An important point in a purchase and sale transaction is the method of payment between the parties. To avoid possible risks, the seller and buyer often use a letter of credit payment system. It does not matter whether the payment is made using your own funds or a mortgage.

What is a letter of credit in simple words

A letter of credit is another method of non-cash payment that can be used by the parties to a purchase and sale agreement, supply, etc. In simple words, a letter of credit is a financial instrument offered by banks associated with the control of payment between the seller and the buyer. The bank acts as a guarantor of an honest transaction and issues funds only subject to compliance with contractual obligations between the participants. During the transaction, the money is kept in a special bank account.

Accreditation scheme

Two credit organizations can take part in such transactions: the issuing bank and the executing bank. The issuing bank opens a letter of credit based on the application of its client and undertakes to make a transfer in favor of its counterparty under the agreement. For this purpose, an order is transmitted to the executing bank. Such an order is possible only after documentary confirmation of the fulfillment of all agreements on the transaction. The transfer occurs on the basis of an order from a Bank client to transfer funds to a third party. Advantages of the service:

1. Cashless payment. There is no need to carry a large amount with you, count it and check for authenticity.
2. The operation is safe. The parties do not risk anything. The seller is guaranteed the transfer of the full amount of funds after fulfilling the terms of the contract. For the buyer, this is an opportunity to purchase an apartment or other real estate and not lose money. Also, return the money in full if the terms are violated by the seller or the agreement is terminated.

For the seller, a documentary letter of credit is an additional guarantee on the part of the bank that funds will be received under the agreement as soon as it fulfills all the conditions. And the buyer is sure that the money will be transferred after providing the documents he named in the application.

Necessary actions to use the service

1. The parties to the transaction enter into an agreement, which spells out in detail all the conditions and circumstances of the fulfillment of obligations.
2. An agreement on settlement using a letter of credit is signed at the bank. Personal and passport details of both parties must be indicated. Conditions for payment of funds.
3. After signing the banking agreement, the buyer fills out an application for a letter of credit.
4. After checking the documents, the bank employee opens an account in the name of the buyer. It is fully credited with funds for real estate, goods, and services. Subsequently, they will be transferred to the correspondent’s account, bank card, or issued in cash.
5. The transfer to the seller will occur after the transaction is completed. He must submit to the bank documents confirming the registration of the purchase and sale agreement and the transfer of ownership.

The letter of credit agreement completely regulates the relations of the participants. It must contain all the necessary information to complete the transaction:

• buyer and seller data. For individuals - this is passport data, full name, residential address. With the participation of an organization, the name, TIN, address, and account details are indicated;
• guaranteed amount of funds placed in a bank account;
• period of fulfillment of obligations;
• the amount of bank commission and the cost of additional services;
• the procedure for transferring money after fulfilling the conditions and providing documents;
• procedure for dealing with unforeseen circumstances, non-payment of debt, etc.;
• rights and obligations of the parties to the transaction.

After signing the agreement, a special account is opened at the bank to reserve money. To open an account, the client writes an application with the obligatory indication of the following data:

• details of the purchase and sale agreement – ​​number, place and date of signing;
• details of the real estate seller, supplier of goods;
• type of account, amount placed on it and period of its validity;
• method of transferring funds;
• information about the acquired property, goods, work, etc.;
• details of the contractor's bank;
• list of documents required to execute payment in favor of the seller

Type of service

Due to different terms of the transaction or changes in circumstances, its participants may use different types and features of the letter of credit payment system:

1. An irrevocable letter of credit is a condition under which the obligation is canceled by the buyer only with the consent of the seller. It is recognized as the most reliable way to conduct a transaction. Termination of banking services is possible only with a bilateral refusal. When a service is revocable, the bank has the right to change the obligation or cancel it without the consent or notification of the recipient.
2. A deposited letter of credit is the right of the bank to write off the client’s own and credit funds at its disposal for the period of settlement. Otherwise, this service is called a covered letter of credit. When the executing bank is involved in the settlements, money can be transferred to its account for the entire duration of the agreement with the bank.
3. An obligation with a red clause is the right of the bank to transfer the authority to make payments to another credit institution.
4. An uncovered letter of credit is the ability of the executor's bank to write off money from the buyer's account or use it in another way. Such an obligation is considered guaranteed. The executing organization is given the right to write off finances from the issuer's correspondent account.
5. A confirmed commitment is a guarantee of receiving money from the bank in the amount stipulated in the agreement. Moreover, for the seller the fact of receipt of funds from the buyer does not matter. Usually occurs when lending.
6. A direct letter of credit is an opportunity to receive money without the participation of the buyer. After the transaction is completed, only the seller can contact the bank.
7. Revolver. Opens for an incomplete amount. As the work progresses, the buyer pays in installments. Such a commitment is convenient when purchasing goods on a schedule.
8. Spare. The seller receives an additional payment guarantee from the bank. Convenient when the buyer is unable or refuses to make a full payment.

Buying an apartment through a letter of credit

Such a transaction is in many ways similar to buying real estate through a safe deposit box. However, using a safe is an easier way with less control from the bank. When considering the topic of what a letter of credit is from a bank when buying an apartment, it is worth keeping in mind the purchase of an apartment on the primary or secondary market. In the first case, housing can be purchased in a house under construction. When settlements with the developer are carried out through a letter of credit, the buyer receives a guarantee of becoming the owner of an apartment in a completed building. The developer will be able to receive funds only after completion of construction and commissioning of the house.

The reliability of this payment method is related to the value of the bank's services. On average, when making a transaction you will have to pay:

• 0.2% of the cost of the apartment specified in the contract. The minimum payment is 1000 rubles.
• with the participation of other financial institutions, the commission will be 0.3% in the range from 1,500 to 10,000 rubles;
• 2000–5000 rubles for servicing the transaction;
• changing the terms of the contract in terms of terms and amount will cost from 1000 to 4500 rubles.

The service is provided to individuals. The application shall indicate:

• contract amount;
• type and term of the letter of credit;
• data on the parties to the settlement;
• purpose of payment;
• list of documents for transfer by the Bank.

In addition to the sale of an apartment, a financial liability can be used for transactions with other real estate (houses, land, parking spaces), expensive movable property (equipment, furniture or art). The service is convenient when paying for services: construction, repairs.

The letter of credit is issued in rubles. The period is set by the buyer and specified in the application. If a mortgage transaction takes place, then on average the period in banks is set at 120 days. Extension is allowed, but not more than 60 days.

An important stage is the control of documents and the issuance of money. In other words, the disclosure of a letter of credit is a fact of confirmation that the seller has fulfilled the terms of the agreement. The bank reviews and verifies the submitted documents within about a week. This bank service is included in the scope of the letter of credit and may be paid additionally. If the control results are positive, the credit institution opens the letter of credit. The former owner receives the right to collect money for the apartment. Usually they are transferred to his account.

Some banks may have restrictions and deadlines for receiving money. Thus, Sberbank charges 1% of the amount for cash withdrawal. If the transaction amount is more than 5 million rubles, the funds must be in the account for 1 month. If the seller takes the funds earlier, 10% will be deducted from him.

In case of an obligation with acceptance, the issuance of money is possible after the buyer confirms the fulfillment of its conditions. The buyer informs the bank in writing that all requirements of the agreement have been met. Credit institutions are responsible for violations of the settlement process. Therefore, it is beneficial for banks to accept only correctly executed documents. Worth taking into account:

• the bank is not responsible for establishing the compliance of the clauses of the main agreement between the parties with the letter of credit agreement;
• the bank does not actually control the execution of the main transaction (actual transfer of property, vacating the apartment by the seller, etc.).

When the obligation expires and the agreed documents are not received from the seller, the letter of credit is closed. The recipient of the money is notified of this by the bank without fail.

Operations on letter of credit transactions

Services for transactions with a letter of credit can be provided in different options, depending on the credit institution. Typically banks carry out the following operations:

So, the payment system for purchasing real estate under a letter of credit is a reliable guarantee of compliance with the terms of the agreement. Long processing times, payment of money and cost justify the risks that participants in transactions involving large amounts are exposed to.

If you are afraid to pay your counterparties in advance, have started cooperation with a new supplier and want to play it safe, or are planning to work with foreign partners, you should pay attention to a form of payment such as a letter of credit. This is one of the most profitable and reliable ways to make payments under a contract, allowing you to avoid significant costs and risks. That's what we'll talk about.

If you are scared by banking terminology and it is difficult to figure out on your own what a letter of credit is, our material is just for you. In it we tried to explain in simple language what a letter of credit is, what types it comes in, what its advantages and disadvantages are.

What is a letter of credit in simple words?

First, let’s find out how the concept of “letter of credit” is defined in domestic legislation. And after that we will try to explain the essence of the phenomenon in simple words.

According to the Civil Code (Article 867), when making payments under a letter of credit, the bank (issuer), on the basis of the payer’s instructions, undertakes the obligation to pay funds, pay a bill issued by the recipient, or take other actions aimed at fulfilling the letter of credit, after the recipient presents certain documents.

Important: This is how a letter of credit is defined in professional language. If we put its interpretation in simpler words, then a letter of credit is an order to the bank to pay a certain amount provided that the recipient provides certain documents. To put it in even simpler terms: opening a letter of credit means putting money aside in a special bank account, which will wait there until they come for it with documents. In this case, you can use your own funds or borrow them from the bank.

After fulfilling the terms of the letter of credit, the bank transfers the money to the recipient. This payment method is used to make payments for goods delivered, work performed and services rendered. The bank participates in this process as a guarantor that payments will be made in full and on time. Therefore, a letter of credit, in simple terms, can be called a payment guarantee. This is also a special form of bank lending, since borrowed funds are often used.

Before opening a letter of credit, the parties must agree that payment will be made in this manner. The agreement is drawn up in the form of a contract. The next step is contacting the bank. The letter of credit is issued in paper form and must contain certain information:

• Opening date and number.
• Sum.
• Details of the person paying under the letter of credit and details of the bank in which it was opened.
• Recipient details.
• A type of letter of credit.
• The period for which the letter of credit is open.
• Method of fulfilling obligations.
• List of documents required for payment and requirements for them.
• Deadline within which documents must be submitted.
• Purpose of payment.
• A mention of whether confirmation is required.
• Procedure for paying commission to the bank.

A letter of credit can be executed by a bank in one of the following ways:

• payment of funds is carried out after the recipient submits certain documents provided for by the terms of the letter of credit;
• the recipient presents a bill of exchange, which is paid by the bank on time;
• a different procedure provided for in the letter of credit is used.

For clarity, we will demonstrate the use of a letter of credit for settlements using an example. Let's say you need to pay for a delivered product, but the required amount is not available. For this purpose, a letter of credit is opened with the attraction of credit funds, that is, in simple terms, you borrow money from the bank, but do not receive it yourself, but put it in a separate account and instruct the bank to pay it to the supplier when he fulfills certain conditions.

After the goods are delivered, the supplier submits supporting documents to the bank, and the agreed amount is transferred to his account. Such documents, as a rule, are invoices. All you have to do is repay the debt to the bank with interest, like a simple loan.

Important: When opening a letter of credit, it is not necessary to borrow funds - you can use your own money.

The person to whom the funds must be paid contacts the bank with the documents provided for by the terms of the letter of credit, and they can also be issued electronically. Then, within 5 working days, they can be checked, after which the bank makes a payment or refuses it. If, within the period for which the letter of credit is issued, it is not applied for with the necessary papers, the funds are returned to the person who opened the letter of credit.

Important: letters of credit are widely used not only in business, but also in payments for purchased apartments in new buildings. This payment method allows both the buyer and the developer to insure themselves against fraud. The client does not have to transfer money before registering ownership of the apartment, and the company that sells the property does not have to worry that it will transfer it and not receive payment.

Types of Letter of Credit

Subject to the possibility of cancellation and revision of conditions:

• Revocable. Its bank may change or cancel it at any time if such an order is received from the payer. However, there is no need to inform the recipient in advance that changes have occurred.
• Irrevocable. Such a letter of credit cannot be changed without obtaining the consent of the recipient of the funds on the account, and to cancel it, the consent of the bank that confirmed the letter of credit is also required.

Based on the availability of coverage, that is, in simple words, the preliminary transfer of funds:

• Covered (deposited). With such a letter of credit, the bank in which it was opened transfers the funds to the recipient's bank in advance.
• Uncoated (guaranteed). In this case, the funds are debited from the correspondent account or reimbursed in another manner agreed upon by the banks.

By mode of use:

• Revolving (renewable). Such a letter of credit is paid in installments. For example, under a supply agreement an invoice is opened for the entire amount and issued to the supplier as the goods are delivered. In simple terms, the bank does not pay everything at once, but gradually, for each shipment delivered.
• Non-renewable. In this case, the payment is made in one amount.

Depending on the availability of additional guarantees:

• Confirmed. This is a type of irrevocable letter of credit. Its peculiarity is that another participant appears - the bank, which, at the request of the main bank (issuer), confirms the letter of credit. After such confirmation, banks bear joint and several obligations to the recipient of funds.
• Unconfirmed. With this form of payment, the recipient's bank simply informs him about the opening of a letter of credit.

According to the payment procedure (form of execution):

• Upon presentation. Payment is made immediately upon presentation of documents that meet certain conditions.
• Negotiable. This letter of credit is especially widespread in China and some English-speaking countries. In this case, the bank issuing the letter of credit purchases a bill of exchange drawn on another bank.
• Accepted. Funds are transferred within a certain time after presentation of the bill of exchange.
• With deferred payment. The bank is given time to verify the documents.

Taking into account other conditions, other types of letters of credit are also distinguished:

• Transferable (transferable). With such a letter of credit, funds are paid to a third party identified by the main recipient. He can also determine what documents must be submitted to the bank to execute the letter of credit.
• Spare. This type of letter of credit is similar to a bank guarantee. It is opened mainly in cases where the legislation of the country of one of the counterparties prohibits guarantees.

Pros and cons of the letter of credit form of payment

Like any other form of payment, a letter of credit has both advantages and disadvantages that should be taken into account when choosing it as a payment method. Let's start with the positive aspects.

Advantages of a letter of credit:

• The risk that the goods supplied, services provided or work performed will remain unpaid is practically reduced to zero. The bank assumes responsibility for carrying out settlements. This is the main advantage of a letter of credit for the recipient of funds.
• The fulfillment of obligations under the contract is guaranteed. The buyer (recipient of services or work) does not have to worry about paying for work not performed or goods not delivered. There are no concerns about the availability of money to pay the supplier.
• You can receive additional income from the funds that could have been transferred to the recipient.
• Legal support is provided under the contract.
• A letter of credit is an economical method of payment. The bank pays lower interest than on a conventional loan.

Disadvantages of a letter of credit:

• Payment depends on how correctly the documents are completed.
• Legislation may limit the use of a letter of credit.
• Depending on the financial situation of the person opening the letter of credit, its maximum amount is set.
• When making payments using a letter of credit, a large number of documents are required and quite a lot of time is spent exchanging them.
• The costs of opening a letter of credit, that is, paying bank commissions, can be quite significant, especially if it is used for international payments.

Let's sum it up

When working with counterparties, it is necessary to choose the optimal method for making settlements with them, which will allow you to make payments on time and insure against the dishonesty of the counterparty. One of the most profitable and safest forms of payment is opening a letter of credit. In simple terms, it can be defined as an order to the bank to pay funds to a certain person (company) provided that certain requirements are met. As a rule, to receive payment it is necessary to submit documents confirming the fulfillment of obligations.

Depending on the terms of the letter of credit, in particular the availability of coverage, confirmation and the possibility of revocation, there are different types of this form of payment. Its main advantages are savings and the ability to protect the parties to the contract from fraud. Disadvantages include the voluminous document exchange and the presence of restrictions on the use of a letter of credit.

Are you afraid of the risks associated with prepayment for a transaction? Do you want to be on the safe side as a first-time customer working with a new supplier? Take advantage of a letter of credit - one of the most reliable and profitable banking instruments used when concluding contracts.

The letter of credit form of payment is beneficial to both the seller and the buyer. It can be used with equal success not only in domestic Russian transactions, but also in foreign trade transactions. Today, settlement services in the form of documentary letters of credit are provided by most large Russian banks.

Letter of credit: what is it in simple terms?

In simple words, a letter of credit is a special account opened at a bank in which funds can be reserved when conducting transactions for the sale of goods or the provision of services (performing work). If both parties fully comply with the conditions specified in the contract, the bank pays the required amount to the account of the recipient (beneficiary).

Thus, the bank acts as a guarantor and assumes responsibility for making payments. The supplier is 100% sure that the product/service will be paid for, and the buyer knows that he will be able to pay for it on time and without debt.

Letter of credit form

It works according to the following scheme.

1. The parties enter into a contract that stipulates the terms of the letter of credit payment.
2. The buyer submits an application to his bank (issuer) to open a letter of credit account and deposits into it the amount necessary to cover the transaction (reserves funds).
3. After the successful opening of a letter of credit, the issuing bank notifies the seller's bank (advising bank) about this.
4. The advising bank notifies the seller about the opening of the letter of credit. The seller ships the goods and provides supporting documents to his bank.
5. After checking the documents, payment is transferred to the seller’s account by the issuing bank or advising bank (depending on the terms of the agreement).

Irrevocable letter of credit

One of the main and frequently used types of documentary payments. Unlike a revocable letter of credit, a confirmed or unconfirmed irrevocable letter of credit is not revoked or amended by either party (including the bank) without the prior consent of the seller/supplier. It is considered the most reliable form of letter of credit payments, as it completely frees the trade and monetary transaction from all possible risks, primarily financial.

If during the transaction the supplier and buyer come to a mutual agreement, the terms of the irrevocable letter of credit may be changed.

Letter of credit agreement

The agreement on a transaction providing for this form of payment stipulates and strictly records any information that can subsequently be used when carrying out a trade and monetary transaction and payment for it:

• names of the supplier and recipient,
• type of letter of credit used (irrevocable/revocable, covered/uncovered),
• the amount reserved on the account to pay for the transaction,
• the duration of the obligation,
• commission size,
• payment order,
• procedure in case of non-payment of debt under a letter of credit,
• rights and obligations of all parties.

Payment by letter of credit

Payments using letters of credit provide for the transfer of funds to the seller’s account only if all the conditions specified in the contract have been met. In particular, money is transferred to the seller’s account after the goods have been fully shipped and all required documents have been submitted to the bank. If the terms of the letter of credit agreement have been violated, the payer (buyer) has the right to refuse payment and return the goods to the supplier.

A nuance: a letter of credit account is opened by the buyer with his own money or with the help of bank credit funds (if he has the right to lend).

Opening a letter of credit

To open a letter of credit account, a written application in the appropriate form is submitted to the banking organization. The statement states:

• number of the agreement under which the letter of credit is opened,
• name and details of the supplier,
• type, validity period, monetary amount of the letter of credit,
• the way to implement it,
• list of shipped (provided) goods/services,
• name of the executing bank under the letter of credit obligation,
• a list of documents that will be used as the basis for payment of funds to the supplier.

Sravni.ru advice: use a letter of credit form of payment if you need to conduct secure trade and monetary transactions with new and “problematic” business partners.

Letter of Credit- an obligation of the bank, provided at the request of the client, to pay a third party when the recipient of the payment provides the bank executing the letter of credit with documents provided for by the terms of the letter of credit. The client company on whose behalf the letter of credit is opened is usually called the payer under the letter of credit, or the applicant. The recipient of payment under a letter of credit is called the beneficiary. In this case, the bank’s obligation is independent of the obligations of the parties under the main agreement, which provides for a letter of credit form of payment between the supplier and the buyer. Thus, the bank acts as a guarantor between them.

Suppose a seller and buyer enter into a deal. They are dealing with each other for the first time and are not ready to work on an advance payment or pre-delivery basis. Then the buyer applies to the bank with an application to open a letter of credit for the amount due to the seller for the shipped goods. Evidence of the fulfillment of the contract on the part of the seller can be, for example, documents on the shipment of goods. As soon as the subject of the transaction is transferred to the buyer or an independent carrier, the seller sends the required documents to the executing bank in accordance with the terms of the letter of credit. The buyer's bank makes payment under the letter of credit in accordance with the instructions received from the nominated bank. Letter of credit transactions involve a number of bank commissions, payable in accordance with the terms of the letter of credit. Typically, the fee for opening a letter of credit is paid by the buyer.

Letters of credit allow you to guarantee payment to the supplier, while, as a rule, funds are not diverted from circulation.

The letter of credit form of payment is used both in foreign and domestic trade. Letters of credit used in international payments are subject to the Uniform Customs and Practice for Documentary Credits, International Chamber of Commerce Publication No. 600, as amended 2007 (hereinafter referred to as UCP 600).

Letters of credit used for domestic Russian settlements are subject to Regulations of the Central Bank of the Russian Federation No. 2-P dated October 3, 2002, and from June 9, 2012 - “Regulations on the rules for transferring funds” No. 383-P dated June 19, 2012.

Domestic letters of credit can be classified into the following groups:

Revocable and irrevocable;

Confirmed and unconfirmed;

Covered (escrowed) and guaranteed.

All letters of credit, in accordance with UOP 600, are currently irrevocable. Coverage in international letters of credit is rarely used - only in the case of confirmation of a letter of credit opened by the issuing bank, for which the confirming bank does not set limits.

A confirmed letter of credit is one under which another bank, in addition to the obligation of the issuing bank, undertakes an additional obligation to make a payment in favor of the beneficiary upon presentation by the latter of documents that fully comply with the terms of the letter of credit, regardless of whether the funds will be transferred to it itself or not. If there is no obligation from another bank, then the letter of credit is unconfirmed.

Covered (deposited) - a letter of credit, the amount of which is transferred in full to the cover account in the beneficiary's bank at the expense of the payer or at the expense of the loan provided.

Uncovered (guaranteed) - a letter of credit, upon opening of which the issuing bank does not transfer funds to the letter of credit account in the beneficiary's bank, but gives it the right to write off the required amount within the amount of the letter of credit from its correspondent account or agrees on payment in another way. Typically, large banks have open lines of credit with each other, so in developed countries virtually all letters of credit are classified as uncovered.

In addition, letters of credit are of the following types.

A letter of credit with a red clause is a letter of credit under which the supplier receives a certain amount in the form of an advance before shipping or other documents evidencing the fulfillment of obligations are provided. In this case, the payment is made against the presentation by the beneficiary of the documents provided for by the terms of the letter of credit. The name comes from the times when such an important clause was highlighted in red ink in the document. Of course, nowadays almost all letters of credit are issued and confirmed electronically.

Revolving - a letter of credit opened for a portion of the payment amount and automatically renewed as payments are made for the next batch of goods. Opens with regular deliveries and payments.

Transferable (transferable) - a letter of credit that provides for the possibility of transferring part of the letter of credit in favor of other beneficiaries.

A standby letter of credit, the so-called stand-by, is a form of bank guarantee in the form of a letter of credit, used where banks are prohibited from issuing guarantees (for example, in the USA). Payment to the exporter is made if the importer refuses to make payment under the contract and presents to the executing bank documents that comply with the terms of the standby letter of credit. That is, such a letter of credit serves to ensure greater security for the supplier.

According to the method of execution, letters of credit are divided into letters of credit with payment upon presentation of documents (by payment at sight), with deferred payment and with acceptance of drafts.

15.10.2016 17 734 0 Reading time: 11 min.

Today we will continue our conversation about banking services and consider what is a letter of credit, where such a service can be used, why it is interesting. This service is more popular for representatives of large and medium-sized businesses, however, recently it has increasingly extended to small entrepreneurs, and even to individuals who are not involved in business. Therefore, knowing what a bank letter of credit is and what types of letters of credit there are will be useful for everyone, even just for general development.

What is a letter of credit?

A letter of credit is an obligation of the payer's bank to make a payment to the recipient's bank only after the payee provides his bank with certain documents required by the terms of the letter of credit.

Letters of credit belong to the so-called. documentary operations of the bank, that is, operations based on document flow. Most often, documentary transactions, in particular letters of credit, are used by enterprises engaged in export-import activities, but this is not the only area of ​​their application.

Why are letters of credit needed? In simple words - in order to prevent fraud between the parties to a certain transaction. The bank simply acts as a legal guarantor between the parties to the transaction, for which it receives its commission.

Letter of credit - basic terms and concepts

Let's look at the basic terms and concepts associated with opening letters of credit.

Letter of Credit Issuer- the bank to which the client applied to open a letter of credit.

Beneficiary bank- the bank that services the client in whose favor the letter of credit is opened.

Beneficiary- recipient of payment under a letter of credit.

Deal- a specific purchase and sale transaction for which a letter of credit is opened for settlement.

Letter of credit amount— the amount of the transaction for settlement of which a letter of credit is opened.

L/C term- a limited period during which the letter of credit is valid.

Type of letter of credit— conditions for opening a letter of credit (I’ll look at the most common options in more detail below).

Fee for opening a letter of credit— the cost of opening a letter of credit, established by the bank’s tariffs. Typically calculated as a percentage per annum of the amount of the letter of credit, it may also include some kind of fixed or minimum payment. In this case, the issuing bank pays part of the received commission to the beneficiary bank for its services.

Let's look at the operation of a letter of credit using an example. Let's say we have a supplier and a buyer of a certain product who do not trust each other and want to insure themselves. The buyer is afraid to send money without seeing the goods, and the supplier is afraid to send the goods without seeing the money.

In such a situation, opening a letter of credit can help. The buyer opens a letter of credit in his bank, deposits the payment amount into a special account, and instructs the supplier to send it to his bank, but only after the supplier provides documents confirming the fact of sending the goods.

The buyer's bank sends a notification to the supplier's bank about the opening of a letter of credit, and the supplier's bank notifies the supplier about this. The supplier, knowing that funds to pay for the goods have already been reserved and will be sent to him, sends the goods and provides documents confirming this fact to his bank. The supplier's bank checks the legal purity of these documents and, based on this, makes the necessary payment, which is reported to the buyer's bank. After this, the buyer's bank transfers the reserved funds of its client to the supplier's bank. The supplier gets his money, the buyer gets the goods, and the banks get their commissions. Everyone is happy. This is the classic scheme of a letter of credit, and depending on the type of service, some actions may vary.

For clarity, an approximate scheme of the operation of a letter of credit can be presented in the following figure (the numbers indicate the order of actions):

Types of letters of credit

Let's look at the most common types of letters of credit - they can be divided according to several criteria.

Based on whether the letter of credit can be canceled, revocable and irrevocable letters of credit are distinguished.

Revocable letter of credit implies the ability of the issuing bank to withdraw (cancel) its order to transfer funds before the submission of the necessary documents by the opposite party, that is, to cancel the operation, without notifying the recipient bank.

Irrevocable letter of credit does not imply the possibility of its cancellation without notifying the receiving bank and without the consent of the direct recipient of the payment. That is, it can also be canceled, but only with the consent of the two parties, and not unilaterally like a revocable letter of credit.

Irrevocable letters of credit are used in practice much more often than revocable ones, since they better satisfy the interests of both parties to the transaction.

According to the degree of responsibility of both banks, confirmed and unconfirmed letters of credit are distinguished.

Confirmed letter of credit guarantees that the recipient's bank, or another third bank, will pay the recipient the amount due, even if the sender's bank does not transfer the money to him.

Unconfirmed letter of credit assumes that the payment will be received by the recipient only if it is actually transferred by the issuing bank.

According to the possible source of funds for payment execution, covered and uncovered letters of credit are distinguished.

Covered (deposited) letter of credit means that the issuing bank transfers the payment amount to the recipient's bank for the entire validity period of the letter of credit. This amount is guaranteed coverage and is immediately at the disposal of the recipient's bank.

Uncovered (guaranteed) letter of credit means that the issuing bank allows the recipient's bank to debit the payment amount from its correspondent account, or stipulates some other conditions for receiving reimbursement. In practice, this type of letter of credit is most often used.

Let's look at some other well-known types of letters of credit.

Letter of credit with red clause means that the issuing bank undertakes to make the beneficiary's bank the agreed amount of the advance payment before receiving supporting documents from the beneficiary.

Revolving letter of credit opens when it is necessary to regularly perform homogeneous operations. Each time it acts on a specific batch of goods and then resumes its effect on the next batch.

Transferable letter of credit implies the possibility of transferring its part to another beneficiary, if necessary.

Standby letter of credit or stand-by letter of credit- this is a kind of symbiosis of a letter of credit and a bank guarantee, under which the supplier receives payment for the goods, even if the buyer refuses to pay him - the payment is made by the bank at its own expense.

Advantages and disadvantages of letters of credit

All the advantages and disadvantages of the letter of credit form of payment come down to one thing. The advantage is the bank’s guarantee that the client will receive the necessary product or service, his money will not be lost, and the opposite party to the transaction is not a fraudster and will not deceive him. The disadvantage is that opening a letter of credit costs money, usually a few percent of the payment amount. Thus, you simply have to pay extra for an increased level of transaction security.

Where are letters of credit used?

Let's consider the most common areas of application of letters of credit:

• Export-import operations;
• Trade operations within the country;
• Large transactions between individuals (for example, the purchase and sale of real estate).

Now that you know the concept and essence of a letter of credit, let's summarize and highlight the most important thing.

A bank letter of credit is a kind of guarantee of the legal purity of a transaction, eliminating almost all risks of fraud, because documents confirming the fact of transfer of goods from the seller to the buyer are checked by experienced bank lawyers. Opening a letter of credit when carrying out export-import operations is also interesting because, regardless of the countries where the supplier and buyer are located, such operations are regulated by a universal document - international Uniform Customs and Practice for Documentary Credits UCP-600, which eliminates the risk of non-compliance of the laws of different countries with the conduct of a certain transaction. Opening a letter of credit will cost the buyer a certain amount, but this amount is significantly lower than, for example, when receiving a loan, and a letter of credit of a certain type includes many parameters of a credit transaction, but also ensures a safe transaction. That is, this is a fairly profitable service, but it requires additional costs.

Now you have an idea of ​​what a letter of credit is, why it is needed, and what types of letters of credit can be found in practice.

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