What are the Different Types of Letters of Credit?

There are basically two types of letters of credit. These types are commercial letters of credit and secondary letters of credit. The commercial letters of credit are a primary payment method, while the standby letters of credit are a more secondary procedure for payment.

Commercial Letter of Credit

A letter of credit is basically a promise made by the bank that the seller of any goods that a person buys will get his money for the goods. This is commonly used in foreign trade. It can also be applicable when a person buys a car and gets a loan through the bank. The bank pays the seller, therefore leaving the buyer to pay the bank back for the car.

What Does the Seller Do?

The seller is obligated to provide the shipping information, when dealing with goods, that prove that they will be shipped to the buyer. The seller also has to verify that the good and services being sold meet the terms stated in the original contract before he can receive payment. That way, the seller does not get cheated out of his money, and the buyer does not get cheated out of his goods.

The Issuing Bank

The bank issuing the trade between the buyer and the seller has the role of paying the seller and being reimbursed by the buyer. They are also required to look over any complaints from either party, and, if they comply with the terms and conditions made in the letter of credit, to confront the faulty party concerning the other’s complaints.

Elements of a Letter of Credit

A letter of credit basically states that the issuing bank is willing to make payment of a specified amount of money to a seller, or the beneficiary, on behalf of the buyer. It is also stated that the beneficiary will provide documents that represent the supply of goods, or the items that the beneficiary is selling. This gets in writing the promise that the bank will pay for the goods that the beneficiary promises to give.

It is also stated in a letter of credit the specified time limits that are given to both parties. One to provide the goods, and one to make the payment. It also says that documents must be parallel or in agreement with the terms stated in the letter of credit, and that these documents are to be presented at a specific time and place. After all of this is taken care of, the beneficiary is responsible only for presenting the goods to the buyer, then it is up to the buyer to reimburse the bank.

Standby Letter of Credit

A standby letter of credit is basically the same thing, but not as significant. It is basically a letter that guarantees the performance of the customer. It’s basically just issued by banks to insure that demands are met by both parties, and that all terms of the contract are met.