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Letter of credit (from Lat. AssgesIbush - trust) is one of the most complex and expensive forms of payment. It is actively used in some spheres of economic activity, especially in international trade. This is due to the fact that it allows to a certain extent to balance the interests of both buyers and sellers and to ensure a certain degree of reliability due to the participation of the bank (banks) in the operation as a trustee.
In banking practice, several types of letters of credit are used, differing in their economic nature and purpose: cash, reserve and documentary letters of credit. A cash letter of credit is used in transactions with individuals. A bank client wishing to receive money in another city or abroad, pays the required amount to the bank and receives a registered document, which will be paid by another bank or a branch of the issuing bank at the destination. The second type of letter of credit - standby letter of credit(stand-by letter of credit) - widespread in the United States and represents a bank guarantee in case of non-fulfillment of the concluded contract. For example, through standby letters of credit can be guaranteed such payments and services as paying bills on demand repayment of bank loans, payment of commodity supply, etc. The third and most common form of letters of credit -. This documentary letter of credit (documentary letter of credit). It is used to pay for the delivery of goods against documents (or against the acceptance of a bill).
Considering the high prevalence of documentary credit, the International Chamber of Commerce (ICC) developed and adopted in 1933 "Universal customs and rules for documentary credit" (hereinafter - UOP). This document establishes general standards in the field of application of documentary credit, which are periodically reviewed and updated. Since 1993, the version of the UOP MTP-500 has been in operation, and since 2007 - the MTP-600.
In Russia, the use of a letter of credit is regulated by the Civil Code of the Russian Federation and Regulation No. 2-P. These standards basically coincide with the ICC document. In the domestic turnover of Russia, the letter of credit is still poorly used. In 2008, both in terms of the number and the volume of payments, the share of payments using letters of credit in the structure of credit transfers amounted to hundredths of a percent. However, the role of this form of non-cash payments is increasing: in 2008 their number and volume increased by 1.2 and 2.1 times and amounted to 51 thousand payments in the amount of 493.8 million rubles | Bank of Russia, 2010b |.
A documentary credit is an agreement by virtue of which the bank (issuing bank), acting at the request and on the basis of the instructions of the client (the issuer of the letter of credit) or on its own behalf, must make a payment to a third party (beneficiary) or his order or must pay or accept the transfer bills (drafts). The issuing bank can also delegate the authority to another bank (executing or advising bank) to carry out these operations.
As follows from this definition, the bank in which the letter of credit is opened is obliged on behalf of the buyer to pay the specified amount to the seller of the goods in strict accordance with the terms of the letter of credit. In this operation, the bank plays the role of a trustee who performs two functions. First, the bank makes sure that the guaranteed amount is provided to the seller immediately upon the fulfillment of the terms of the letter of credit. Secondly, he does his best to protect the interests of the buyer against the seller (beneficiary), if the documents, for some reason, do not meet the conditions of the letter of credit. A documentary credit can also be defined as a transaction that consists of payment upon delivery of goods or services. Moreover, the execution of this operation is not associated with a strictly set time and place. So, the seller, who uses a documentary credit for settlements, is sure that a party that is independent of the buyer will make the payment when the goods are delivered, and the bank will fulfill the conditions prescribed in the documentary credit, including transferring the agreed documents. In turn, the buyer is sure that the amount under the documentary credit will be paid only against the presentation of the documents that were indicated to him.
The main participants in the letter of credit transactions in foreign trade settlements are:
Covered and uncovered letters of credit differ depending on the method of collateral. When a covered letter of credit is used, the issuing bank transfers in advance to the nominated bank the funds needed to pay off the letter of credit. The provision of coverage makes the letter of credit particularly reliable. Under the uncovered letter of credit, money paid to the supplier by the nominated bank will be reimbursed to him by a subsequent transfer.
By the nature of the obligations of the issuing bank, revocable and irrevocable letters of credit can be distinguished. A revocable letter of credit can be canceled or changed at any time without prior notice to the beneficiary. However, the issuing bank must notify him of this no later than the business day following the day the conditions are changed or the letter of credit is canceled. Revocable letters of credit are rarely used in world practice. In the case of an irrevocable letter of credit, its terms and conditions cannot be changed or canceled without the consent of the beneficiary. If the order for opening a letter of credit does not indicate the form of the letter of credit, such letter of credit is considered irrevocable.
Depending on the availability of a guarantee of the executing bank for payment of the letter of credit, letters of credit are divided into confirmed and unconfirmed letters of credit. In the first case, the nominated bank assumes a separate obligation to make payment, accept or purchase (negotiate) the bill. With a confirmed letter of credit, there is a double guarantee on the fulfillment of its conditions both from the issuing bank and from the nominated bank. However, the issuing bank cannot confirm its own letter of credit. When an unconfirmed letter of credit is used, the nominated bank does not assume any obligations under the letter of credit, but acts solely as an agent of the issuing bank.
Note that the most reliable form of letter of credit for the seller of goods is an irrevocable confirmed letter of credit, since it cannot be revoked or changed without his consent. In addition, this type of letter of credit assumes a guarantee of payment by both banks: the issuing bank and the nominated bank. As a rule, in most cases, such a letter of credit is confirmed by a bank in the exporting country, therefore, political risk and the risk of transferring funds are excluded.
The main stages of calculations using an uncovered letter of credit are shown in Fig. 3.3.
12. The issuing bank transfers to the importer the shipping documents paid for by the letter of credit.
Documents that are subject to verification under the terms of the letter of credit (UOP - Art. 23-25):
Once again, it should be emphasized that the bank verifying the documents is not bound by the terms of the contract. If the product is of poor quality or part of it has not been ordered, but the submitted documents meet the terms of the letter of credit, the bank is obliged to pay. The bank can refuse to pay only if it finds that the documents do not comply with the terms of the letter of credit or if an incomplete set of documents is presented to it.
Earlier, we examined the types of letters of credit depending on the degree of security for the beneficiary. Letters of credit are also distinguished depending on the methods of implementation, for example, letters of credit with immediate payment, with payment by installments, with the acceptance of drafts, with negotiation, etc.
When using a letter of credit with payment at sight (payment letter of credit), the money is paid to the beneficiary immediately after all the required documents have been submitted to the bank and posted to the accounts. If the beneficiary receives the obligation of the bank to make payment in the future after a certain time after the submission of documents (for example, from the date of the bill of lading or shipment, etc.), then in this case we are talking about a letter of credit with payment by installments. In the event of a partial payment deferral, the bank undertakes to pay part of the amount immediately upon presentation of documents, and the bank provides a loan for the remainder of the amount.
There are letters of credit that provide for the possibility of obtaining a reimbursement loan by accepting the beneficiary's drafts. The beneficiary submits the documents and the bill of lading to the issuing bank or nominated bank. The bill is accepted by the bank and returned to the exporter, who can discount it (that is, sell it at a discount on the money market). The beneficiary (exporter), in the event of the sale of the draft, will receive the money immediately (minus the discount), and the buyer will deposit the money to the accepting bank before the due date of the draft. Commercial letters of credit provide for the negotiation (purchase) of drafts of the beneficiary.The beneficiary may receive the amount from the nominated bank authorized to negotiate the bill. With a freely negotiable letter of credit, any bank is the nominated bank. By purchasing the draft, the bank becomes the holder of the bill of exchange and receives the right of recourse to the exporter if the importer refuses to pay and if the draft was challenged in a timely manner.
A letter of credit with a "red clause" gives the exporter the opportunity to receive an advance payment of up to 100% of the amount of the letter of credit before submitting the shipping documents to the bank, and sometimes before the goods are shipped. Exporters are usually well-known suppliers who are in dire need of funds to purchase the raw materials used in the production of final products.
In the case of a revolving letter of credit, the amount of the letter of credit is automatically renewed to the original amount during the entire period of the letter of credit. Within the framework of the revolving letter of credit, it is assumed that the goods will be shipped in partial deliveries.
Standby letter of credit (“stand by” letter of credit) is the obligation of the issuing bank to pay the importer's drafts by payment upon presentation within a specific period and amount. It is similar to the guarantee obligation of the exporter to the importer for the proper execution of the delivery or for the return of the advance. A transferable letter of credit (transferable letter of credit) allows a reseller to transfer its right to receive funds from a client's letter of credit in whole or in parts to one or more suppliers (second beneficiaries). Secondary beneficiaries are not entitled to further transfer of the transferable letter of credit. This letter of credit, as a rule, is opened when the first exporter does not supply the goods himself, but there are a number of primary suppliers of the goods. Partial shipments of goods are assumed.
If a reseller wishes to transfer his letter of credit claim to a supplier, he has two options: a back to back letter of credit or an assignment of proceeds from the letter of credit. With a compensation letter of creditthe reseller opens a counter letter of credit in favor of the supplier, relying only on the existence of a letter of credit in his favor (to a certain extent, "back to back" to the supplier). He authorizes his bank to open a letter of credit in favor of the exporter. As a rule, back to back L / C is used for re-export of goods and for compensation transactions. The terms of both letters of credit must be nearly identical, with the exception of prices and invoices. The beneficiary of the letter of credit can also assign the proceeds of the letter of credit in whole or in part to the benefit of the subsupplier (make an assignment). This opportunity is often used by industrial enterprises, which assign part of the proceeds under the letter of credit to sub-suppliers of materials, parts, etc.
Thus, the letter of credit form of settlement provides a guarantee of payment. It is especially beneficial for sellers of goods (exporters). First, the bank pays funds regardless of the buyer, guided only by the terms of the letter of credit. Secondly, the buyer cannot block payment for any claim regarding the quality or completeness of the goods, since these claims are not related to the letter of credit. For the importer (buyer), the documentary credit is also beneficial, since it guarantees the timely receipt of the goods in accordance with the contract (especially if there is a representative of the customer at the place of shipment in order to control the quality and quantity of the goods). At the same time, the inconvenience lies in the fact that by opening a letter of credit, the importer diverts a part of the working capital,
In case of documentary collection, in contrast to the letter of credit form of settlements, the payment of funds to the beneficiary occurs only after receiving the payment from the bank to which the documents were sent. This means that the seller has to wait longer for the transfer of money for the goods and services supplied than when using the letter of credit. In the case of documentary collection, it is important that a relationship of trust is established between the buyer and the seller. Otherwise, there is a risk of non-receipt of payment for goods and services within a specified period.
A comparison of the two main forms of international settlements - documentary collection and documentary letter of credit - is presented in Appendix 1.
Thus, for the seller, the most reliable form of payment is a documentary letter of credit, which provides for the seller to receive proceeds immediately after submitting his documents to him. In the case of documentary collection, the seller can receive payment for the goods delivered or services rendered only after the payment has been made by the buyer or the bill of exchange has been accepted. Consequently, the higher cost of using the letter of credit form of settlement in comparison with documentary collection also ensures higher security of the documentary credit as a form of settlement in international trade. In addition, for the beneficiary, an irrevocable confirmed letter of credit is the most reliable form of payment, since this type of letter of credit implies a guarantee of payment by both the issuing bank and the executing bank.
In banking practice, several types of letters of credit are used, differing in their economic nature and purpose: cash, reserve and documentary letters of credit. A cash letter of credit is used in transactions with individuals. A bank client wishing to receive money in another city or abroad, pays the required amount to the bank and receives a registered document, which will be paid by another bank or a branch of the issuing bank at the destination. The second type of letter of credit - standby letter of credit(stand-by letter of credit) - widespread in the United States and represents a bank guarantee in case of non-fulfillment of the concluded contract. For example, through standby letters of credit can be guaranteed such payments and services as paying bills on demand repayment of bank loans, payment of commodity supply, etc. The third and most common form of letters of credit -. This documentary letter of credit (documentary letter of credit). It is used to pay for the delivery of goods against documents (or against the acceptance of a bill).
Considering the high prevalence of documentary credit, the International Chamber of Commerce (ICC) developed and adopted in 1933 "Universal customs and rules for documentary credit" (hereinafter - UOP). This document establishes general standards in the field of application of documentary credit, which are periodically reviewed and updated. Since 1993, the version of the UOP MTP-500 has been in operation, and since 2007 - the MTP-600.
In Russia, the use of a letter of credit is regulated by the Civil Code of the Russian Federation and Regulation No. 2-P. These standards basically coincide with the ICC document. In the domestic turnover of Russia, the letter of credit is still poorly used. In 2008, both in terms of the number and the volume of payments, the share of payments using letters of credit in the structure of credit transfers amounted to hundredths of a percent. However, the role of this form of non-cash payments is increasing: in 2008 their number and volume increased by 1.2 and 2.1 times and amounted to 51 thousand payments in the amount of 493.8 million rubles | Bank of Russia, 2010b |.
A documentary credit is an agreement by virtue of which the bank (issuing bank), acting at the request and on the basis of the instructions of the client (the issuer of the letter of credit) or on its own behalf, must make a payment to a third party (beneficiary) or his order or must pay or accept the transfer bills (drafts). The issuing bank can also delegate the authority to another bank (executing or advising bank) to carry out these operations.
As follows from this definition, the bank in which the letter of credit is opened is obliged on behalf of the buyer to pay the specified amount to the seller of the goods in strict accordance with the terms of the letter of credit. In this operation, the bank plays the role of a trustee who performs two functions. First, the bank makes sure that the guaranteed amount is provided to the seller immediately upon the fulfillment of the terms of the letter of credit. Secondly, he does his best to protect the interests of the buyer against the seller (beneficiary), if the documents, for some reason, do not meet the conditions of the letter of credit. A documentary credit can also be defined as a transaction that consists of payment upon delivery of goods or services. Moreover, the execution of this operation is not associated with a strictly set time and place. So, the seller, who uses a documentary credit for settlements, is sure that a party that is independent of the buyer will make the payment when the goods are delivered, and the bank will fulfill the conditions prescribed in the documentary credit, including transferring the agreed documents. In turn, the buyer is sure that the amount under the documentary credit will be paid only against the presentation of the documents that were indicated to him.
The main participants in the letter of credit transactions in foreign trade settlements are:
- 1. The ordering party (the letter of credit, the importer, who is also the buyer and payer). This person gives orders to his bank to open a letter of credit in favor of the seller.
- 2. Issuing bank (letter of credit, buyer's (importer's) bank) - a bank that opens a letter of credit by order of the seller (importer).
- 3. Supplier of goods - exporter (seller, recipient of money, beneficiary).
- 4. Advising bank - a bank that is located at the location of the beneficiary (seller) and is the correspondent of the issuing bank. He notifies the exporter of opening a letter of credit in his favor. This bank can assess the creditworthiness of the beneficiary.
Covered and uncovered letters of credit differ depending on the method of collateral. When a covered letter of credit is used, the issuing bank transfers in advance to the nominated bank the funds needed to pay off the letter of credit. The provision of coverage makes the letter of credit particularly reliable. Under the uncovered letter of credit, money paid to the supplier by the nominated bank will be reimbursed to him by a subsequent transfer.
By the nature of the obligations of the issuing bank, revocable and irrevocable letters of credit can be distinguished. A revocable letter of credit can be canceled or changed at any time without prior notice to the beneficiary. However, the issuing bank must notify him of this no later than the business day following the day the conditions are changed or the letter of credit is canceled. Revocable letters of credit are rarely used in world practice. In the case of an irrevocable letter of credit, its terms and conditions cannot be changed or canceled without the consent of the beneficiary. If the order for opening a letter of credit does not indicate the form of the letter of credit, such letter of credit is considered irrevocable.
Depending on the availability of a guarantee of the executing bank for payment of the letter of credit, letters of credit are divided into confirmed and unconfirmed letters of credit. In the first case, the nominated bank assumes a separate obligation to make payment, accept or purchase (negotiate) the bill. With a confirmed letter of credit, there is a double guarantee on the fulfillment of its conditions both from the issuing bank and from the nominated bank. However, the issuing bank cannot confirm its own letter of credit. When an unconfirmed letter of credit is used, the nominated bank does not assume any obligations under the letter of credit, but acts solely as an agent of the issuing bank.
Note that the most reliable form of letter of credit for the seller of goods is an irrevocable confirmed letter of credit, since it cannot be revoked or changed without his consent. In addition, this type of letter of credit assumes a guarantee of payment by both banks: the issuing bank and the nominated bank. As a rule, in most cases, such a letter of credit is confirmed by a bank in the exporting country, therefore, political risk and the risk of transferring funds are excluded.
The main stages of calculations using an uncovered letter of credit are shown in Fig. 3.3.
- 1. On the basis of a foreign trade contract, the importer undertakes to open a documentary credit. He sends to his bank an application for opening a letter of credit, where he indicates the name of the issuing bank and the executing bank; type of letter of credit (revocable / irrevocable, covered / uncovered, etc.), terms of payment of the letter of credit, list and characteristics of documents submitted by the recipient of money, date of closing the letter of credit. The importer informs the bank of a detailed list of goods (services) that are payable under the letter of credit, and also indicates the consignor, consignee, destination of the goods, etc. All this information is entered into the text of the letter of credit. In addition, the client undertakes to pay the bank a commission for carrying out operations under the letter of credit.
- 2. The issuing bank debits funds from the buyer's current account in the amount of the letter of credit to be opened.
- 3. The issuing bank records these funds on an off-balance sheet account.
- 4. Letter of credit is sent to the executing bank, which, after verifying its authenticity, transfers it to the beneficiary (sender of the goods). In this case, the nominated bank is not responsible for the execution of the letter of credit.
- 5. The payer's funds are transferred to the disposal of the executing bank.
- 6 . Upon receipt of the letter of credit, the exporter checks the letter of credit for compliance with the contract.
- 7. If there are no comments, he ships the goods and receives transport documents from the carrier company, which testify to the actual dispatch of the goods to the importer's address.
- 8. He then submits these documents to the nominated bank along with other documents specified in the letter of credit (draft, invoice, etc.).
- 9. The bank checks the documents and, if it has no comments about the exporter, pays the amount to the seller minus its commission. Payment is made against documents on the basis of external signs. The documents must be submitted within the time period specified in the terms of the letter of credit. If the term is not specified, then the documents must be submitted no later than 21 days after the shipment of the goods.
- 10. After checking the documents, the executing bank sends the register of accounts and shipping documents to the issuing bank for payment or acceptance (depending on the conditions).
- 11. The issuing bank checks the documents. If the documents comply with the terms of the letter of credit, he writes off the used letter of credit from the off-balance sheet account and transfers the money to the nominated bank, reimbursing its expenses.
12. The issuing bank transfers to the importer the shipping documents paid for by the letter of credit.
Documents that are subject to verification under the terms of the letter of credit (UOP - Art. 23-25):
- 1. Invoice (invoice), issued in the name of the recipient. The list and description of the goods specified in it must comply with the terms of the letter of credit.
- 2. Bill of exchange (draft) issued in the currency of the letter of credit.
- 3. Transport documents - sea bill of lading or railway bill of lading, air waybill. The Bill of Lading confirms the acceptance of the cargo on board the ship and is signed by the captain.
- 4. An insurance policy is issued for the amount of the value of the goods and covers all the risks specified in the letter of credit from the date of shipment of the goods. For example, when insuring on the terms
Once again, it should be emphasized that the bank verifying the documents is not bound by the terms of the contract. If the product is of poor quality or part of it has not been ordered, but the submitted documents meet the terms of the letter of credit, the bank is obliged to pay. The bank can refuse to pay only if it finds that the documents do not comply with the terms of the letter of credit or if an incomplete set of documents is presented to it.
Earlier, we examined the types of letters of credit depending on the degree of security for the beneficiary. Letters of credit are also distinguished depending on the methods of implementation, for example, letters of credit with immediate payment, with payment by installments, with the acceptance of drafts, with negotiation, etc.
When using a letter of credit with payment at sight (payment letter of credit), the money is paid to the beneficiary immediately after all the required documents have been submitted to the bank and posted to the accounts. If the beneficiary receives the obligation of the bank to make payment in the future after a certain time after the submission of documents (for example, from the date of the bill of lading or shipment, etc.), then in this case we are talking about a letter of credit with payment by installments. In the event of a partial payment deferral, the bank undertakes to pay part of the amount immediately upon presentation of documents, and the bank provides a loan for the remainder of the amount.
There are letters of credit that provide for the possibility of obtaining a reimbursement loan by accepting the beneficiary's drafts. The beneficiary submits the documents and the bill of lading to the issuing bank or nominated bank. The bill is accepted by the bank and returned to the exporter, who can discount it (that is, sell it at a discount on the money market). The beneficiary (exporter), in the event of the sale of the draft, will receive the money immediately (minus the discount), and the buyer will deposit the money to the accepting bank before the due date of the draft. Commercial letters of credit provide for the negotiation (purchase) of drafts of the beneficiary.The beneficiary may receive the amount from the nominated bank authorized to negotiate the bill. With a freely negotiable letter of credit, any bank is the nominated bank. By purchasing the draft, the bank becomes the holder of the bill of exchange and receives the right of recourse to the exporter if the importer refuses to pay and if the draft was challenged in a timely manner.
A letter of credit with a "red clause" gives the exporter the opportunity to receive an advance payment of up to 100% of the amount of the letter of credit before submitting the shipping documents to the bank, and sometimes before the goods are shipped. Exporters are usually well-known suppliers who are in dire need of funds to purchase the raw materials used in the production of final products.
In the case of a revolving letter of credit, the amount of the letter of credit is automatically renewed to the original amount during the entire period of the letter of credit. Within the framework of the revolving letter of credit, it is assumed that the goods will be shipped in partial deliveries.
Standby letter of credit (“stand by” letter of credit) is the obligation of the issuing bank to pay the importer's drafts by payment upon presentation within a specific period and amount. It is similar to the guarantee obligation of the exporter to the importer for the proper execution of the delivery or for the return of the advance. A transferable letter of credit (transferable letter of credit) allows a reseller to transfer its right to receive funds from a client's letter of credit in whole or in parts to one or more suppliers (second beneficiaries). Secondary beneficiaries are not entitled to further transfer of the transferable letter of credit. This letter of credit, as a rule, is opened when the first exporter does not supply the goods himself, but there are a number of primary suppliers of the goods. Partial shipments of goods are assumed.
If a reseller wishes to transfer his letter of credit claim to a supplier, he has two options: a back to back letter of credit or an assignment of proceeds from the letter of credit. With a compensation letter of creditthe reseller opens a counter letter of credit in favor of the supplier, relying only on the existence of a letter of credit in his favor (to a certain extent, "back to back" to the supplier). He authorizes his bank to open a letter of credit in favor of the exporter. As a rule, back to back L / C is used for re-export of goods and for compensation transactions. The terms of both letters of credit must be nearly identical, with the exception of prices and invoices. The beneficiary of the letter of credit can also assign the proceeds of the letter of credit in whole or in part to the benefit of the subsupplier (make an assignment). This opportunity is often used by industrial enterprises, which assign part of the proceeds under the letter of credit to sub-suppliers of materials, parts, etc.
Thus, the letter of credit form of settlement provides a guarantee of payment. It is especially beneficial for sellers of goods (exporters). First, the bank pays funds regardless of the buyer, guided only by the terms of the letter of credit. Secondly, the buyer cannot block payment for any claim regarding the quality or completeness of the goods, since these claims are not related to the letter of credit. For the importer (buyer), the documentary credit is also beneficial, since it guarantees the timely receipt of the goods in accordance with the contract (especially if there is a representative of the customer at the place of shipment in order to control the quality and quantity of the goods). At the same time, the inconvenience lies in the fact that by opening a letter of credit, the importer diverts a part of the working capital,
In case of documentary collection, in contrast to the letter of credit form of settlements, the payment of funds to the beneficiary occurs only after receiving the payment from the bank to which the documents were sent. This means that the seller has to wait longer for the transfer of money for the goods and services supplied than when using the letter of credit. In the case of documentary collection, it is important that a relationship of trust is established between the buyer and the seller. Otherwise, there is a risk of non-receipt of payment for goods and services within a specified period.
A comparison of the two main forms of international settlements - documentary collection and documentary letter of credit - is presented in Appendix 1.
Thus, for the seller, the most reliable form of payment is a documentary letter of credit, which provides for the seller to receive proceeds immediately after submitting his documents to him. In the case of documentary collection, the seller can receive payment for the goods delivered or services rendered only after the payment has been made by the buyer or the bill of exchange has been accepted. Consequently, the higher cost of using the letter of credit form of settlement in comparison with documentary collection also ensures higher security of the documentary credit as a form of settlement in international trade. In addition, for the beneficiary, an irrevocable confirmed letter of credit is the most reliable form of payment, since this type of letter of credit implies a guarantee of payment by both the issuing bank and the executing bank.
