Letter of Credit – Everything You Need To Know

May 1st, 2020

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In international trade, the relationship between the importer and exporter can result in a conflict of interest. This is because both parties are prone to risks of engaging in overseas transactions. To avoid business scams, the two parties need to come to a compromise by agreeing on one method of payment.

What is Letter Of Credit

A letter of credit is a commercial instrument designed to facilitate the movement of goods by providing protection and finance to the buyer and seller. You should not confuse this with the Letter of Guarantee.

Parties To A Letter Of Credit

letter-of-credit

There are five major parties to a documentary letter of credit, and they are as follows;

  • The Importer or Applicant – This is the initiator of the letter of credit. He pays the Naira cover when the loan is due, including bank charges. To do this, the bank must rank such applicant as creditworthy, and he also provides collateral before he gets the credit.
  • Issuing Bank – The Issuing Bank is the bank that opens a credit (i.e. importers bank). The issuing bank advises details to the correspondent bank. The bank guarantees payment to the exporter and thus is primarily liable on credit.
  • Advising Bank – The advising Bank receives details of the credit from the issuing Bank and issues the same information to the beneficiary. The exporter who acts according to the details of the instructions will only be paid on presentation of the substantiating document. The advising bank is also the receiving bank.
  • Confirming bank – the confirming bank can sometimes be the advising bank. The confirming banks are the banks that confirm the letter of credit in issue by the issuing bank
  • Exporter or Beneficiary – The exporter is the beneficiary of the documentary letter of credit and is responsible for keeping to the terms and conditions of the credit. If the documents are in order, he is sure of the payment immediately for sight bill.

How Letters of Credit Work

A letter of credit is a document you generate from a bank that guarantees payment transactions. There are various kinds of letters of credit, and they provide the security needed for carrying out operations.

  • Seller protection: If a buyer is unable to pay a seller, the issuing bank that raised and issued a letter of credit will pay the seller. The seller must meet all requirements in the letter of credit. This provides security when the buyer and seller are in different countries.
  • Buyer protection: In the case of buyers. If you pay someone to provide a product or service and they are unable to deliver, you might be able to receive payment using an anchor letter of credit. The amount can be a fine to the company that was unable to deliver, and it’s equal to a refund. You can pay someone else to provide the product or service needed with the money you received

Information Provided By an Applicant

The applicant for the letter of credit has to complete a form. The information needed by an applicant includes the following;

  1. State whether the credit is to be revocable or irrevocable
  2. The name and address of the ex[porter or beneficiary
  3. The amount of credit and the currency involved.
  4. The maturity date of the credit
  5. The last shipment date
  6. How the credit is to be advised 
  7. Description of the goods or services
  8. The documents which will be required to be produced

Conclusion 

The Letter of Credit is a kind of credit that a person who indulges in international trade gets. It is a conditional guarantee of payment by the bank given that the exporter fulfils certain conditions. The underlying conditions are certain before payment can be effected. Before you enter into a business transaction with an overseas customer, it is better to include it into the conditions. This puts both the buyer and seller at ease and secures their exposure to each other.

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