Documentary letters of credit
The bank opens a letter of credit on the instruction of the client, the buyer, in favour of the seller (beneficiary of the letter of credit), if the contract between them envisages a documentary letter of credit. According to the payment terms under the letter of credit, the bank pays the beneficiary subject to proper presentation, by the beneficiary, of the documents as defined in the letter of credit, typically after shipment of the goods/delivery of the services. In the course of deals based on letters of credit, the parties only deal with documents (against which the payment is made) rather than with goods, services or works to which the documents relate. A letter of credit is an agreement which is separate from the underlying contract.
A letter of credit is used to ensure that the parties perform their obligations under the contract and increase the company’s working capital (unsecured letter of credit) without having to attract debt financing in the form of credit.
Advantages of letters of credit:
- For the seller — minimisation of the risk of the buyer defaulting on the contract after the seller has performed his obligations.
- For the buyer — minimisation of the risk of the seller’s failure to fully comply with its obligations under the terms and conditions of the contract.
- For the seller and the buyer — where the contract stipulates delivery of the goods/performance of the works on the condition of deferred payment, namely, in case of the issue of a deferred payment letter of credit:
- For the buyer — the opportunity to defer the payment (trade credit) under the contract against obligations of the issuing bank under the letter of credit.
- For the seller — the opportunity to collect contractual payment (in case the documents are negotiated by the authorised bank) by the day of payment of reimbursement to the authorised bank by the issuer bank (i.e. by the day of the buyer’s performance of its contractual payment obligations).
Pivdenny Bank issues the following types of letters of credit for its clients:
Secured documentary letter of credit — to open an LC of this type and perform subsequent payments thereunder, the client must reserve the full amount of the LC in advance in the respective currency on a separate deposit account with the bank.
Unsecured documentary letter of credit — to open the LC, the client must provide collateral (real estate, equipment, goods in turnover, etc.) to the bank and undertake to pay, when requested by the bank, the amount of the letter of credit (by reserving the funds on the coverage account) before the settlement under the letter of credit.
Procedure for payments under letters of credit:
- The buyer signs a contract with the seller envisaging LC-based payments.
- The buyer’s bank (the issuing bank) opens a letter of credit and sends it to the seller’s bank (advising bank) or to a confirming (executing) bank (in case of a confirmed letter of credit) for further dispatch to the beneficiary. The advising/executing bank informs the beneficiary of the opening of the letter of credit.
- The seller ships the goods/delivers the services and provides documents as per the letter of credit to the advising bank to enable their dispatch to the executive bank.
- The executing bank verifies the documents for their compliance with the terms and conditions of the letter of credit and, in the absence of discrepancies from the terms and conditions of the letter of credit (proper presentation), performs the obligation or negotiates the documents within its authorities and sends the documents to the issuing (buyer’s) bank. At this stage, the executing bank may pay against presentation of the documents or an advance payment in favour of the beneficiary, or comply with its obligation in another way.
- The issuing bank reimburses the executive bank or performs its obligations according to a process specified in the letter of credit (subject to proper presentation of the documents). The issuing bank is held to perform its obligations from the moment of opening the letter of credit.
- The issuing bank receives documents from the executing/advising bank and transfers them to the party, the buyer, that requested the letter of credit.
How do I apply?
Contact your personal manager
for existing clients of the bank.