Question

a sample of a full document of the letter of credit issued by the buyer's bank

Answer 1

A letter of credit is a document that directly guarantees the buyer’s payment to the sellers. This letter is issued by a bank and ensures the timely full or partial payment to the seller. If the buyer is unable to make or initiate any of such payment, the bank covers the full or the partial amount on the behalf of the buyer. A letter of credit is mandatory issued against a valid pledge of cash or securities. The banks usually collect a fee or interest for service, i.e., a percentage of the initiated amount through the letter of credit.

The importance of the letter of credit is since the nature of global market trade or international trades includes elements such as the distance of both markets, different laws and policies in each country, and the lack of direct contact (face-to-face transactions) during international trade, the scope for letters of credit make a reliable and trusted payment mechanism for both buyer and seller. The major types of letters of credit are acceptance credit/ time credit, sight credit, and revocable and irrevocable credit options.

Sample procedures of the letter of credit (Process)

Drafting a letter of credit based on buyer and seller through the bank.

Example: A buyer (manufacture of ABC) receives an order from a new customer from the overseas. The manufacturer has no guarantee knowing if this new customer can (or will make) pay for the ordered goods after producing, organizing, packing, and shipping the products.

To manage the risk in the whole process, the seller (manufacturer) uses a legal agreement that requires the buyer (or the new customer) to pay with a letter of credit as soon as the shipment is made or complete.

To move forward the operation, the buyer (new customer) needs to apply for a letter of credit at a respective country bank in their home country. The buyer may need to have the required funds on hand at that bank or get an instant approval for financing the orders from the bank.

The bank will only release the agreed funds to the seller after the seller (manufacturer) proves that the shipment has happened. To do so, the seller usually provides adequate documents showing how goods or products were shipped (with details like invoice number, exact dates, destination, and contents shipped). In some other ways, the buyer (new customer) also enjoys the legal protection under a letter of credit from the bank. The buyers might prefer to pay a bank with a huge legal department or a safe way rather than send the hard-earned money directly to an unknown seller overseas.

In other cases, if the buyer is concerned about the approach of the dishonest seller, there are additional options available in the bank for the buyer’s safety under financial protection. For example, somebody on the loop can directly inspect the shipment before the approved payment is released.

Parties involved in the letter of credit

The letter of credit usually contains the terminology associated to process.

Applicant: The party who directly requests the letter of credit.

Beneficiary: The party who receives the payment.

Issuing Bank: The bank which creates or issues the letter of credit based on the applicant’s request. It is typically a country bank where the applicant (party) already does the business (in the applicant’s country itself, where the applicant has the bank account or a line of credit).

Negotiating bank: The bank that works directly with the beneficiary. This bank is often located in the beneficiary’s country itself, and it may be a bank where the beneficiary account is active.

Confirming bank: A bank that “guarantees” the payment to the beneficiary based on the requirements in the letter of credit are completely satisfied. The issuing bank always ensure the payment of the guarantee, but the beneficiary might prefer an active guarantee from a bank in their own country

Advising bank: The advising bank that receives the letter of credit from the issuing bank and directly notifies the beneficiary (party) that the letter is active or available. This bank is also called the notifying bank.

Intermediary: A legal entity or company that connects between the buyers and sellers, and sometimes uses the letters of credit to initiate the transactions. They use the transferable letters of credit in most of the time.

Freight forwarder: A company or agent that assists with international shipping procedures or processes in the other country. Freight forwarders usually provide the required documents where exporters need to provide in order to get paid.

Shipper: The logistics company that transports the goods from place to place.

Legal counsel: A firm that directly advises the applicants and beneficiaries on how to use the letters of credit in a legal way. The counsel is essential to get guidance or help from a legal expert who is more familiar with these kinds of transactions.