Letters of credit
Letters of credit help hedge the risks related to foreign trade
Use letters of credit as a flexible means of financing
- Release funds from deadlines for commercial transactions
- Manage trade-related delivery and payment risks both for imports and exports
- Request a consultation and we will find the best solution for your particular transaction
What is a letter of credit?
A letter of credit is a payment method used in international trade where the buyer’s bank issues an obligation in their name to pay the seller for the product or service supplied when the seller fulfils their contractual obligation to deliver the goods or to provide a service and verifies it by presenting the documents specified in the letter of credit.
Advantages for the buyer
- Safer than an advance.
- The bank will only pay if the documents submitted by the seller satisfy the conditions agreed upon in the letter of credit.
- A letter can be used with a payment deadline that allows better management of the company’s cash flows.
Advantages for the seller
- Payments are guaranteed by the bank, not the buyer.
- The seller is assured that the buyer cannot change the conditions of a letter of credit without the seller’s consent.
- A letter of credit with a payment deadline allows a payment deadline to be offered to the buyer, while the seller’s bank may, if they want, confirm the letter of credit and discount a payment term to the seller, thereby improving the liquidity of both the buyer and the seller.
The buyer and the seller wish to use a letter of credit as the means of payment. The buyer approaches their bank to apply for a limit for a letter of credit. If the answer is positive, the bank opens a letter of credit in favour of the seller.
The seller can now be assured that when they dispatch the goods or provide a service and present the documents required with the letter of credit, the buyer’s bank will pay them for the transaction.
The seller sends the documents through their bank to the buyer’s bank, who verifies, before making the payment, whether they comply with the terms and conditions of the letter of credit. The bank only pays when the terms and conditions of the letter of credit have been fulfilled.
Types of letters of credit
An import letter of credit is used for buying goods and an export letter of credit is used for selling goods. At the request of the buyer, the bank opens a letter of credit in favour of the seller. With the letter of credit, the bank guarantees the seller payment if the latter dispatches the goods and forwards the documents concerning the consignment of the goods to the bank. On the basis of the documents the bank checks that all terms and conditions of the letter of credit have been fulfilled. Only after having performed conformity control on the documents, shall the bank make payment to the seller. A letter of credit is an alternative to an advance payment. If payment terms, as per the terms and conditions of a letter of credit, are used upon payment, it is possible to apply for financing of the payment terms from your bank.
A standby letter of guarantee is a guarantee in the form of a letter of credit. A standby letter of credit is not paid until the buyer has paid the seller for the goods in accordance with the conditions of the agreement. If the buyer fails to fulfil its payment obligation, the seller shall be entitled to present the goods and accompanying documents to the buyer’s bank under the standby letter of credit and demand payment of the outstanding amount on the basis thereof. LHV Pank treats a standby letter of credit as a payment guarantee.
A transferrable letter of credit is a means of payment, above all, for intermediaries of goods, who have no guarantees and funds to pay for the mediated goods or to guarantee payment. In such a case, the bank of the buyer of the goods opens the letter of credit in favour of the intermediary, who in turn transfers the letter of credit in favour of the seller through its own bank. The rules of transferrable letters of credit are strictly regulated internationally; accordingly, it is not possible to use this means of payment for all trade deals.