Letter of credit

A letter of credit is opened by the buyer’s bank at the buyer’s request. The bank undertakes to pay the seller if the seller presents the documents listed in the terms on time. The bank checks only the documents, not the goods themselves. In the Russian Civil Code, settlements by letter of credit are covered in Chapter 46. International letters of credit are usually subject to the rules of the International Chamber of Commerce, UCP 600.

Who is involved

• Applicant: the buyer who asks for the letter of credit to be opened.
• Issuing bank: opens the letter of credit and pays.
• Advising bank: notifies the seller that the letter of credit has been opened, checks its authenticity and passes on the terms.
• Confirming bank: adds its own undertaking to pay. Not always present.
• Beneficiary: the seller who receives the money.

How a letter of credit payment works

1. The parties write payment by letter of credit into the contract: the amount, the validity period and the list of documents.
2. The buyer instructs the issuing bank to open the letter of credit. The buyer deposits the cover or uses a bank loan.
3. The seller receives the terms through the advising bank and checks whether it can meet them.
4. The seller ships the goods and collects the documents: the invoice, the bill of lading or another transport document, certificates.
5. The bank checks the documents against the terms. If they fully match, the seller gets the money and the buyer gets the documents for the goods.

If even one detail does not match, such as the shipment date or the description of the goods, the bank is entitled to refuse payment.

Types

Covered and uncovered. Confirmed, when a second bank also undertakes to pay. Revolving, for regular deliveries. Transferable, when the seller transfers the right to the money to its own supplier. Standby, which works like a bank guarantee. Under UCP 600, a letter of credit is irrevocable.

Pros and cons

The seller can be confident of payment, and the buyer pays only for goods that have been shipped. In return, a letter of credit costs more than a direct transfer, takes a long time to open and requires a lot of paperwork. The terms must be written so that the seller can meet them: unrealistic deadlines and unnecessary documents lead to discrepancies.

For companies from Russia

A letter of credit works only if the parties’ banks are ready to work with each other. Foreign banks do not open, confirm and honor letters of credit for Russian companies in every country, and processing takes longer. That is why payment by transfer through an agent is more common.

A broker does not open letters of credit. At VEDmost, the agent, the exchange rate and the fee are known before the roubles are debited, and if you need a guarantee, on request the roubles wait for execution in a special escrow account at a Russian bank, for an additional fee. How this works is described on the Payment protection page. How the routes through a bank, a single agent and a broker differ: broker, agent or bank.