In the banking sector, there are quite a few terms that seem rather complicated at first glance. However, if you look, then these terms are hiding fairly simple concepts. Many who hear the word "letter of credit" consider this something incomprehensible and complex. In this article we will try to figure out what it is and in what cases it is applied.
Definition and essence of the concept
A letter of credit is considered the most reliable and affordable way to protect an individual or an organization from the risks that arise when making an advance payment on a transaction. Also, a letter of credit allows you to get certain guarantees when working with new suppliers. A letter of credit is indispensable for individuals when concluding a transaction of sale of property.
Thus, a letter of credit is an account specially opened with a banking organization to reserve the amount for a certain period (for the time of conclusion of a transaction, for example). At the moment when the participants fulfill the conditions of the transaction, the bank assumes the obligation to pay the required amount to one of the parties.
Bank Letter of Credit
In the case considered above, the bank acts as an intermediary and guarantor. He is responsible for the payment of funds deposited in the account. Such a financial scheme is certainly beneficial and reliable for both the supplier and the recipient.
The Bank acts as a kind of insurer and assumes responsibility for the payment of funds under the terms of the agreement. This becomes beneficial to both the supplier and the recipient. The first one knows for sure that he will receive payment for the delivered goods, and the second is sure that he will be able to pay in time. Moreover, the letter of credit tariffs for individuals and for organizations are almost the same.
In addition, such a safe method of settlement guarantees both parties the fulfillment of their obligations, which allows to accelerate the process of sale.
Bank Intermediation Steps
A transaction using a letter of credit implies the following sequence of actions:
The conclusion of a contract between the parties to the transaction, which sets out all the conditions under which the calculation will be made, including a letter of credit.
The party interested in the purchase must contact the selected bank to draw up an account and deposit the amount of money agreed upon in the agreement, which is booked for a specified period.
The other side of the transaction provides the bank with the required package of securities.
Having opened a letter of credit, the bank informs the seller's bank (advising bank) about this.
The supplier is notified by the advising bank of the opening of a letter of credit.
The supplier transfers the goods to the recipient and transfers to the issuing bank all the necessary documents to confirm the implementation of the contract.
All documents submitted are checked by the advising bank.
Based on the agreement, the funds are credited to the seller’s account by the issuing bank in which the letter of credit was opened.
Letter of credit agreement and payment
The contract is a document that spells out all the relations of the parties to the transaction and the information necessary for its successful conclusion. Mandatory clauses of the contract are:
1. All details of both parties to the transaction.
2. The form in which the transaction is concluded.
3. The amount that will be reserved for further transfer to the seller.
4. The terms by which the terms of the transaction will be met.
five.The size of the commission.
6. The sequence according to which payments will occur.
7. Clauses providing for non-compliance with the terms of an agreement of one of the parties.
8. Obligations and rights of participants in the transaction.
It should be noted that such financial transactions can be performed not only by legal entities, but also by individuals, while the sequence of actions for issuing a letter of credit for an individual does not change.
In which case is a money transfer made among the participants in the transaction?
The transfer of reserved funds is carried out only after the fulfillment of all the necessary conditions of the contract has been documented. That is, money is transferred to the seller only after the goods have been delivered to the buyer, and papers have been provided to the issuing bank confirming this. If the terms of the contract were not fulfilled or were violated, the buyer is authorized to arrange for the return of the goods to the supplier and not to pay for it. The account itself is opened at the buyer's expense or through a loan.
The process of opening a letter of credit in a banking organization
In order to complete the transaction in question in a banking organization, for example, to open a letter of credit for individuals with VTB 24, you need to fill out a statement in the form of a bank with the following information:
1. Information about the contract (date of conclusion, number).
2. Information about the supplier, including details.
3. The form of payment of funds.
4. Information about the goods that must be provided to the buyer.
5. Information on the advising bank.
6. Documents that will need to be provided for the transfer of funds to the supplier.
Whether you choose this bank or you want to open a letter of credit at Sberbank for individuals, it is worth checking the rates directly at the bank's branch or on the website.
Types of letters of credit
There are several types of letters of credit, depending on the authority of the parties to the transaction and the bank:
1. Recallable. In this type of letter of credit, the bank is entitled to cancel the account on the basis of the buyer’s application without notifying the seller. This type of accounts is not popular due to the lack of guarantees from the seller.
2. Irrevocable. The most common type of letters of credit for individuals at VTB. It is impossible to withdraw funds. That is, after fulfilling the terms of the transaction, the funds will be guaranteedly transferred to the supplier’s account.
3. Confirmed. In this case, the bank will transfer the money to the seller, even if there are no funds in the buyer's account. This option, however, is risky for a banking organization, therefore it is subject to a rather large commission.
4. Reserve. The bank that opens the account gives the seller a formal written obligation that payments will be made even if the buyer does not fulfill the conditions specified in the contract. This type guarantees payment to the supplier.
5. Revolving. It is opened only for a part of the agreed amount. After fulfillment of obligations it is supplemented by the remaining part of the amount. It is usually used in cases when the goods are delivered on a specific schedule.
6. Circular. Allows you to receive money at any branch of the advising bank.
7. With a red clause. The issuer agrees to the transfer of money to the seller even before confirmation of the fulfilled terms of the contract.
Letters of credit for individuals
It is possible to use letters of credit not only in commodity-money relations, but also in the work of individuals. The essence of the operations performed remains unchanged, and the account acts as a guarantor of the fulfillment of obligations. A letter of credit for individuals is used to protect against fraudulent schemes, as well as in transactions with real estate.
An analogue of a letter of credit can be the opening of a bank cell where money can be stored until the transaction is completed. This happens as follows:
1. In the presence of the recipient, funds are deposited in the cell.
2. The amount deposited is verified.
3. There is a delivery of goods or purchase of property.
4. Documents confirming the fulfillment of contractual obligations are provided to the bank.
5. The seller receives money from the cell.
Transactions using a cell, as a rule, take more time, so people engaged in entrepreneurial activities prefer a letter of credit, despite the cost of a letter of credit for individuals.
Reviews
A letter of credit is a convenient form of guaranteeing the fulfillment of financial obligations between two parties to a transaction. In entrepreneurial activity, this type of accounts is used everywhere. However, it is not so widespread among individuals, although such large financial organizations as Sberbank, in every way advertise and support a letter of credit for individuals. There are practically no reviews in this area due to the fact that when concluding a contract of sale, a bank cell is more often used. However, all comments indicate the unconditional reliability of this method of calculation. In VTB letters of credit for individuals and legal entities also take place, and as is known from informative sources, VTB24 and Sberbank are financial organizations with the highest degree of trust among various groups of citizens.
Advantages and disadvantages of a letter of credit for all groups of persons
Summarizing all the submitted reviews, we can distinguish the following advantages of letters of credit:
1. Monitoring the fulfillment of obligations under the contract from a legal point of view (the bank will not engage in dubious transactions, everything is checked).
2. The risks for the supplier are minimal; in fact, he is guaranteed to receive his money.
3. A letter of credit for individuals or organizations guarantees the timely fulfillment of obligations by the supplier.
4. Unlike conventional lending, in this case there is the opportunity to save on interest payments.
However, there are several disadvantages of letters of credit, namely:
1. If you do not provide the documents necessary to confirm the fulfillment of obligations under the contract, the funds will not be transferred to the supplier.
2. Due to the large volume of documents, the transaction can be quite lengthy.
3. Letter of credit transactions may be limited by law.
4. Commissions for services under letters of credit for individuals are quite high. The same applies to a legal entity.