Recently, a special form of mutual settlements between sellers and buyers has been increasingly used, which guarantees insurance of risks associated with non-receipt of goods or non-payment. It should consider the types of letters of credit, their advantages and disadvantages, as well as issues that arise most often.
General concept
So, for starters, it is worth considering an irrevocable letter of credit in general terms. The basic concept that is used for this looks something like this. The letter of credit is a conditional monetary obligation which is accepted by the bank in accordance with the order of the applicant, to make a payment to the beneficiary of the amount specified in the contract.
Payment is made after documents have been submitted to the bank that confirm compliance with the conditions of the letter of credit within the specified time. It turns out that at the request of a party, the bank will transfer funds to the beneficiary, or the funds will be transferred to the account of the executing bank. In this case, the relationship between the parties to the transaction does not affect banks.
Types of letters of credit
To regulate the letter of credit form of interaction in the Russian Federation, the Regulation “On non-cash payments” is used, which defines the types of letters of credit that are available for opening at banks:
- covered and uncovered (deposited and guaranteed);
- revocable and irrevocable.
You can consider each of the species in more detail. A deposited irrevocable letter of credit is a form of interaction in accordance with which the issuing bank transfers, at the expense of the payer's financial assets, or the loan received by it, the amount of the letter of credit at the disposal of the executing bank throughout the term of the contract. This form of payment is used by banks quite often for such lending purposes as the acquisition of real estate abroad, the purchase of equipment in order not only to reduce their risks, but also the risks of the client.
An uncovered irrevocable letter of credit assumes that the issuing bank gives the executing bank the right to write off monetary assets from the correspondent account maintained within it within the framework of the letter of credit, or it indicates a different way of reimbursing the executing bank for the amounts paid in accordance with the contract. An agreement is concluded between banks, according to which funds are debited from correspondent account in the bank. The procedure in which the payer will make a refund on an open letter of credit is established in the contract concluded between the client and the issuing bank.
An irrevocable letter of credit is a form of document in which cancellation or amendment of the conditions is allowed only after the executing bank has received the consent of the recipient of funds for certain changes in the current conditions.
Full classification
A letter of credit with a red clause is such an agreement, according to which the issuing bank authorizes the executing bank to pay the advance payment for the agreed amount before the confirmation document is submitted.
An irrevocable covered deposited letter of credit is an agreement, the opening of which is carried out by the issuing bank with the obligatory transfer at the expense of the payer, or of a loan granted to it for the amount of the letter of credit at the disposal of the executing bank for the entire duration of the document.
Covered letter of credit is used for settlements in the Russian Federation. In international settlements by banks, a set of interbank agreements is used, in accordance with which the coverage is either completely absent, i.e., pure credit line, or it is being placed in agreed forms (deposit account, securities and other assets). In international practice, this term is not used at all.
An open irrevocable letter of credit is a contract upon opening which the issuing bank gives the executing bank the right to debit funds from the correspondent account maintained within it within the amount of the letter of credit, or an agreement is reached with the executing financial institution on other conditions for reimbursing the funds already paid to the beneficiary. In the practice of international economic relations, the term “guaranteed” (or “uncovered”) is not used, since most letters of credit that are used have become such.
A confirmed letter of credit is an agreement in which the executing bank undertakes to make the payment of the amount indicated in the letter of credit, regardless of the receipt of funds from the structure in which it was opened.
A revolving letter of credit is a contract that is opened for a part of the amount of payments, and its renewal is made automatically after payment is made for the next batch of goods.
A circular letter of credit is such an agreement, upon conclusion of which the client can receive money within the limits of this loan in all correspondent banks of the institution that issued the specified letter of credit.
Reserve - this is one of the types of bank guarantees, which is documentary in nature and is subject to the documents of the International Chamber of Commerce for letters of credit. This option is used for financing in the field of international trade with countries in which it is not allowed to use bank guarantees in trade transactions, it is forbidden to document guarantees, and it is also appropriate to use it when conducting transactions with international financial institutions.
The cumulative irrevocable letter of credit allows the applicant to add the unspent amount of funds under the current letter of credit to the amount of a new one opened in the same bank. Otherwise, the unspent amount is usually sent back to the issuing bank for crediting to the current accounts of the depositors.
The procedure for working with letters of credit
So, you decided to use a letter of credit for mutual settlements - revocable and irrevocable, or some other form. To do this, you must submit an application for opening it to the issuing bank. This statement will serve as the basis for the bank to open a letter of credit and send it to the beneficiary through the executing bank.
Further, it is required to execute the contract in the form of the provision of services or shipment of products. After that, the beneficiary must provide the bank with documents proving the performance of work or the provision of the service. After that, he can receive a payment.
A register of accounts is sent from the executing bank to the issuing bank for transfer to the payer. The issuing bank has the important task of verifying the correctness of all documents submitted.
Next, the issuing bank issues the paid documents to the lender, after which the proceeds are transferred to the beneficiary with the help of the executing bank.
Letter of credit in practice
This form of mutual settlement is traditionally used for foreign trade relations, and in domestic trade it is much less common. This is due to the fact that an irrevocable documentary letter of credit is the most advantageous form of settlements between participants in transactions of a foreign economic nature. For the exporter, they represent the occurrence of the bank’s obligations to make settlements, as well as a customer obligation to make payment under the contract. From the opposite position, they are a guarantee to the importer that payment will be made after the goods or service are delivered.
For example, if the importer company needs to purchase a tugboat docked in another country, then both parties have a certain risk of non-delivery of goods or non-payment of delivery. An irrevocable, covered, non-acceptance letter of credit will be a good way out in this case, since the exporter wishes to receive the full amount under the concluded agreement in a timely manner, while the importer is ready to pay it only when the ship is at its destination. In this type of interaction, the tug will be acquired under an import contract concluded between the supplier and the buyer. The exporter will receive payments by attracted funds of a foreign bank in a letter of credit. And a foreign bank will provide a deferral of payment in favor of the importer.
Settlement Participants
An irrevocable documentary unconfirmed letter of credit implies the presence of several participants in mutual settlements:
- the importer, who is also the issuer, applying to the local issuing bank with a request to open a letter of credit;
- issuing bank whose task is to open a letter of credit;
- a foreign bank, which should notify the exporter that an irrevocable unconfirmed letter of credit was opened in his favor, passing him the text of the agreement with the obligatory preliminary authentication of his authenticity;
- beneficiary exporter in whose favor a letter of credit was opened.
Work stages
In the previously mentioned example, you can consider the sequence of steps in accordance with which all actions will be performed. First you need to conclude a contract between the importer and the company, which is the seller of the tug. Next, you need to fill out an application for opening a letter of credit from the applicant to the issuing bank. After that, a notification on the opening of a letter of credit is sent from the issuing bank. Further, an irrevocable divisible letter of credit must be advised. All of these procedures precede the delivery of the tug. At the next stage, workflow between banks with their advising is carried out. After debiting the importer's account, funds are transferred to the performing bank. At the end of all this, the exporter receives his legal payment.
All this testifies in favor of the fact that the letter of credit can be considered insurance of business against risks associated with the conclusion major deals especially when it comes to post-import financing.
Arbitrage practice
With this form of settlement, sometimes legal disputes arise, which are caused by a lack of understanding of the very essence of the scheme of work. For example, the most common question is responsibility to the payer in case of failure by the issuing bank to return the money to the paying bank: in this case, the issuing bank is responsible for the payer, and the executing bank is already responsible to the bank. It is worth knowing that a letter of credit is recognized as irrevocable, which cannot be canceled without the consent of the recipient of funds. The execution of the confirmed agreement is ensured not only by the issuing bank, but also by the executing bank, and it is important that the letter of credit can be withdrawn only if there is consent from the recipient of the funds.
Another important question concerns whether the issuing bank can be exempted from liability in case of unlawful actions by the person of the executing bank, when the issuing bank itself appointed the executing bank in accordance with the initiative of the payer. In accordance with the applicable legislation, the responsibility for the executing bank is usually assigned by the court upon an application from the payer, if it was a question of incorrect payment of money by the executing bank.
Most often, disputes arise against the background of such an interaction tool as an irrevocable covered letter of credit. What is it? This is such a form of settlements, in which there is the greatest scope for fraudulent transactions. In this case, they propose to abandon such a letter of credit in favor of using the design of blocked accounts.
Opportunities to use
Today, many banks offer their customers a service such as an irrevocable letter of credit when selling an apartment. It is worth saying that this is a rather expensive service. For example, for settlements on a mortgage transaction through a letter of credit, an open bank account is required, as well as a commission for opening a contract in the amount of 2000 rubles. Reception of documents with their subsequent verification, as well as further payment are free of charge.
You can use such a banking service as an irrevocable letter of credit. Sberbank offers its customers favorable conditions in this regard. The commission for its opening depends on the amount of the letter of credit itself and may amount to 1,500-15,000 rubles. This form of settlement is much safer. For violations committed in the process of its use, banks are liable in accordance with the law.
findings
The considered material speaks in favor of the fact that the letter of credit represents the most advantageous transaction and guarantee for both parties, since when participating in a bank transaction, the possibility of using incomplete documents is excluded. In most cases, the parties to the contract choose exactly this form of relationship, since it turns out to be really beneficial and convenient.
