Letters of credit do their purpose by replacing the credit of the bank for that of the buyer, for the sake of facilitating international trade.
There are two main types: commercial and standby letters of credit.
The commercial letter of credit is the primary payment mechanism for an exchange, while the standby letter of credit is a secondary payment mechanism. Commercial letters of credit have been employed for many years to aid payment in global trade. Their use may continue to increase as the world economy develops. Letters of credit utilized in global transactions are ruled by the World Chamber of Commerce Uniform Customs and Practice for Documentary Credits. The general provisions and definitions of the World Chamber of Commerce are binding on all parties. Domestic collections in the U. S. are ruled by the Uniform Commercial Code.
A commercial letter of credit is a contractual agreement between a bank, called the issuing bank, for one of its consumers, authorizing another bank, called the advising or confirming bank, to make payment to the beneficiary. The issuing bank, on the request of its customer, opens the letter of credit. The issuing bank makes a dedication to respect drawings made under the credit. The beneficiary is usually the provider of products and/or services.
Fundamentally, the issuing bank replaces the bank's shopper as the payee.
Elements of a Letter of Credit:
A payment undertaking given by a bank (issuing bank) for a customer (candidate).
To pay a seller (beneficiary) for a fixed amount of cash.
On display of cited documents representing the provision of products.
Inside cited time boundaries.
Documents must comply with T&Cs laid out in the letter of credit.
Documents to be presented at a stated place.
The beneficiary has entitlement to payment so long as he will be able to supply the documentary proof needed by the letter of credit. The letter of credit is a definite and separate exchange from the contract on which it is based. All parties deal in documents and not in products. The issuing bank isn't responsible for performance of the fundamental contract existing between the buyer and beneficiary. The issuing bank's requirement to the purchaser, is to look at all documents to insure that they meet all of the conditions of the credit. On asking for requirement for payment the beneficiary warrants that all conditions of the contract have been went along with.
If the beneficiary (seller) fits with the letter of credit, the vendor must be paid by the bank. The issuing bank's culpability to pay and to be repaid from its client becomes profound on the completion of the conditions of the letter of credit. Under the provisions of the Uniform Customs and Practice for Documentary Credits, the bank is given a fair quantity of time after bill of the documents to laud the draft.
The issuing bank's role is to offer a guarantee to the vendor that if compliant documents are presented, the bank will pay the vendor the sum outstanding and to look at the documents, and only pay if these documents go along with the terms set down in the letter of credit. Generally the documents requested will include a commercial invoice, a transport document like a bill of lading or airway bill and an insurance document; but there are several others.
Letters of credit deal in documents, not products. An advising bank, sometimes a foreign reporter bank of the issuing bank will counsel the beneficiary. Usually, the beneficiary would like to utilize a local bank to insure the letter of credit is valid. Additionally, the advising bank would be answerable for sending the documents to the issuing bank. The advising bank has no other obligation under the letter of credit. If the issuing bank doesn't pay the beneficiary, the advising bank isn't responsible to pay. The correspondent bank may confirm the letter of credit for the beneficiary at the request of the issuing bank, the correspondent obligates itself to insure payment under the letter of credit. The confirming bank wouldn't confirm the credit until it evaluated the country and bank where the letter of credit originates.
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