A documentary letter of credit is a commitment of the bank issued at the request of the buyer to pay the seller of goods a certain amount, after the latter has submitted documents to the bank, which comply with the conditions and terms of the letter of credit. A letter of credit can be used to pay not only for the delivered goods but also for the works performed or services rendered.
When is a letter of credit used?
- When trading partners do not know or know insufficiently one another.
- When the seller doubts the buyer's ability to pay.
- When trade agreements are concluded with partners from politically instable or economically weak countries.
- When the laws of the country require that.
- When there is a possibility to receive financing under favourable conditions.
How does settlement by a letter of credit work?
- The seller and the buyer sign an agreement in which they provide for settling accounts by means of a letter of credit.
- The buyer applies to its bank with request to issue a letter of credit.
- The buyer's bank issues a letter of credit and forwards it to the seller's bank.
- The seller's bank advises the seller about the letter of credit.
- The seller forwards the goods to the buyer.
- The seller submits the documents specified in the terms and conditions of the letter of credit to its bank.
- The seller's bank forwards the documents to the buyer's bank.
- The buyer's bank examines the documents and if they comply with the terms and conditions of the letter of credit, it debits client's account for the documents value and forwards documents to the buyer. The buyer acquires the right to the goods.
- The buyer's bank transfers money to the seller's bank.
- The seller's bank credits the seller's account.
What are the conditions for issuing a letter of credit?
- The bank issues a letter of credit after the client has deposited money in the account that is specially opened for that purpose.
- The bank issues a letter of credit after the client has mortgaged other movable or immovable property (the client is given the credit line).