If you are afraid to settle with counterparties on an advance payment, have started cooperation with a new supplier and want to insure yourself or plan to work with foreign partners, you should pay attention to such a form of payment as a letter of credit. This is one of the most profitable and reliable ways to pay under the contract, which allows you to avoid significant costs and risks. We will talk about him.
If you are afraid of banking terminology and it is difficult to figure out what a letter of credit is on your own, our material is just for you. In it, we tried to tell in simple terms what a letter of credit is, what types it is, what are its advantages and disadvantages.
To begin with, let's find out how the concept of "letter of credit" is deciphered in domestic legislation. And after that we will try to explain the essence of the phenomenon in simple words.
According to the Civil Code (Article 867), when making settlements under a letter of credit, the bank (issuer), on the basis of the payer's instruction, undertakes to pay the funds, pay the promissory note issued by the recipient, or perform other actions aimed at fulfilling the letter of credit, after the recipient presents certain documents.
Important: this is how a letter of credit is defined in professional language. If we state its interpretation in simpler words, then a letter of credit is an instruction to a bank to pay a certain amount, provided that its recipient provides certain documents. To put it even more simply: to open a letter of credit is to set aside money in a special bank account, which will be there waiting for them to come with documents. In this case, you can use your own funds or borrow them from the bank.
After fulfilling the terms of the letter of credit, the bank transfers the money to the recipient. This method of payment is used to make payments for the delivered goods, work performed and services rendered. The Bank participates in this process in the role of a guarantor that payments will be made in full and on time. Therefore, a letter of credit, in simple terms, can be called a guarantee of payment. It is also a special form bank lending because borrowed funds are often used.
Before opening a letter of credit, the parties must agree that payment will be made in this manner. The agreement is in the form of a contract. The next step is to contact the bank. The letter of credit is issued in paper form and must contain certain information:
The letter of credit can be executed by the bank in one of the following ways:
For clarity, we will demonstrate the use of a letter of credit for settlements using an example. Let's say you need to pay for a delivered product, but the required amount is not available. For this purpose, a letter of credit is opened with the attraction of credit funds, that is, in simple terms, you borrow money from the bank, but do not receive it yourself, but save it to a separate account and instruct the bank to pay them to the supplier when he fulfills certain conditions.
After the goods are delivered, the supplier submits supporting documents to the bank, and the agreed amount is transferred to his account. As such documents, as a rule, bills of lading are bills of lading. You just have to return the debt to the bank with interest, like a simple loan.
Important: when opening a letter of credit, it is not necessary to borrow funds - you can use your own money.
The person to whom the funds are to be paid applies to the bank with the documents stipulated by the terms of the letter of credit, and they can be drawn up in in electronic format. Further, within 5 working days, they can be checked, after which the bank makes a payment or refuses it. If within the period for which the letter of credit is issued, the necessary papers are not applied for, the funds are returned to the one who opened the letter of credit.
Important: a letter of credit is widely used not only in business, but also when paying for purchased apartments in new buildings. This method of payment allows both the buyer and the developer to insure against fraud. The client does not have to transfer money before registering the ownership of the apartment, and the company that sells the apartment may not be afraid that it will issue its transfer, but will not receive payment.
Depending on the possibility of cancellation and revision of the conditions:
Based on the availability of coverage, that is, in simple words, the preliminary transfer of funds:
By mode of use:
Depending on the availability of additional warranties:
According to the payment procedure (form of execution):
Subject to other conditions, other types of letters of credit are also distinguished:
Like any other form of settlement, a letter of credit has both advantages and disadvantages that should be considered when choosing it as a payment method. Let's start with the positives.
Advantages of a letter of credit:
Cons of a letter of credit:
When working with counterparties, it is necessary to choose the best way to make settlements with them, which will allow you to make payments on time and insure against dishonesty of the counterparty. One of the most profitable and safest forms of payment is the opening of a letter of credit. In simple terms, it can be defined as an instruction to the bank to pay funds to a certain person (company) on the condition that certain requirements are met. As a rule, in order to receive payment, it is necessary to provide documents confirming the fulfillment of obligations.
Depending on the terms of the letter of credit, in particular on the availability of coverage, confirmation and the possibility of revocation, there are various types of this form of payment. Its main advantages are savings and the ability to protect the parties to the contract from fraud. Among the shortcomings can be called a voluminous document exchange and the presence of restrictions on the use of a letter of credit.
An important point in the sale and purchase transaction is the method of settlement between the parties. To avoid possible risks, the seller and the buyer often turn to the letter of credit settlement system. It doesn't matter if you are paying for your own or mortgage funds.
A letter of credit is another cashless payment method that can be used by the parties to a contract of sale, delivery, etc. In simple words, a letter of credit is financial instrument, offered by banks, associated with the control of settlement between the seller and the buyer. The Bank acts as a guarantor of an honest transaction, issues funds only if the contractual obligations between the participants are observed. For the duration of the transaction, the money is kept in a special bank account.
Accreditation Scheme
Two credit institutions may participate in such transactions: the issuing bank and the executing bank. The issuing bank opens a letter of credit based on the application of its client and undertakes to make a transfer in favor of its counterparty under the agreement. For this, an order is sent to the executing bank. Such an order is possible only after documentary confirmation of the fulfillment of all agreements on the transaction. The transfer takes place on the basis of the order of the Bank's client to transfer funds to a third party. Service benefits:
For the seller, a documentary letter of credit is an additional guarantee from the bank in the receipt of funds under the contract, as soon as it fulfills all the conditions. And the buyer is sure that the money will be transferred after providing the documents named by him in the application.
The letter of credit agreement fully regulates the relations of the participants. It must contain all the necessary information for the transaction:
After signing the agreement, a special account is opened in the bank to reserve money. To open an account, the client writes an application with the obligatory indication of the following data:
Due to various terms of the transaction or changes in circumstances, its participants can use different types and features of the letter of credit settlement system:
Such a transaction is in many ways similar to the purchase of real estate through safe deposit box. However, the use of the safe is more in a simple way with less bank control. Considering the topic of what a letter of credit in a bank is when buying an apartment, you should keep in mind the purchase of an apartment in the primary or secondary market. In the first case, housing can be purchased in a house under construction. When settlements with the developer are carried out through a letter of credit, the buyer receives a guarantee to become the owner of the apartment in the completed house. The developer will be able to receive funds only after the completion of construction and commissioning of the house.
The reliability of this payment method is associated with the high cost of bank services. On average, when making a transaction, you will have to pay:
The service is provided to individuals. The statement states:
In addition to the sale of the apartment, financial liability can be used for transactions with other not movable property(houses, land, parking places), expensive movable property (equipment, furniture or art). The service is convenient when paying for services: construction, repair.
The letter of credit is issued in rubles. The term is set by the buyer and negotiated in the application. If a mortgage transaction goes through, then the average term in banks is set at 120 days. Extension is allowed, but not more than 60 days.
An important stage is the control of documents and the issuance of money. In other words, the disclosure of a letter of credit is the fact of confirmation of the seller's fulfillment of the terms of the agreement. The bank reviews and checks the submitted documents within about a week. Such a bank service is included in the scope of the letter of credit and may be paid additionally. If the control results are positive, the credit institution opens a letter of credit. former owner gets the right to take the money for the apartment. Usually they are transferred to his account.
Some banks may set limits and terms for receiving money. So, in Sberbank, 1% of the amount is charged for cash withdrawals. If the transaction amount is more than 5 million rubles, the funds must be on the account for 1 month. If the seller withdraws the funds earlier, 10% will be deducted from him.
With an obligation with acceptance, the issue of money is possible after the buyer confirms the fulfillment of its conditions. The buyer informs the bank in writing about compliance with all requirements of the agreement. Credit institutions are liable for violations of the settlement process. Therefore, it is beneficial for banks to accept only correctly executed documents. It is worth taking into account:
At the end of the obligation and non-receipt of the agreed documents from the seller, the letter of credit is closed. The recipient of the money is notified of this by the bank without fail.
Services for transactions with a letter of credit can be carried out in different ways, depending on the credit institution. Banks usually do the following:
So, the settlement system when buying real estate under a letter of credit is a reliable guarantee of compliance with the terms of the agreement. Long terms processing, payment of money and cost justify the risks to which participants in transactions for large amounts are exposed.
15.10.2016 17 733 0 Reading time: 11 min.
Today we will continue talking about banking services and consider, what is a letter of credit where such a service can be used, why it is interesting. This service is more popular for representatives of large and medium-sized businesses, however, recently it has been increasingly extended to small entrepreneurs, and even to individuals who are not engaged in business. Therefore, knowing what a bank letter of credit is, what types of letters of credit are available will be useful to everyone, even just for general development.
A letter of credit is an obligation of the payer's bank to make a payment to the beneficiary's bank only after the payee provides his bank with certain documents stipulated by the conditions for opening a letter of credit.
Letters of credit belong to the so-called. documentary operations of the bank, that is, to operations based on document flow. Most often, documentary transactions, in particular letters of credit, are used by enterprises engaged in export-import activities, but this is not the only area of their application.
Why are letters of credit needed? In simple words, in order to exclude fraud between the parties to a particular transaction. The bank simply acts as a legal guarantor between the parties to the transaction, for which it receives its commission.
Consider the basic terms and concepts associated with the opening of letters of credit.
Letter of credit issuer- the bank to which the client applied, wishing to open a letter of credit.
Beneficiary bank- the bank in which the client is served, in whose favor the letter of credit is opened.
Beneficiary- beneficiary of payment under a letter of credit.
Deal- a certain sale and purchase operation, for the settlement of which a letter of credit is opened.
Letter of credit amount- the amount of the transaction, for the settlement of which a letter of credit is opened.
Letter of credit term— the limited period during which the letter of credit is valid.
Type of letter of credit– conditions for opening a letter of credit (I will consider the most common options below in more detail).
Commission for opening a letter of credit- the cost of opening a letter of credit, established by the bank's tariffs. Usually calculated as a percentage per annum of the amount of the letter of credit, it may also include some fixed or minimum payment. At the same time, the issuing bank pays part of the commission received to the beneficiary bank for its services.
Consider the scheme of the letter of credit on an example. Let's say we have a supplier and a buyer of a certain product who do not trust each other and want to make sure. The buyer is afraid to send money without seeing the goods, and the supplier is afraid to send goods without seeing the money.
In such a situation, opening a letter of credit can help. The buyer opens a letter of credit in his bank, pays the payment amount to a special account, and instructs the supplier to send it to his bank, but only after the supplier provides documents confirming the fact of sending the goods.
The buyer's bank sends the supplier's bank a notice of opening a letter of credit, and the supplier's bank informs the supplier about it. The supplier, knowing that the funds for payment for the goods have already been reserved and will be sent to him, sends the goods and provides documents confirming this fact to his bank. The supplier's bank checks the legality of these documents and, on the basis of this, makes the necessary payment, which is reported to the buyer's bank. After that, the buyer's bank transfers the reserved funds of its client to the supplier's bank. The supplier gets his money, the buyer gets the product, and the banks get their commission. Everyone is happy. This is the classic letter of credit scheme, and depending on the type of service, some actions may vary.
For clarity, an approximate scheme of the letter of credit can be presented in the following figure (numbers indicate the procedure):
Consider the most common types of letters of credit - they can be divided according to several criteria.
Based on whether it is possible to cancel the action of a letter of credit, there are revocable and irrevocable letters of credit.
Revocable letter of credit implies the possibility of the issuing bank to withdraw (cancel) its instruction to transfer funds before the moment of submission required documents by the opposite party, that is, cancel the operation, without notifying the beneficiary bank.
Irrevocable letter of credit does not imply the possibility of its cancellation without notifying the beneficiary bank and without the consent of the direct recipient of the payment. That is, it can also be canceled, but only with the consent of the two parties, and not in unilaterally as a revocable letter of credit.
Irrevocable letters of credit are used in practice much more often than revocable ones, since they satisfy the interests of both parties to the transaction more.
According to the degree of responsibility of both banks, confirmed and unconfirmed letters of credit are distinguished.
Confirmed letter of credit guarantees that the recipient's bank or another third bank will pay the recipient the amount due, even if the sender's bank does not transfer the money to him.
Unconfirmed letter of credit assumes that the payment will go to the recipient only if it is actually transferred by the issuing bank.
According to the possible source of funds for the execution of the payment, covered and uncovered letters of credit are distinguished.
Covered (deposited) letter of credit means that the issuing bank transfers the payment amount to the beneficiary's bank for the entire period of the letter of credit. This amount is a guaranteed cover, and is immediately at the disposal of the beneficiary's bank.
Uncovered (guaranteed) letter of credit means that the issuing bank allows the beneficiary's bank to debit the payment amount from its correspondent account, or stipulates some other conditions for receiving a refund. In practice, this type of letter of credit is most often used.
Consider some other well-known types of letters of credit.
Letter of credit with a red clause means that the issuing bank undertakes to make the agreed amount of advance payment to the beneficiary's bank even before the receipt of supporting documents from the beneficiary.
Revolving letter of credit opens when it is necessary to regularly perform homogeneous operations. Each time it acts on a certain batch of goods and then resumes its effect on the next batch.
Transferable (transferable) letter of credit implies the possibility of transferring part of it to another beneficiary, if necessary.
Standby letter of credit or stand-by letter of credit- this is a kind of symbiosis of a letter of credit and a bank guarantee, under the action of which the supplier receives payment for the goods, even if the buyer refuses to pay him - the bank makes the payment at its own expense.
All the advantages and disadvantages of the letter of credit form of payment are reduced to one. The advantage is the bank guarantee that the client will receive the necessary product-service, his money will not be lost, the opposite side of the transaction is not a fraudster and will not deceive him. And the disadvantage is that opening a letter of credit costs money, as a rule, it is a few percent of the payment amount. Thus, for an increased level of security of the transaction, you just have to pay extra.
Consider the most common areas of application for letters of credit:
Now that you know the concept and essence of a letter of credit, let's summarize and highlight the most important thing.
A bank letter of credit is a kind of guarantee of the legal purity of a transaction, removing almost all the risks of fraud, because documents confirming the transfer of goods from the seller to the buyer are checked by experienced banking lawyers. Opening a letter of credit in the implementation of export-import operations is also interesting because, regardless of the countries where the supplier and buyer are located, such operations are regulated by a universal document - international Uniform rules and customs for documentary letters of credit UCP-600, which eliminates the risk of non-compliance with legislation different countries carrying out a certain transaction. Opening a letter of credit will cost the buyer a certain amount, but this amount is significantly lower than, for example, when obtaining a loan, and a letter of credit of a certain type includes many parameters credit operation, but at the same time it also ensures a safe transaction. That is, this is a rather profitable service, but it requires additional costs.
Now you have an idea of what a letter of credit is, why it is needed, what types of letters of credit can be found in practice.
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Estimate:
A letter of credit is a form of cashless payments that is understandable in essence, but cumbersome in execution. The main difference between a letter of credit and ordinary payments from one account to another is the greater participation of banks in contractual relations between customers.
It is more convenient to explain what a letter of credit is with examples.
Imagine that the supplier and the buyer of the goods do not have sufficient confidence in each other, but intend to ship the goods (provide a service) and pay for it.
For mutual certainty, they involve a third party - the bank - in the transaction.
The buyer instructs the bank to transfer money to the supplier after providing documents on the shipment of goods. Such a payer is called applicant and his bank issuer .
The bank assumes 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, it is defined as beneficiary, submits to his bank documents confirming the fulfillment of the obligation. This bank is called acting.
The beneficiary's bank receives the agreed amount from the correspondent account of the bank that opened the letter of credit.
The bank serving the payer writes off from his account the amount of the letter of credit and the fee for the operation.
The transaction is considered completed.
In operations using a letter of credit, the goods (services) are transferred from the seller to the buyer. The payment goes from the buyer to the seller. The banks involved in the transfers receive their remuneration for making the payment and providing a guarantee, expressed in assuming responsibility and checking incoming documents.
The buyer usually bears the cost of the letter of credit.
Benefits of banks from letters of credit is greater than with conventional payments, remuneration.
The benefit of the supplier is the confidence that his product (service) will be paid for.
The buyer's interest in transferring the risk of "payment without goods" to the bank. And also in the ability to make a deal without touching your own funds until the operation is confirmed.
Payments by letter of credit are often used in international trade or within one state with insufficient trust of counterparties to each other and to 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 customers 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:
This is not a complete list of letters of credit used in world practice. Their choice depends on the needs of customers and the willingness of banks to apply certain tools.
Nowadays, in order to ordinary person to make any purchase it is not necessary to have cash in your pocket. Any transaction, including the purchase of real estate, can be paid not only by bank transfer, but also on credit, in installments, or through a bank letter of credit.
At first glance, such a complex concept as "Bank letter of credit" is very difficult to understand. But in fact, everything is very simple. As statistics show, recently this form of calculation has been successfully used not only by legal entities, but also by individuals. So what's the point? Let's figure it out.
So, in this article we will talk about what constitutes a "Bank letter of credit", what is needed to issue it, and what advantages and disadvantages does it have?
Many financial terms are not only difficult to pronounce, but often difficult to understand. In addition, the descriptions for them are given in a very confusing language. In order not to find yourself in an awkward situation, and to successfully use the service, we will give the concept of "Bank letter of credit" an explanation in a more understandable language.
A bank letter of credit is a kind of protection against risks associated with financial transactions. This is a way to protect yourself and your savings from possible fraudulent actions when concluding contracts. A letter of credit is especially relevant when it comes to prepayments, or transactions are made with new previously unfamiliar persons who have not yet managed to establish themselves as reliable partners.
The essence of the letter of credit is that a special account is opened in the bank, on which a predetermined amount is reserved. In cases where both parties participating in the auction fulfill all the conditions stipulated by the agreement concluded between them, the bank is obliged to transfer the amount of money on the account to the seller.
In this case financial institution acts as a kind of guarantor and takes responsibility for transferring money to the recipient. A certain fee will be charged for the services provided. It is noteworthy that each bank sets its own rates. For example, with regard to Sberbank, if a letter of credit is issued between two individuals, its rates are 0.2% of the transaction amount, a minimum of 1,500 ₽, a maximum of 5,000 ₽ per transaction.
Thus, a bank letter of credit is a form of payment that, on the one hand, has an increased level of security, and, on the other hand, guarantees for both parties to the transaction. It should be noted that due to the presence of these two components, the process of transferring, for example, ownership rights is much faster.
A bank letter of credit, as it turned out, has several types. They differ depending on the powers of the bank and the number of parties. This information is presented in more detail in the table:
| Type of letter of credit | Description |
|---|---|
| revocable | This type of letter of credit is different in that banking institution has the right to close the account unilaterally in the presence of a written application from the payer. It is issued extremely rarely, since the seller does not have a guarantee. |
| irrevocable | The most common type. In this case, the buyer does not have the opportunity to withdraw the funds. And after providing the relevant documents, the seller will receive the money. |
| Confirmed | This type is most convenient in the first place for the buyer. The bank undertakes to transfer the required amount of money to the seller's account even if there is no money on the payer's account. Naturally, at the same time, the bank's risks increase, which means that an additional commission will be charged. |
| Unconfirmed | Funds are transferred to the seller's account only when they are received from the buyer. |
| Coated | Means that the buyer's bank undertakes to transfer funds to the beneficiary's account within a certain period of time. |
| Uncovered | With an interbank transfer, funds are first transferred to the correspondent account, and then directly to the recipient's account. With an uncovered letter of credit, the buyer's bank allows the seller's bank to write off the money due from the correspondent account. |
| Spare | This type is more like a bank guarantee. Its essence lies in the fact that if the buyer violates the terms of the contract, the bank at its own expense undertakes to pay the seller the entire amount. |
| revolver | The type of letter of credit is most relevant for payments with a fixed schedule. It is not opened for the entire amount of the purchase, but only for part of it. After the buyer makes a payment, such an agreement will be renewed up to the previously agreed figure. |
| With red clause | According to such an agreement, the buyer's bank may instruct the recipient's bank to credit funds even before providing documents confirming the fulfillment of the terms of the purchase and sale agreement. |
As can be seen from the information presented, there are a whole host of types of bank letters of credit. In order to get acquainted with each of them in more detail, and choose the most convenient one for yourself, you should contact the authorized branch of the bank where you plan to draw up an agreement, go to the official page on the Internet, or call hotline institutions.
After the reader has become better acquainted with the letter of credit and has learned its types, it's time to study the sequence of actions that inevitably occur after the corresponding agreement with the bank is signed and the compensation due to him has been paid.
The scheme of the letter of credit is as follows:
| No. p / p | Action | Note |
|---|---|---|
| 1 | The parties to the transaction enter into an agreement | Such a document should contain detailed clauses about the terms of the transaction. The greatest attention should be paid to the topic of calculation. |
| 2 | The buyer chooses a bank and opens an account | The choice of a banking institution should be treated with increased attention. Don't forget that big banks may charge high commissions for their services. However, these institutions are high level trust. |
| 3 | Buyer pays money | The amount that the buyer must deposit into the account must correspond to the one that was agreed in the contract. In another way, this action is called booking funds. |
| 4 | The supplier or buyer provides securities to the bank | The essence of this stage is that the second party must submit to the bank documents confirming the fact that the terms of the agreement have been fully fulfilled. |
| 5 | Opening a letter of credit account | The letter of credit is the number of the seller's account, to which the buyer transfers the due amount of money. However, it will open after the bank examines the submitted documentation in detail. |
| 6 | Sending notice to the buyer | After all the above steps have been completed, the banking institution is obliged to notify the buyer that all conditions have been met by the seller. |
| 7 | Money transfer in progress | This operation takes place in strict accordance with the terms of the previously concluded agreement. |
