What is letter of credit?
What Does letter of credit Mean
A letter of credit is a payment tool that is governed by international standards. This instrument allows a person to instruct a bank to make a payment to a third party, as long as certain conditions are met.
documentation, such as the purchase invoice, customs certificates, etc.
It should be noted that the payer is, in any case, who will make the payment at the end of the process. The recipient of this payment, in turn, will be the seller of the merchandise.
In this way, we find the fact that the action that generates a letter of credit supposes that four clearly defined subjects intervene in this process. Thus, there is the payer or importer who is the one who buys the merchandise in question and orders the issuing bank to pay according to a series of conditions that are established; the issuing bank, which is the one that opens the documentary credit and makes the aforementioned and corresponding payment based on the aforementioned clauses; the correspondent bank, which is the one that must deliver the money in question to the beneficiary; and finally the beneficiary or exporter who is the one who sells the goods and the one who ultimately receives the payment.
Specialists affirm that, thanks to its characteristics, the letter of credit is the safest mechanism in international trade , by minimizing the risk in collection. There are two banks involved (one in the country from whom it imports and issues the letter, another in the country of the exporter that will receive the payment) and the payment only materializes when the buyer receives what was agreed.
It is important to note that when the importer does not pay, the bank of the importer's country maintains the payment obligation once the operation expires.
Letters of credit can have different characteristics. In general, they are irrevocable , that is, the agreement established between the parties cannot be modified without the consent of all those involved. The letters are also usually nominative , since they state which banks are authorized to participate in the operation.
In addition to these two kinds of letters of credit, we have to emphasize that there are also others such as commercial ones. These in particular are those that are opened when the action that is carried out is a purchase option, either locally or internationally.
Likewise, we cannot ignore the existence of the so-called private letters of credit which in turn are divided into four clearly differentiated groups. Thus, there are first the transferable, then the rotary, the advance and finally the known as "back to back". The latter in particular are those that are launched by the bank on the basis of a greater credit of which the originator himself is the beneficiary.