Letter of Credit
Understand what is a Letter of Credit and how it is used in International Trade Activities.
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COURSE DESCRIPTION
Importance of Letter of Credit
Companies and laypeople often do not have the capital they need
to fund projects or make large purchases on their own. They have to turn
to credit in order to secure the financing they need. Letters of credit
are letters that banks issue to verify the credit a business or person
has. They are useful because they tell sellers that the bank will back
the buyer in the event the buyer can't pay on his own.
Purpose
The primary purpose of a letter of credit is to guarantee
payment. Although the conditions of a letter of credit may vary based on
your situation and the bank's regulations, letters of credit
essentially let you capitalize on the bank's credit instead of relying
on your own. The seller knows that if you don't come through with funds,
the bank will. This promise to pay is vital for establishing new
business relationships.
Letter of Credit in International Trade
In general, people use letters of credit for international trade.
This is because people may be less familiar with companies, sellers and
banks the farther away they are. It also is harder for effective
communication to take place in international trade, although technology
greatly is improving communication difficulties. Letters of credit also
are useful for any domestic transactions where the buyer and seller have
not worked with each other previously.
Advantages of Letter of credit
·The seller has the obligation of buyer's bank's to pay for the shipped goods;
·Reducing the production risk, if the buyer cancels or changes his order
·The opportunity to get financing in the period between the
shipment of the goods and receipt of payment (especially, in case of
deferred payment).
·The seller is able to calculate the payment date for the goods.
·The buyer will not be able to refuse to pay due to a complaint about the goods
·The bank will pay the seller for the goods, on condition that
the latter presents to the bank the determined documents in line with
the terms of the letter of credit;
·The buyer can control the time period for shipping of the goods;
·By a letter of credit, the buyer demonstrates his solvency;
·In the case of issuing a letter of credit providing for delayed payment, the seller grants a credit to the buyer.
·Providing a letter of credit allows the buyer to avoid or reduce pre-payment.
Letters of credit are often used in international transactions
to ensure that payment will be received. Due to the nature of
international dealings including factors such as distance, differing
laws in each country and difficulty in knowing each party personally,
the use of letters of credit has become a very important aspect of
international trade. The bank also acts on behalf of the buyer (holder
of letter of credit) by ensuring that the supplier will not be paid
until the bank receives a confirmation that the goods have been shipped.
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