Methods of Payment/Letters of Credit

Letters of Credit
A letter of credit is a bank instrument that can be used to even the risk between a buyer and a seller since a buyer is guaranteed to receive payment if when he/she has  complied with the exact requirements of this buyer. A letter of credit offers a seller numerous advantages but only if that seller complies exactly with its terms and conditions of the transaction. In addition to providing reduced risk for both a seller and a buyer, there are many variables that can be used with a letter of credit to reduce the political and commercial risks that may accompany the transaction as well as provide extended terms to a buyer through the letter of credit instrument.

The terminology that is used when working with letters of credit is very specific and should be understood.

Involved Parties:
 * Applicant = Buyer/ Importer
 * Beneficiary = Seller/Exporter
 * Opening Bank = Importer’s Bank >> Issues L/C
 * Advising Bank= Exporter’s Bank >> Advises L/C
 * Confirming Bank = Advising Bank or 3rd Party Bank >> Confirms L/C
 * Paying Bank = Any Bank as Specified in L/C >> Pays the Draft

Activities and Terms:
 * Advice – review and approval of L/C
 * Amendment – change to L/C
 * Confirmed – the commercial, political and economic risk of the transaction absorbed by the confirming bank
 * Discrepancy – mistake in the documentation
 * Documentation – documents required within L/C
 * Draft – negotiable order to pay
 * Sight Draft – payment assured upon shipment and presentation of documents in compliance with its terms
 * Time Draft – bank assurance of payment at the maturity of the banker’s acceptance with option of obtaining immediate funds by discounting the BA (30, 60, 90 days at sight or acceptance)
 * Irrevocable – cannot be changed without approval from beneficiary or advising bank
 * Issuance – opening of L/C
 * Negotiation – review of documents
 * Revocable – can be changed without approval of beneficiary or advising bank

Types of L/Cs:

 * Back-to-Back – credit and terms of a transaction rollover to a new transaction upon completion, which eliminates the need to apply or issue a new L/C for identical shipments
 * Confirmed – credit risk taken by bank and agreement to pay (fee charged)
 * Straight – payable only at paying bank
 * Negotiation – payable at negotiating bank
 * Sight – payable at acceptance of documents
 * Standby – used by the beneficiary for payment should the applicant not pay the exporter directly
 * Transferable – part or all of the proceeds from the L/C may be transferred to another party, used by sales brokers or agents to disguise buyers and sellers
 * Usance – time draft based on invoice, bill of lading, or documents, up to 180 days