What is a Letter of Credit?

When dealing in international trade, a letter of credit is sometimes used. This document is also referred to as bankers’ commercial credit. It is a payment tool that is used for international trade to help provide a guarantee of payment from a creditworthy institution to the exporter of the goods. International trade finance companies can help you obtain a letter, so your business can prosper.

Exporters want a letter of credit, so they can receive their full payment in a timely manner. If the buyer cannot pay in full, the bank that issued the letter must pay the total amount – or what is leftover from the purchase price. International dealings involve a variety of factors including a considerable distance between the importer and exporter, distinct guidelines, and the inability to know each business participant personally. Due to these reasons, international trade has become dependent on letters of credit to ensure prompt and proper payment.

How Does a Letter of Credit Work?

A letter of credit is negotiable, which means that it can be passed to any bank designated by the beneficiary and must be paid by the issuing bank. The issuing bank will make payment to the financial institution designated by the recipient or directly to the recipient. If the letter is transferable, the beneficiary has the right to assign the letter to another party, such as a third party or the corporate parent organization. The bank will collect a service fee, which usually corresponds to the value of the letter.

The Different Kinds of Letters of Credit

Not all letters of credit are the same. The different kinds of letters of credit include:

  • A commercial letter of credit is a direct method of payment as the issuing financial institution releases the payment to the beneficiary. This is a common letter of credit type.
  • A standby letter serves as a secondary payment method in which payment is made to the beneficiary by the bank only when the holder of the letter is unable to do so.
  • Revolving letters of credit allow the customer to make several draws within a specific period during a pre-set timeframe.
  • A confirmed letter involves an additional bank – other than the bank issuing the letter. The second bank is usually the seller’s bank and is referred to as the confirming bank. The confirming bank will ensure the payment is made per the letter if both the issuing bank and the letter’s holder default. A confirmed letter is often required by the issuing bank of letters used for international transactions.

What Are Some Major Details About Letters of Credit That Should Be Known?

The basic details that apply to a letter of credit and international trade include:

● Letters of credit are documents from a bank guaranteeing the seller will receive payment from the buyer promptly and in full.

● Not all letters of credit are the same –there are several different kinds.

● Banks receive a fee, usually a percentage of the value of the letter, for their services of providing the letter.

Final Thoughts

To ensure your finances are in order while doing business with international suppliers, it is best to work with a leading international trade finance company like Tradewind Finance that specializes in supply chain financing and factoring. In addition, it is important to confirm you have the proper letter of credit for your specific transaction. This will guarantee your supplier continues providing the products you need to help your business grow.

To learn more about letters of credit, contact the experts at Tradewind Finance today. One of our licensed professionals will be happy to answer your questions and determine the best way to meet your business needs.