment of the terms of the agreement. However, in this case, the executing bank bears the risk of non-return of the transferred funds. As a result, this form of letter of credit is not used very often;
Unconfirmed. Transfer of funds to the second party of the transaction is carried out only if there are funds in the account. Banks prefer this form of payment to avoid losing their own money.

The procedure for writing off funds divides letters of credit into two types:

Coated. The issuing bank transfers the funds to the nominated bank when specified conditions are met. The amount credited is called coverage, which is where the name letter of credit comes from. The covered form of payment is used exclusively in Russia;
Uncovered. The issuing bank gives the nominated bank the right to write off funds up to the amount of the letter of credit. This form of payment is widely used abroad, where covered letters of credit are not found at all.

There is also letter of credit with red clause. It implies that an advance payment is transferred to the supplier’s account before the terms of the contract begin to be fulfilled. In this case, documents for shipment, performance of work or provision of services are also provided after the advance payment has been transferred.

Revolving letter of credit means that only part of the services specified in the contract is paid as they are performed. As soon as the next shipment occurs or other work is completed under the agreement, the next transfer is carried out. This form of payment is convenient for a contract concluded for a long term and implying regular interaction between its parties.

If the bank has the right to transfer funds in favor of several other beneficiaries, then transferable letter of credit. If funds are transferred to the account of one party to the transaction when the terms of the contract are violated by the other, then we are talking about a standby letter of credit. It is an additional guarantee for the parties to the agreement. This type of payment is used in countries where the use of a bank guarantee is prohibited.

We issue a letter of credit

To apply payments under a letter of credit between the parties to a transaction, it is necessary to draw up an agreement. It is drawn up on a documentary basis and necessarily indicates the form of payment.

The agreement includes the following points:

Name of the parties to the transaction (supplier and its buyer);
Type of payment and its type (for example, irrevocable uncovered letter of credit);
The amount of funds that will be transferred to the supplier upon fulfillment of the terms of the agreement;
The period for which the contract is concluded;
Amount of commissions;
The procedure for making payments (the entire amount at once or in advance payments);
Actions of the parties in case of failure to fulfill the conditions for which the payment letter of credit was applied;
The rights of participants, as well as their responsibilities.

For the signed agreement to come into force, the buyer must contact the bank and write an application indicating the letter of credit payment form.

The statement also states:

A reference to the agreement under which a letter of credit will be used between the parties;
The name of the supplier's organization, as well as its data according to the information;
Type of letter of credit;
The amount due to the seller;
Validity period of the contract and, accordingly, the letter of credit;
Method of implementation of a cash letter of credit (advance or the entire amount, and upon the occurrence of what conditions they are due);
The name and quantity of goods, the supply of which is indicated in the contract (or maybe these are services or some kind of work);
Name of the bank that will fulfill the obligations;
List of documents that will be accepted by the bank as confirmation of compliance with the terms of the agreement.

From the moment the application is signed and registered, the letter of credit comes into force. An executed letter of credit can be extended for a new period by mutual agreement of the parties.

Advantages of settlements using a letter of credit

Letter of credit payment under an agreement is convenient, despite the high commission rates charged by banks when applying for this service.

Among the advantages of mutual settlements using letters of credit are the following:

Transaction guarantee for seller and buyer. If the terms of the contract are met, the funds will be sent to the seller. If the terms of the agreement are violated, the money will be returned to the buyer’s account. In other words, the risk of contacting unscrupulous persons is zero. In this case, both parties to the transaction will deal with cashless payments, which also greatly simplifies the purchase and sale process);
The seller will receive the funds due to him under the contract even if the buyer’s financial condition has deteriorated after shipment of the goods (the money is already in the bank account. This is a prerequisite for payments with letters of credit);
The nuances of the agreement, forms of payment and types of letter of credit are negotiated independently by the parties to the transaction (they are prescribed in the agreement based on the preferences of the parties. Taking into account such features is very important so that the interests of the participants are not violated during the execution of the agreement);
It is possible to refuse an accepted letter of credit at any time if the seller and buyer decide so (it is also possible to change the terms of the signed agreement);
The contract has legal force, unlike an oral agreement, and if one of the parties to the transaction fails to comply with the terms, the issue can be resolved in court;
A guarantee that the buyer will receive the goods on time (after all, the seller is interested in receiving funds within the short period of time specified in the terms of the contract);
If credit funds act as a letter of credit, the buyer can save money, since the rate on them is significantly lower than on a regular bank loan.

Of course, the main advantage of a letter of credit is the guarantee that the supplier will receive money or return it if the buyer fails to fulfill the terms of the transaction. Thanks to this advantage, letters of credit are popular.

Payment scheme via letters of credit

A letter of credit is not a simple procedure. But if you use it at least once, then all its rules will become clear to you, and in the future you will easily use this calculation system.

The transaction process based on a letter of credit is structured in several stages. We will highlight the most important of them, which are taken as the basis for any type of letter of credit.

So, the steps when concluding a letter of credit agreement:

The two parties to the transaction draw up an agreement and indicate in it the letter of credit as a payment system (important nuances of interaction are also described here, as well as the responsibilities of the parties to the agreement);
The buyer contacts the issuing bank to open a letter of credit and draw up an application (this bank is considered the issuer in relation to the other party to the transaction);
As soon as the buyer deposits money in the amount of the agreement into the account, the bank registers the letter of credit;
The issuing bank then notifies the vendor's (seller) bank of the merchant's action;
The executing bank notifies the other party to the transaction about the successful opening of a letter of credit account;
The supplier ships the transaction items to the buyer’s address and delivers the supporting documents to the executing bank (this step is called issuing a letter of credit);
The bank checks the documentation, and if there are no errors in them, and the terms of the agreement are met, then it transfers funds to the seller’s account by means of a payment order.

If the contract between the parties is concluded for a long period and includes several deliveries of goods, each of which is paid separately, then the supplier must go to the bank each time and provide accompanying documents.

In the future, if the buyer and seller are confident in cooperation, they can refuse the letter of credit and make payments independently. While they don’t know each other well, a letter of credit is the most preferred payment option for both parties.

A letter of credit is a form of non-cash payments that is understandable in essence, but cumbersome in execution. The main difference between a letter of credit and regular payments from one account to another is the greater participation of banks in the contractual relationship between clients.

It is more convenient to explain what a letter of credit is using examples.

Let’s imagine that the supplier and buyer of a product do not have sufficient trust in each other, but intend to ship the product (provide a service) and pay for it.

For mutual confidence, they involve a third party - a bank - in completing the transaction.

The buyer instructs the bank to transfer money to the supplier after providing documents confirming the shipment of the goods. Such a payer is called applicant, and his bank - issuer .

The bank accepts the obligation and informs the other bank serving the supplier about the terms of the letter of credit.

The supplier (recipient of money), within the framework of the transaction, is defined as beneficiary, provides documents confirming the fulfillment of the obligation to its bank. This bank is called performing.

The beneficiary's bank receives the agreed amount from the correspondent account of the bank that opened the letter of credit.

The bank servicing the payer debits the amount of the letter of credit and the fee for the transaction from his account.

The transaction is considered completed.

Purpose of the letter of credit

In transactions using a letter of credit, a product (service) is transferred from the seller to the buyer. The payment passes from the buyer to the seller. The banks participating in the transfers receive their remuneration for making the payment and providing a guarantee, expressed in accepting responsibility and verifying incoming documents.

The costs of a letter of credit are usually borne by the buyer.

The benefit of banks from issuing letters of credit is greater remuneration than for conventional payments.

The benefit of the supplier is the confidence that his product (service) will be paid for.

The buyer's interest is in transferring the risk of “payment without goods” to the bank. And also the ability to make a transaction without touching your own funds until the transaction is confirmed.

Types and conditions of application of letters of credit

Settlements by letter of credit are often used in international trade or within one state when counterparties have insufficient trust in each other and in the situation.

Letters of credit are professional instruments of interbank relations. Ordinary sellers and buyers do not directly participate in the handling of letters of credit; they only give instructions for their opening and provide documents on transactions. Therefore, it is enough for bank clients to know what guarantees banks offer for letters of credit and the cost of these services.

In practice, it is customary to distinguish the following types of letters of credit:

Confirmed- here the executing bank agrees to pay the amount of the letter of credit upon the occurrence of the agreed conditions (provision of documents), even if the issuing bank does not make the necessary transfer of funds to it.
Unconfirmed- if the executing bank does not assume additional obligations.
Covered- when the amount of the letter of credit from the payer’s bank is transferred to the recipient’s bank account.
Uncoated- if such a transfer does not occur. Nowadays, most letters of credit are uncovered, because... Banks have each other's correspondent accounts and mutual lines of credit.
Revolving- such a letter of credit is issued multiple times, in parallel with the delivery and payment of consignments of goods. In demand for regularly recurring transactions.
Transferable- this option allows the transfer of funds to other beneficiaries.
Reserve (stand-by)- such letters of credit are paid if the buyer refuses to pay for the shipped goods. This is a form of bank guarantee used in international trade.
With payment against documents, i.e. after documentary confirmation of delivery.
Paid with deferment.

This is not a complete list of letters of credit used in global practice. Their choice depends on the needs of clients and the willingness of banks to use certain instruments.

Letter of Credit- an obligation of the bank, provided at the request of the client, to pay a third party when the recipient of the payment provides the bank executing the letter of credit with documents provided for by the terms of the letter of credit. The client company on whose behalf the letter of credit is opened is usually called the payer under the letter of credit, or the applicant. The recipient of payment under a letter of credit is called the beneficiary. In this case, the bank’s obligation is independent of the obligations of the parties under the main agreement, which provides for a letter of credit form of payment between the supplier and the buyer. Thus, the bank acts as a guarantor between them.

Suppose a seller and buyer enter into a deal. They are dealing with each other for the first time and are not ready to work on an advance payment or pre-delivery basis. Then the buyer applies to the bank with an application to open a letter of credit for the amount due to the seller for the shipped goods. Evidence of the fulfillment of the contract on the part of the seller can be, for example, documents on the shipment of goods. As soon as the subject of the transaction is transferred to the buyer or an independent carrier, the seller sends the required documents to the executing bank in accordance with the terms of the letter of credit. The buyer's bank makes payment under the letter of credit in accordance with the instructions received from the nominated bank. Letter of credit transactions involve a number of bank commissions, payable in accordance with the terms of the letter of credit. Typically, the fee for opening a letter of credit is paid by the buyer.

Letters of credit allow you to guarantee payment to the supplier, while, as a rule, funds are not diverted from circulation.

The letter of credit form of payment is used both in foreign and domestic trade. Letters of credit used in international payments are subject to the Uniform Customs and Practice for Documentary Credits, International Chamber of Commerce Publication No. 600, as amended 2007 (hereinafter referred to as UCP 600).

Letters of credit used for domestic Russian settlements are subject to Regulations of the Central Bank of the Russian Federation No. 2-P dated October 3, 2002, and from June 9, 2012 - “Regulations on the rules for transferring funds” No. 383-P dated June 19, 2012.

Domestic letters of credit can be classified into the following groups:

Revocable and irrevocable;

Confirmed and unconfirmed;

Covered (escrowed) and guaranteed.

All letters of credit, in accordance with UOP 600, are currently irrevocable. Coverage in international letters of credit is rarely used - only in the case of confirmation of a letter of credit opened by the issuing bank, for which the confirming bank does not set limits.

A confirmed letter of credit is one under which another bank, in addition to the obligation of the issuing bank, undertakes an additional obligation to make a payment in favor of the beneficiary upon presentation by the latter of documents that fully comply with the terms of the letter of credit, regardless of whether the funds will be transferred to it itself or not. If there is no obligation from another bank, then the letter of credit is unconfirmed.

Covered (deposited) - a letter of credit, the amount of which is transferred in full to the cover account in the beneficiary's bank at the expense of the payer or at the expense of the loan provided.

Uncovered (guaranteed) - a letter of credit, upon opening of which the issuing bank does not transfer funds to the letter of credit account in the beneficiary's bank, but gives it the right to write off the required amount within the amount of the letter of credit from its correspondent account or agrees on payment in another way. Typically, large banks have open lines of credit with each other, so in developed countries virtually all letters of credit are classified as uncovered.

In addition, letters of credit are of the following types.

A letter of credit with a red clause is a letter of credit under which the supplier receives a certain amount in the form of an advance before shipping or other documents evidencing the fulfillment of obligations are provided. In this case, the payment is made against the presentation by the beneficiary of the documents provided for by the terms of the letter of credit. The name comes from the times when such an important clause was highlighted in red ink in the document. Of course, nowadays almost all letters of credit are issued and confirmed electronically.

Revolving - a letter of credit opened for a portion of the payment amount and automatically renewed as payments are made for the next batch of goods. Opens with regular deliveries and payments.

Transferable (transferable) - a letter of credit that provides for the possibility of transferring part of the letter of credit in favor of other beneficiaries.

A standby letter of credit, the so-called stand-by, is a form of bank guarantee in the form of a letter of credit, used where banks are prohibited from issuing guarantees (for example, in the USA). Payment to the exporter is made if the importer refuses to make payment under the contract and presents to the executing bank documents that comply with the terms of the standby letter of credit. That is, such a letter of credit serves to ensure greater security for the supplier.

According to the method of execution, letters of credit are divided into letters of credit with payment upon presentation of documents (by payment at sight), with deferred payment and with acceptance of drafts.

Are you afraid of the risks associated with prepayment for a transaction? Do you want to be on the safe side as a first-time customer working with a new supplier? Take advantage of a letter of credit - one of the most reliable and profitable banking instruments used when concluding contracts.

The letter of credit form of payment is beneficial to both the seller and the buyer. It can be used with equal success not only in domestic Russian transactions, but also in foreign trade transactions. Today, settlement services in the form of documentary letters of credit are provided by most large Russian banks.

Letter of credit: what is it in simple terms?

In simple words, a letter of credit is a special account opened at a bank in which funds can be reserved when conducting transactions for the sale of goods or the provision of services (performing work). If both parties fully comply with the conditions specified in the contract, the bank pays the required amount to the account of the recipient (beneficiary).

Thus, the bank acts as a guarantor and assumes responsibility for making payments. The supplier is 100% sure that the product/service will be paid for, and the buyer knows that he will be able to pay for it on time and without debt.

Letter of credit form

It works according to the following scheme.

The parties enter into a contract that stipulates the terms of the letter of credit payment.
The buyer submits an application to his bank (issuer) to open a letter of credit account and deposits into it the amount necessary to cover the transaction (reserves funds).
After the successful opening of a letter of credit, the issuing bank notifies the seller's bank (advising bank) about this.
The advising bank notifies the seller about the opening of the letter of credit. The seller ships the goods and provides supporting documents to his bank.
After checking the documents, payment is transferred to the seller’s account by the issuing bank or advising bank (depending on the terms of the agreement).

Irrevocable letter of credit

One of the main and frequently used types of documentary payments. Unlike a revocable letter of credit, a confirmed or unconfirmed irrevocable letter of credit is not revoked or amended by either party (including the bank) without the prior consent of the seller/supplier. It is considered the most reliable form of letter of credit payments, as it completely frees the trade and monetary transaction from all possible risks, primarily financial.

If during the transaction the supplier and buyer come to a mutual agreement, the terms of the irrevocable letter of credit may be changed.

Letter of credit agreement

The agreement on a transaction providing for this form of payment stipulates and strictly records any information that can subsequently be used when carrying out a trade and monetary transaction and payment for it:

names of the supplier and recipient,
type of letter of credit used (irrevocable/revocable, covered/uncovered),
the amount reserved on the account to pay for the transaction,
the duration of the obligation,
commission size,
payment order,
procedure in case of non-payment of debt under a letter of credit,
rights and obligations of all parties.

Payment by letter of credit

Payments using letters of credit provide for the transfer of funds to the seller’s account only if all the conditions specified in the contract have been met. In particular, money is transferred to the seller’s account after the goods have been fully shipped and all required documents have been submitted to the bank. If the terms of the letter of credit agreement have been violated, the payer (buyer) has the right to refuse payment and return the goods to the supplier.

A nuance: a letter of credit account is opened by the buyer with his own money or with the help of bank credit funds (if he has the right to lend).

Opening a letter of credit

To open a letter of credit account, a written application in the appropriate form is submitted to the banking organization. The statement states:

number of the agreement under which the letter of credit is opened,
name and details of the supplier,
type, validity period, monetary amount of the letter of credit,
the way to implement it,
list of shipped (provided) goods/services,
name of the executing bank under the letter of credit obligation,
a list of documents that will be used as the basis for payment of funds to the supplier.

Sravni.ru advice: use a letter of credit form of payment if you need to conduct secure trade and monetary transactions with new and “problematic” business partners.

Letters of credit are instructions from the paying bank to the receiving bank to make payments to individuals or legal entities of funds within a specified amount under the conditions specified in this instruction. This is the general definition of the term. It should be considered in more detail to have a complete understanding.

Basics

When it comes to establishing new partnerships between organizations and enterprises, individual entrepreneurs and individuals, a completely logical question arises: how not to face the loss of money when concluding a transaction with an unfamiliar company and subsequent settlements with it? Everyone wants to insure their business against dishonest or unscrupulous partners, especially when it comes to large sums of money or long deadlines. In this case, the answer is quite simple: you can use letters of credit. This is a convenient form of interaction, but due to its complexity, few people use it. A bank client who once took the time to carefully study this form of interaction begins to use it and rarely abandons it. So, letters of credit are a form of payment that involves the work of two banks, while non-compliance with the terms of contracts concluded earlier, both on the part of the product supplier and the buyer, is completely excluded. The result of this is security for both parties.

Character traits

Letters of credit are the safest form of mutual settlements between clients. We can give an example where the use of such a form of mutual settlements allowed all participants to benefit. In Soviet times, the majority of consumers of caustic soda switched to a letter of credit form of interaction with the enterprise, which at that time was on the verge of bankruptcy. Although the company was on the verge of bankruptcy, it still continued its activities. The bank credited funds to the current account under the letter of credit only after the supplier company provided the necessary documentation in accordance with the payers’ instructions and concluded contracts. The documents provided were thoroughly checked. It was the letter of credit that gave the parties confidence. What it is can be described in simple terms like this. Consumers receive confidence that if there is no shipment at the right time, payments will be successfully returned to their accounts, and the plant that produces the goods receives confidence that the next consumer will not be left without payment.

How it works?

Letters of credit are settlement documents on paper, on their basis the bank, which acts on behalf of the payer to open a letter of credit, undertakes obligations to make payments in favor of recipients of funds when the latter is provided with documents that comply with the terms of the concluded contract, or transfers authority to the second bank to make such payments.

In the case of using this form of mutual settlements, it is very important to choose the most suitable type. Any types of letters of credit are opened by banks in accordance with the instructions of the payers, therefore, the selected type is indicated in the draft agreement. All existing forms are prescribed by regulations of the Central Bank of the country. In the case of the Russian Federation, there is a Regulation that sets out the possibility of opening the following types of letters of credit:

covered (deposited);
uncovered (guaranteed);
revocable;
irrevocable;
confirmed (revocable or irrevocable).

You can consider each of them separately for a better understanding of their essence.

A covered bank letter of credit is a form in which, upon opening, the issuing bank transfers the amount at the expense of the payer to the executing financial institution for the entire term of the agreement. This type is the most common.
Next, you can consider an uncovered letter of credit. What it is can be described in simple terms like this. When opening a letter of credit, the issuing bank does not transfer funds, but gives the executing bank the right to write off funds from the correspondent account maintained by it, within the agreed amount. The procedure for debiting funds from an account with the issuing bank is determined depending on the existing interbank agreement.
A revocable letter of credit is a form of interaction that can be modified or canceled by the issuing bank based on a written order from the payer. In this case, no prior approval is required from the recipient of the funds, and any banking circumstances are not specified to the recipient of the funds in the event of a payment revocation.
An irrevocable letter of credit is an agreement that can be canceled only from the moment the executing bank receives consent to change the conditions from the recipient of the funds. Partial acceptance of the terms of an irrevocable letter of credit is not permitted.
A confirmed letter of credit is a form of interaction in which the executing bank undertakes obligations to make payment of the amount specified in it, regardless of the receipt of bank funds. The order in which confirmation is made depends on the agreement between the banks.

Additional varieties

At the moment, there are several other types of letters of credit, which are variations of those described above.

A letter of credit with a red clause is an agreement under which the issuing bank authorizes the executing bank to make an advance payment to the supplier of products in an amount specifically agreed upon before all the necessary documents are presented to them, that is, until the goods are shipped or the service will be provided.

There is also such a type as a revolving letter of credit. What this is can be described in simple language as follows. This is a letter of credit that is opened for a portion of payments from the total amount under the concluded contract, automatically renewed as payments are made for the next batch of goods or services provided. The opening of a revolving letter of credit is carried out with uniform deliveries, which are spread out over time in order to cyclically reduce the contract amount.

In one of these ways, the recipient of funds has the opportunity to refuse to use the letter of credit before its expiration, if the terms of the concluded agreement generally provide for the possibility of such a refusal. In addition, the conditions may specify acceptance by a person authorized by the payer.

Payments using letters of credit

Contracts clearly state the procedure and method of making payments for the provision of services and the supply of goods, performance of work and other activities, and also indicate the form of payment. When it comes to using a letter of credit form of mutual settlements, the agreement must necessarily reflect certain conditions: the names of the banks with which interaction is carried out are indicated; the name of the recipient of the funds is indicated; amount and type of letter of credit; the method of notifying the recipient that the letter of credit has been opened; a method of notifying the payer about the account number on which the funds will be deposited; validity; terms of payment and liability for non-fulfillment.

Often contracts contain other conditions that relate to the payment procedure. For example, partial payments may be provided. Payments are made in cashless form by transferring the agreed amount of the letter of credit to the recipient's account.

It is important to note that for violations that may be committed during the execution of the letter of credit form of mutual settlements, banks are held liable in full accordance with current legislation. If this is taken into account, then it can be understood that the executing bank will not accept unfinished documents that serve as evidence of the delivery of goods, provision of services or performance of work.

Settlement procedure

As described earlier, a letter of credit turns out to be a convenient form of interaction in many situations. The procedure is not particularly complicated. Settlements in this way can be made between legal entities, between individuals and legal entities.

Calculation algorithm for the recipient

A letter of credit should be included as a form of payment under the terms of the concluded agreement.
After this, you need to contact the bank office where your organization is serviced to fill out an application for opening a letter of credit. The bank must be provided with a copy of the agreement for the supply of goods or provision of certain services.
Upon delivery of goods to the bank, you are required to provide a package of documents that confirm it. Each transaction uses its own list of documents, which must be specified in the agreement concluded when opening a letter of credit.
If the transaction does not take place and the documents were not provided to the bank after the expiration of the letter of credit, then the entire amount is returned to the recipient’s account.

Advantages

Using any form of letter of credit, you can get a whole range of advantages, including the following. Risk reduction is ensured by the fact that after submitting a package of supporting documents to the bank, the seller will receive funds regardless of the financial condition of the seller. The terms of mutual settlements can be determined independently. The parties to the transaction have the right to change the terms of the letter of credit or completely refuse it in case of mutual agreement.

International practice

International letters of credit represent the most civilized terms of payment, which are widely used in payments at the international level. If we speak from the position of protecting the interests of the parties involved, then such conditions of interaction can be called ideal. For international settlements, there are certain rules that should be considered. So, what letters of credit are has been described in detail earlier, but how do they work in the case of international relations? At the moment, there is a list of unified rules that spell out all the features of the process.

In the system of international mutual settlements, only one form is most often used - a simple covered irrevocable documentary letter of credit. The advantages of this method of calculation were described earlier, however, in the case of such interaction, certain disadvantages can be identified.

Difficulties of the international procedure

In such a transaction there are four parties, and not two, as in ordinary mutual settlements. In addition to the customer and the supplier, the customer’s bank and the supplier’s bank are also involved. This will be difficult for a novice participant in foreign economic activity to understand.

Requirements for documents and deadlines

This form of payment always requires strict adherence to deadlines, documentation requirements, and also complicates the registration procedure. Whenever the deadline for the fulfillment of obligations by any participant in the transaction changes, documentary evidence with the signatures of all parties is always required. In addition to the contract between customers and suppliers, additional exchange of documents is required between banks. Despite the fact that now this is all done electronically and happens instantly, this requires time, as well as control of all procedures performed.

Letter of credit cost

Another disadvantage is the cost of this form of payment. From the moment the letter of credit is opened, the buyer’s funds are frozen in the bank account, and coverage of the letter of credit or a fee for a bank guarantee in the case of an uncovered letter of credit is generated. A supplier who does not have the funds to purchase materials for production has a need for borrowed funds, for which the buyer also ultimately pays. Banking fees apply to all transactions involving letters of credit.

Afterword

So, now that you have an idea of what letters of credit are, you may think that it is very complicated, but when you decide to go through the entire procedure step by step, you will understand that this form of payment is quite convenient and reliable. When you choose a reputable bank, most of the work will be done for you. When working with foreign partners, using a letter of credit will allow you to declare yourself as a specialist, which will arouse respect for your entire company.