Definition
A binding document that a buyer can request from his
bank in order to guarantee that
the payment
for goods
will be transferred to the seller. Basically, a
letter of credit
gives the seller reassurance that he will receive the payment for the goods. In
order for the payment to occur, the seller has to present the bank with the
necessary shipping documents
confirming the shipment of goods within a given time frame. It is often used in
international
trade to eliminate
risks such as
unfamiliarity with the foreign
country, customs,
or political instability.
· History
The International Chamber of Commerce has drawn up a
set of rules to which international banks have to adhere to when issuing
letters of credit. These rules are know as The Uniform Customs and Practice for
Documentary Credits (UCP 600 – version July 2007). All letters of credits
issued should state that they have been issued in accordance with the rules of
the UCP.
Specifications
Documentary credits are amongst the safest and most
commonly used forms of payment in exporting (other than payment in advance).
They are typically used to pay for exports to customers that you have not sold
to before, as well as for customers and countries that represent particular
credit risks. A documentary credit carries assurances for both the exporter and
the importer. The L/C is an undertaking by a bank - the exporter therefore
relies on the ability of the bank instead of the importer to pay. The importer,
in turn, has the assurance that the bank will not release the money to pay for
the goods until the exporter has presented the necessary documents which will
include proof of dispatch of the goods to their final destination. The
advantages can be listed as :
1-
L/C creates : More confident business for both parties by transferring
the risks to the Banks
2-
High diversity of L/C`s creates : More convenient business
3-
Uniform / Int`l practices of L/C reduce disputes in business
4-
L/C is applicable for the business of both products & services
5-
L/C creates enough Financial Credit for both parties
6-
More convenient control and accurate policies of governments in
L/C-based transactions
7-
More accurate Cash Flow in Banks` Foreign Currencies in L/C-based
transactions
