The letter of credit. Kinds of letters of credit and ways of their execution

A letter of credit is a financial transaction within which a bank is issued an order to the payer in the direction of the beneficiary's bank. Bank manipulation is carried out on the initiative of clients, on their behalf in accordance with the partnership agreement. The instruction consists in carrying out payments by an individual or a legal entity within the framework of the stipulated conditions under the order.

Examples of banking operations

Having studied the concept and types of letters of credit, let us dwell on the fact that this format of mutual settlements through the bank has both positive moments and its shortcomings. A letter of credit can be called a contingent monetary obligation, which is accepted by the bank at the direction of the applicant, in accordance with which the financial institution assumes the responsibility to pay to the beneficiary in the amount indicated in the documents. This determines a high level of security and guarantees that neither side will be deceived. You can describe the situation easier. For example, one company wants to purchase from another certain product, but because of the risk does not want to pay it immediately. In this situation, the buyer asks the bank to pay for the goods for him, giving him a receipt that the payment will occur later, upon receipt of the goods. The bank transfers a certain amount of money to the seller, and then, on the basis of a receipt, collects funds from the buyer. Settlements with the bank and between the parties in this format are known as settlements by letters of credit. Types of letters of credit define certain subtleties of partnership between the four parties.

Letter of credit as a form of minimizing risks

When forming a partnership between an entrepreneur and an organization, as well as between private individuals and entrepreneurs, there is a high risk of losing money or goods when concluding a contract or when making mutual payments. The types of letters of credit presented in the banking sector make it possible to avoid significant losses when carrying out transactions for large amounts. Minimization of risks is due to the fact that any financial process under the letter of credit is implemented under strict control simultaneously by the two banks. Failure to comply with the terms of the contract with each of the parties is completely ruled out. The supplier of the products, in fact, as well as its buyer, simply can not fail to fulfill their obligations within the framework of the partnership.

Types of letters of credit

When using letters of credit in making mutual settlements, it is extremely important to choose the appropriate type of transaction. The latter is opened by the bank solely at the direction of the payer, and therefore the choice regarding the format of the transaction remains with the payer. Information on the alleged subtype of banking transactions is entered into the contract. In accordance with the standards of the CBR, it is customary to allocate the following types of letters of credit:

• Coated, or deposited.
• Uncovered, or guaranteed.
• Revocable.
• Irrevocable.
• Confirmed. It can be either revocable or irrevocable.

Covered and uncovered banking transactions

Deposited and guaranteed transactions are the most common calculations by letters of credit. Types of letters of credit define the specification of the transactions themselves.

• Covered operation. In this situation, when the letter of credit is opened, the issuing bank performs the transfer of funds by the payer's account to the entire amount of the letter of credit. This is called coverage. The funds are transferred to the bank of the contractor for the entire term of the contract.
• Uncovered operation. Guaranteed banking operation provides for the opening of a letter of credit transfer of funds by the issuing bank. The executing bank is simply given the right to debit the funds from the account available to it within the limits of the letter of credit cost. The procedure for debiting funds from a correspondent account located in the issuing bank is determined by special agreements between financial institutions.

Variations of a confirmed banking transaction

A confirmed letter of credit, the types of which may differ depending on the specification of transactions (revocable and irrevocable), is a letter of credit, in which the executive financial institution assumes obligations in making a payment, regardless of the fact of transfer of money from the bank where the confirming letter of credit was issued. The order of the coordination of nuances on carrying out of operation is defined by interbank agreements. The answer to the question of which combination of types of letter of credit is impossible is covered in the above definition. Other tandems are simply unacceptable.

Revocable and Irrevocable Transactions

Not less demanded in the conduct of mutual settlements is considered to be both revocable and irrevocable letter of credit. Types of letters of credit of this category also have their own specifics.

• The withdrawal banking transaction can be modernized or completely canceled by the issuing bank. The basis for refusal can serve as a written instruction of the payer. Coordination with the recipient of funds in this situation is not required. After the letter of credit is revoked, the issuing bank does not bear any responsibility to the payer.
• A failure-free operation can only be withdrawn if the recipient agrees to change the terms of the partnership and provides it to the performing bank. Partial change of conditions for this category of mutual settlements is not provided.

The recipient of funds for a banking transaction has the right to refuse payment, but until the expiration of its validity period and provided that this nuance is stipulated in the contract. Allowed by prior arrangement and acceptance of a third party, which is authorized by the payer.

Varieties of the main formats of banking operations

Allocate not only the main types of letters of credit, but also their varieties. It is possible to mention the following modifications of the banking operation:

• With a red reservation. This is a contract in accordance with which the issuing bank grants the right to the executing bank to pay in the form of an advance payment to the supplier of goods. The amount of the advance is determined in advance and is provided until the moment the service is rendered or the goods are shipped. It is these types of letters of credit in international settlements that are most in demand, since they raise the level of trust between the parties.
• Revolver operation. It is a letter of credit that is opened in part for payments within the amount of the contract. It is automatically updated as you calculate for each of the lots of goods or for a certain amount of services. For a cyclical reduction in the monetary volume of the contract with a systematic supply, this letter of credit is ideally suited. Types of letters of credit of this category are popular.

Mutual settlements

When concluding contracts in contracts, the form of mutual settlements, as well as the features of the delivery of the goods or the scheme for providing the service, must be indicated. Mandatory types of letters of credit and their characteristics are prescribed in the papers. To avoid problems, the paper must contain the following information:

• Name of the issuing bank.
• The name of the financial institution that will service the recipient of funds.
• Identification data of the recipient of funds.
• The size of the banking transaction.
• Types of documentary credit to be used.
• Format of informing the recipient about opening a banking transaction.
• The format of informing the payer about the account number, which is intended for the deposit of money. The account is opened by the executive financial institution.
• The validity period of the letter of credit itself, the terms of submission of documents and the standards for their registration.
• Specification of transaction payment.

Important points

In order for the partnership to be successful, the payor must independently or with the help of a specialist study this format of banking operations, focusing on who uses what kinds. Letters of credit differ depending on the format of mutual settlements. For the specific case, you need to choose the optimal format for the partnership. It is worth saying that in the event of a violation of the format of payments, all responsibility is assigned to financial institutions in accordance with the law. This determines the fact that representatives of financial institutions are particularly attentive to the verification of documentation, which confirms the delivery of goods, the performance of a certain amount of work or the provision of services.

Advantages and disadvantages

For this type of non - cash payment, there are pluses and minuses. The positive sides of the partnership include the presence of a 100-percent guarantee of making payments to the seller of goods or a representative of services. Control over the implementation of mutual settlements under the transaction is realized by the financial institutions themselves, which excludes the risk of fraud and proper fulfillment of their obligations by each of the parties. When carrying out a banking transaction, due to a delay in payment, the buyer does not withdraw part of the capital from the economic turnover. Payment for goods or services is carried out in installments. At the time of signing the contract, the buyer may not have the funds on hand. The same moment is also a disadvantage, but for the seller of goods and a representative of services. They receive money with a delay. It is worth mentioning that the scheme of partnership on a letter of credit is very complicated, it will not be possible to understand it at once. However, the world practice shows that businessmen who once used the offer, never use other payment formats. The advantage in terms of high security indicators completely covers the complex scheme of document circulation and relatively high commissions of banks.