subject: Letter of Credit - How the Process Takes Place? [print this page] Letter of Credit - How the Process Takes Place?
Bringing the goods from overseas can always be the most risky because sum of money is required to bring the goods from abroad. In order to decrease the size of risk and increase trust letter of credit is used to ensure that transaction between the two parties remains successful. This does not only make the payment easier but also helps the parties overcome trust deficit.
Parties always try to ensure that the transaction made is always done through commercial letter of credit where bank itself process the transaction act as an uninterested party hence fulfill the transaction between the buyer and the seller. This instrument has provided solutions for centuries and has revolutionize the international trade by providing assurance to the buyer that they can receive the merchandise as per the agreed specification and also assure seller that the payment will be made to them if the goods supplied as per agreed terms and conditions. To understand the process how it can be done we need to go in detail below:-
They are four parties that are involving in the process of letter of credit :-
1. Applicant: Buyer
2. Beneficiary: Seller
3. Issuing bank: Place where the buyer draws the letter of credit
4. Advising/Beneficiary bank: Place where the seller maintains an account
Now we will try to make sure how the process is done
1. A buyer in the US or another country agrees to purchase a product from a seller, e.g. toys from China. Both parties agreed a balance of $150,000 will be paid upon shipment.
2. The buyer goes to the bank where they normally do business and draws up a $150,000 letter of credit for the seller.
3. The process of underwriting goes on by the issuing bank to ensure the buyer has the credit or collateral for the letter of credit and issues the L/C if they are satisfied.
4. Once the process is completed, the issuing bank sends the letter of credit to the advising bank. The advising bank notifies the seller that the payment is ready.
5. When the issuing bank is satisfied all the conditions in the letter of credit have been met, the money will be released to the advising bank, and the seller will be paid. For example, if the payment is to be made upon shipment, the seller will be paid when they provide the proper documentation (such as an official bill of lading) proving the goods has been shipped.
Important things to know:
A letter of credit is about documents and not the quality of goods.It's required to understand all the conditions before reaching an agreement.Time frames are the most essential part and if someone fails to deliver letter of credit will lost the negotiated business.
The failure to produce the required documentation on time can nullify the letter of credit .
Small errors in documentation such as spelling mistakes can make a letter of credit invalid, so it's advised to properly check the documentation.
A letter of credit is not a guarantee that seller would receive payment. The issuing bank is authorized to pay only when documents are presented, and all the terms and conditions of the letter of credit have been complied.
