Calculations under a letter of credit are The procedure for settlements, types of letters of credit and methods for their execution

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

When expanding business, many companies find new partners and enter into contracts with them. At the same time, there is a risk of failure: non-payment of funds, ignoring the terms of the contract, refusal to supply goods, etc. are possible. To protect themselves and guarantee the success of the transaction, they resort to settlements by letters of credit at the bank. This method of making payments fully ensures compliance with all agreements between partners and satisfies the requirements and expectations from the transaction of both parties.

The essence of the payment order

A letter of credit is a financial obligation of the bank to pay by bank transfer the documents of the seller's client in the amount and on the terms specified in the document. All details are determined by the buyer, about which he reports to his bank, also providing a completed application for opening this credit account. Letter of credit payments are gooda way to secure the transaction for partners under the terms of the contract.

There are cash and documentary payment orders. The first type is nominal documents that provide for the contribution of a certain amount by an individual or legal entity to withdraw it in another country. The second type is, in fact, an agreement on the basis of which the client's bank must, in accordance with its instructions, pay money to a third party. This commercial organization can instruct another bank - a fourth party - to make a payment after providing the agreed documents.

Deal participants

The following people take part in the execution and implementation of this type of settlements:

• buyer - an individual or legal entity (applicant, importer), he initiates a bank settlement by a letter of credit under an agreement in favor of the seller and transfers the required amount of money to the bank account;
• issuing bank: it opens a letter of credit and assumes obligations to the seller on behalf of the buyer;
• bank that pays for the letter of credit (executing bank);
• seller (exporter, beneficiary) - a person in whose favor a letter of credit is opened and to whose account funds will be received.

The issuing bank can be simultaneously the executing bank, i.e. it opens a letter of credit and pays the recipient of funds when the latter submits the documents provided for by the payment order. But often the authority to pay is transferred to the executing bank. This happens mainly when the buyer and sellerare located in different countries. In this case, it is inconvenient to make payments by checks. Settlements by letters of credit are the best way to establish a trusting relationship. Therefore, the issuing bank does not work with the clerk directly, but by involving a fourth party - the executing bank, which is located in the country of the recipient of the funds. This bank informs the seller about the letter of credit and its terms, and confirms the authenticity of this payment obligation.

Important detail

When paying for goods in the above way, banks work only with the documents provided by the applicant. These organizations have nothing to do with the product. Existing agreements between the buyer and the seller are also not taken into account. Non-cash payments by letters of credit provide only the documentary side, agreed upon when opening a payment obligation. And persons wishing to use this type of payment should take this into account.

Need for bank guarantee

Providing a loan to a client by an executing bank in accordance with an agreement is quite common. Payments through a letter of credit are often made when conducting foreign trade transactions, or when expanding the sales market. It happens that the supplier does not want to provide the goods without a guarantee of payment, and the buyer refuses to pay, not being sure that the agreed products will be delivered in accordance with the terms of the contract. In this case, settlement under a letter of credit is a way to reach a consensus between the parties to the agreement.

Cashless payment procedure

The transfer of funds in the form of a letter of credit is carried out in several stages:

1. Signing an agreement between the seller of goods and the buyer.
2. Filing the latest application to the issuing bank to open a letter of credit. Official notification (by telegraph or mail) of the counterparty (executor) bank about the opening of a letter of credit to the seller.
3. Delivery to the buyer of the goods.
4. Providing documents: from the seller to the executive bank, from the latter - to the issuing bank, from it - to the buyer. Write-off of funds from the buyer's account.
5. Transfer of funds to the executive bank from the issuer. Making payment to the seller.

In the course of the transaction, the issuer debits the amount specified in the contract from the client's account and sends it to the executing bank, which, by analogy, selects the "Letter of credit" settlement form and pre-deposits the funds intended to pay for the goods ("deposited letter of credit"). But there is also a "guaranteed letter of credit". Then the payment is made only under the guarantee of the bank.

When a letter of credit is deposited, the issuing bank transfers to the counterparty bank the amount specified in the contract for the full duration of the payment obligation. The funds are provided by the buyer, or he is given a loan, under which payments are made.

In the case of a guaranteed letter of credit, the executing bank receives the right to debit funds from the correspondent accountthe issuing bank within the amount of the letter of credit, or provides for other methods of payment. The procedure for compensation of funds to the issuing bank by the payer is prescribed in the contract.

When the goods are shipped, and the supplier confirms this fact with the relevant documents, the executing bank pays for the transaction. Thus, the time allocated for settlements is greatly reduced.

Types of letters of credit

Payment bank orders are divided into the following:

• Irrevocable: the payer cannot change the terms of the obligation unilaterally, without prior agreement with the payee.
• Revocable: the payer has the right to change the terms of the contract without the consent of the recipient of funds and can revoke it before the end of the agreed period.
• Confirmed - the executing bank takes responsibility for the payment.
• Unconfirmed - the bank does not undertake to control the payment.
• Renewable (revolving) - a letter of credit that is repeated when a transaction is repeated or is systematic.
• Cashless settlement with a red clause - authorizing the executing bank to make an advance payment to the seller for a certain amount before providing the necessary documents.
• Transferable - applies if other persons are the suppliers of the goods. Then the procedure for calculating letters of credit changes slightly: the seller instructs the executing bank to partially or completely transfer to themauthority to receive funds.
• Cumulative - provides an opportunity for the applicant to add the amount not spent during the transaction to a new letter of credit held in the same executing bank (otherwise, the finances are returned to the buyer's account in the issuing bank).
• Circular: makes it possible to receive money in any banks - counterparties of the issuing bank that provided the loan.

Payments under a letter of credit are always non-cash transactions that provide for registration for payment to only one individual or legal entity.

Subtleties of the operation

When processing payment obligations of this type, customers should take into account some nuances:

1. In the event of a change in the terms of a revocable letter of credit or its cancellation, the issuing bank must inform the recipient of funds about this fact. This must be done no later than the business day following the day on which the changes were made.
2. An irrevocable letter of credit is considered modified or canceled when the executing bank receives the consent of the recipient of the funds. Partial modification of the terms of letters of credit by the latter is not allowed.
3. To make changes or cancel a confirmed letter of credit, the consent of the nominated bank and the recipient of funds is required.
4. Calculations under a letter of credit are payments made by commercial organizations, therefore, the recipient of funds learns about the opening of a monetary obligation directly from the issuing bank or from his bank (withconsent of the latter).
5. This type of payments are made only by bank transfer.
6. Payments of funds under a letter of credit are governed by customer agreements with banks and agreements between the latter.

Application Form

To pay for the goods in the above way, the payer submits 2 applications to the bank, which are an instruction to the bank to open a letter of credit. The application is submitted in the form developed by the company itself. In this case, the following data must be indicated:

• date and document number;
• payment amount;
• details of all parties to the transaction: payer, issuing bank, executing organization, recipient of funds;
• type of letter of credit;
• its validity period;
• list of documents to be provided by the recipient of funds, requirements for them and the final date of their submission;
• how the letter of credit is executed;
• purpose of this payment;
• shipper, consignee, destination;
• date of closing the money transfer process;
• commission percentage of banks from the transaction and the procedure for its payment.

This is a list of basic information, but the document may contain any data that is of interest to the applicant. More detailed information is contained in the Regulation of the Central Bank of the Russian Federation of June 19, 2012 N 383-P "On the rules for the transfer of funds" (clause 6.7).

Methods of execution of letters of credit

There are several methods used by banks to pay for transactions oncashless:

1. Making payment after the seller provides the necessary documents.

2. Delayed payment: carried out a few days after the bank receives the agreed list of documents or after a certain period after the shipment of the goods.

3. Making a mixed payment: part of the amount is paid upon presentation of documents, part - a few days after shipment.

4. Acceptance of a bill of exchange: it is accepted by the issuing bank or executor and paid within the agreed time.

5. Negotiation of documents: the executing bank purchases a bill of exchange (draft) drawn on a completely different bank, or documents by advancing to the beneficiary (seller) or promising to pay the advance before the banking day on which the bank should receive a refund from the issuing bank. This method is used when the owner of the goods wants to receive money immediately, and the buyer wants to pay for the wholesale some time after receiving it.

Pros of bank liabilities

Payments by letters of credit are financial transactions that have a number of advantages, namely:

• assignment of responsibility to commercial organizations for the legality of monetary transactions in the form of a letter of credit;
• ensure payment to the seller in full;
• return the full amount to the buyer in case of cancellation of the sale;
• full compliance with the terms of the contract between the parties due to bank control;
• preservation of buyer funds within the organization.

Conssettlements through a letter of credit

In addition to the positive aspects, these payment orders have some disadvantages, namely:

• at each stage of the transaction, it is necessary to provide a large number of documents;
• high cost of this cashless payment for both parties.

Despite the inconvenience that exists with this form of payment, settlements by documentary letters of credit guarantee the success of the transaction, ensure its transparency and legality, and also allow bank customers to find new business partners and make relationships open, successful and promising.