What is the Credit Letter?
The credit letters are used as the financial tool in many situations. Do you think that the letter of credit verifies your creditworthiness? This is not the case completely but such a letter is a document that is issued by the third party in order to provide a guarantee for payment of goods and services. This happens when the seller provides all the required documents.
Such a letter is generally, issued by the financial institutions and banks. Under few circumstances, such a letter is issued by the financial institution like insurance companies or mutual funds.
Three participants are involved in this type of letter.
- The first part is the beneficiary
- The second party is the buyer or an applicant
- The third party is the issuing bank
The letter of credit is mostly used in international trades and there are also many situations when it can be used.
Types of the Credit Letters
Import/export letter of credits
Import/export letter of credits are generally used in the international trades. Such letters can be termed as:
- If it is by an importer, then you can call it as an import letter of credit
- If it is by an exporter, then you can call it as an export letter of credit
In most of the cases, in such a letter of credit you can say that:
- Importer is the buyer, and
- Exporter is the beneficiary
Revocable and irrevocable letter of credit
In this type of letter of credit, changes can be done at any point of time by the buyer and the issuing bank. In such a scenario, they won’t be giving notification to the beneficiary. An irrevocable letter of credit, on the other hand, allows issuing bank to make changes or cancel the letter of credit.
Confirmed and unconfirmed letter of credit
At the request of the issuing bank, the second bank agrees to pay in this type of credit letter. In a case of insolvency, the issuing bank might only have to issue the confirmed letter of credit. The guarantee is provided only by the issuing bank, in a case of an unconfirmed letter of credit.
Transferable and un-transferable letter of credit
Transfer of payments can be made in the transferable letter of credit. A transferable letter of credit is used when the beneficiary is one among the suppliers group. It can also be used when the beneficiary is an intermediate for the actual supplier of goods and services. In such a case, a beneficiary can submit its own documents but can transfer part of the payment or an entire payment to the actual supplier. No transfer of payments can be made in the un-transferable letter of credits.
Deferred letter of credit
In a regular letter of credit, a seller can request or ask for the payment, immediately upon the receipt of the shipping documents. When the words like deferred payments arise in such letter of credit, the payment is not made to the seller when the documents are submitted. Here the payment is made later on, at the defined time period in the credit letter. In other words, it can be said that in such a letter of credit, the guarantee is provided by an importer’s bank to an exporter.
Red clause letter of credit
In the letter of credit with a red clause, the buyer can extend an unsecured loan to the seller. In this type of letter of credit, there is a provision that is traditionally written or typed in a red ink.
Back-to-back letter of credit
Back-to-back letter of credit allows you to secure the goods with the letter of credit of buyer’s as collateral. Generally, it consists of two letter of credits among which one is issued by the buyer’s bank to the intermediary and another is issued by the bank of intermediary’s to the seller. These letters are used together to finance a transaction.
Documentation Requirements with the Credit Letter
Why are documents so important with the credit letter? It can be said that documents are the most important part of letter of credits and bank deals with the documents and not with the goods.
In a letter of credit transactions, few documents used are like:
Transport related documents
- Multimodal or combined transport document
- Transport bill of lading
- Air transport documents
- Charter party bill of lading
- Road transport document
- Rail transport document
- Waterway transport document
- Negotiable transport bill of lading
- Non-negotiable sea waybill
Insurance related documents
- Insurance policy
- Insurance certificate
Financial and commercial related documents
- Bill of exchange
- Proforma invoice
- International sale contract
- Inspection certificate
- Weight list
- Commercial invoice
- Packing list
- Analysis certificate
- Shipment advice
- Health certificate
- Certificate of origin
- Legalized invoice
- Consular invoice
Main parties of letter of credit
In the letter of credit transaction, here are the few important parties:
- Applicant
- Beneficiary
- Issuing bank
- Confirming bank
- Nominated bank
Applicant
The buyer of goods and services is an applicant and on the request of the applicant, such a letter is opened by the issuing bank.
Beneficiary
The seller of goods or services is called as the beneficiary and such a letter is opened by the issuing bank in the favour of the beneficiary.
Issuing Bank
The letter of credit is issued by an issuing bank, on the request of an applicant.
Nominated Bank
Credit is available to the nominated bank.
Advising Bank
On the request of the issuing bank, an advising bank advises the credit.
Confirming Bank
On the request of the issuing bank, confirming bank provides confirmation to the credit. Such a bank may or may not add confirmation to the letter of credit.
How to Write a Credit Letter?
Whatever may be the circumstances, but it is important to make use of the courteous tone, while writing the letter of credit. While giving a reason for taking a particular action, it is important for you to make use of the professional tone. Here are the few tips that can help you to write a letter of credit:
- In order to convey your request properly, it is important to make use of the clear tone.
- Depending on the audience, you can customize your letter.
- It is important to be straightforward while writing such a letter.
- You need to be confident and persuasive.
- It is essential to be assertive but don’t be arrogant.
- Maintain confidential facto, if required.