Letter of credit types
A letter of credit is a contract stipulating an obligation of the issuing bank according to which the bank shall, on behalf of the customer (the letter of credit applicant) or on its own behalf, make payment to the supplier of goods or services, and shall nominate another (the nominated) bank to effect such payment against documents which meet the letter of credit conditions.
A letter of credit is an agreement separate from the sales contract or other document having the effect of an agreement on which it is based.
- A covered (confirmed) letter of credit - is one for payment under which the payer funds in the full amount are booked in advance on a separate account with the issuing bank or the nominated bank
- Uncovered (guaranteed) letter of credit - payment for which (if payer is temporarily out of funds) is guaranteed by the issuing bank for a bank loan.
- A revocable letter of credit - may be amended or cancelled by the issuing bank at any time without prior notice to the payee (supplier of goods or services).
- An irrevocable letter of credit - is one which may be cancelled or terms of which can be amended only with the consent of the payee, to whose benefit the letter of credit was opened.
Letter of credit transactions
PrivatBank performs the following transactions involving documentary letters of credits in the national currency of Ukraine:
- Opening a letter of credit – iissue of an obligation by the issuing bank according to instructions from the applicant (a customer of the bank) under which the bank shall, on behalf of the applicant or on its own behalf, make a payment to a supplier of goods or services, or nominate another (the nominated) bank to effect such payment against documents which meet the conditions of the letter of credit.
- Confirmation of a letter of credit – issue of an additional obligation on paying a letter of credit opened by another bank.
- Advising a letter of credit – official notification by the bank as to opening, amending or cancelling a letter of credit, furnished in hard copy or by electronic means of communication.
- Executing a letter of credit – verification of documents under the letter of credit provided by the payee (supplier of goods or services), followed by advising the issuing bank on execution of the letter of credit (i.e., on the need for transferring funds, if the payment is to be effected by the issuing bank), provided the documents comply with the letter of credit conditions (if not, letter of credit execution is not effected or shall be effected subject to the bank obtaining the consent of the applicant as to payment under the documents with discrepancies).
In which cases is a letter of credit used?
In terms of delivering goods and services risks may appear at different stages varying from raw material acquisition, manufacture and storage of goods to timely delivery/provision of services and payment. Use of a letter of credit as a payment instrument in such situations allows for protection of the interests of both the seller and buyer.
The most important issue for the buyer is properly-implemented delivery of goods/provision of services/work, while for the seller it is timely receipt of the payment. The associated risks are exacerbated in difficult economic situations, when it is onerous for the buyer to evaluate the seller's reliability. Naturally, the reverse holds true for the seller: while executing a sale the seller takes risks associated both with transport of the goods and with non-payment.
Most often, a letter of credit is used for settlements in the following cases:
- Business partners have established new, untested business relationships
- The seller is unsure about the buyer solvency, and the buyer is unsure about the seller's ability to deliver the goods/do work/provide services
- Contracts are subject to large-scale projects or products made by special order.
A letter of credit is helpful in the following cases:
- There is a need to obtain a guarantee of performing obligations under the contract by the other party
- The parties bargain for a large amount
- You start working with new partners in terms of an as-yet-untried business relationship
- There is a need for strict control of a range of conditions and obligations of the parties to each other
Interest on your money in the coverage account which is accrued as on a current deposit An uncovered letter of credit is issued in the event you are using bank credit funds to secure the transaction. In this case, collateralisation is made with funds in deposit accounts, movable or immovable property of a legal entity or by an individual serving as collateral.
- Minimum bank fees, since you are not using credit funds interest
- Interest on your money in the coverage account which is accrued as on a current deposit
- Formal registration term – not exceeding 2 days.
An uncovered letter of credit is issued in case you are using bank credit funds to secure the transaction. In this case, collateralization is made with funds in deposit accounts, movable or immovable property of a legal entity or an individual serving as collateral.
- Monetary funds are not diverted from circulation
- Competitive fees
- Formal registration term - not exceeding 1 week.
What are the benefits of opening a letter of credit in PrivatBank?
If you decide to open a letter of credit with PrivatBank, our specialists will provide you with expert assistance regarding the following:
- Drafting contracts providing for documentary forms of paymentdeveloping
- Developing individual settlement schemes using letters of credit
- Design shipping documents
- Development of non-standard documentary operations, such as: Transfers (transferable), revolving or standby letters of credit
To open a letter of credit:
Step 1. Agree the letter of credit settlement scheme under the contract with your counterparty.
Step 2. Register documents at PrivatBank Regional Directorate:
1) on documentary credit operation:
- for covered letters of credit
- only your application
- for uncovered letters of credit
- your application, uncovered letter of credit opening agreement, collateral agreement
2) on identification (in the event you are not yet our customer).
Step 3. Pay the fee.
For consultancy on documentary operations for settlements in the territory of Ukraine put your question to the Head Office experts by emailing to firstname.lastname@example.org
Frequently asked questions
- What documents should I submit for opening a letter of credit? If the customer has not been identified by the bank before, then for opening both covered and uncovered letters of credit you should submit identification documents (constituent documents, state registration certificate, documents certifying the representative's authority, etc.)Also the following documents are required:1) for uncovered letters of credit:- financial statements (Forms 1 and 2, flow of funds in the accounts, a statement or a protocol of the supreme management body, etc.)- documents for opening a letter of credit (the business contract, application for opening an uncovered letter of credit).2) for covered letters of credit - documents for opening a letter of credit (the business contract, application for opening a covered letter of credit).
- What should the list of documents in the letter of credit comprise? The letter of credit should have a list of documents sufficient to confirm performance of the contract obligations by the seller. Typically, the list of documents comprises the following:- commercial invoice- transport document (as evidence of goods acceptance by the carrier for transportation)- various certificates (regarding goods origin, quality, inspection by third parties, etc.)- insurance policy. Contents of a list depend on terms of delivery, type of transport, requirements to documents for customs clearance of specific type of goods.It is recommended that the list includes documents issued by independent third parties (carriers, chambers of commerce and industry, insurance companies, inspectorates), which reduces the risk of documentation forging and provides for additional confirmation of parameters of the goods shipped (quantity, quality, etc.).
- What is a transferable letter of credit? A transferable letter of credit is a special transferable form of a documentary letter of credit opened for the benefit of the intermediate seller (the first beneficiary). The transferable form allows the intermediate seller to apply to the nominated bank with request of transferring the letter of credit in whole or in part to the supplier (the second beneficiary). In case the intermediate seller purchases products from multiple suppliers, it has the right to instruct the nominated bank to transfer the letter of credit by parts to each of the suppliers.
- The remainder not transferred is the intermediate seller's profit.What is a revolving letter of credit? A revolving letter of credit is opened not for the whole amount of payments, but for a part thereof while being subject to automatic replenishment as it is being used within the established total limit and validity term taking into account payments made for subsequent batches of goods delivered. Such a letter of credit is opened in case of regular time-stretched deliveries with the purpose of reducing the sum specified therein.
- What is a standby letter of credit? A standby letter of credit is a guarantee issued in the form of a letter of credit. A standby letter of credit can be used in case the law of your contractor country does not permit issuance of guarantees.Standby letters of credit are governed by the "Uniform Customs and Practice for Documentary Credits" which eliminates problems associated with the fact that guarantees are usually governed by the laws of a specific country (that of the guarantor bank).
- What is an advising bank? The advising bank is the bank officially advising the seller as to opening of a letter of credit for the benefit of the latter and serving as the correspondent for transferring letter of credit conditions, documents or amendments thereto. The advising bank is obliged to establish the authenticity of the letter of credit received and transfer it as intended without delay.
- What is a nominated bank? The nominated bank (specified when issuing a letter of credit) performs execution of a letter of credit, i.e. verification of documents for their compliance with the letter of credit conditions. The nominated bank has no obligation to effect the payment (unless it grants the letter of credit acceptance), but pays after The nominated bank (specified when issuing a letter of credit) performs execution of a letter of credit, i.e. verification of documents for their compliance with the letter of credit conditions. The nominated bank has no obligation to effect the payment (unless it grants the letter of credit acceptance), but pays after the issuing bank has provided respective funds.the issuing bank has provided respective funds.
- To which bank should the documents for payment under the letter of credit be provided? The letter of credit documents should be submitted to the nominated bank before the letter of credit expiry date. As a rule, the beneficiary submits documents to the advising bank (through which the letter of credit is received), even in case of the latter not being the nominated bank. Address for provision of documents is specified in the bank letter regarding advising the letter of credit.The advising bank further transfers the documents to the nominated bank, thus confirming those have been provided by the beneficiary and supplies instructions for the revenue transfer.
- How to correctly draw up payment section of the contract and to draft a letter of credit? It is recommended that the payment section of the contract specifies in maximum detail the letter of credit conditions (terms, participating banks, list of documents, etc.), so that after the opening there is no need to introduce amendments to the letter of credit, which is rather time-consuming and also increases the bank fees. In certain cases it is advisable to include an appendix to the contract containing a draft letter of credit with all conditions.
- What if the letter of credit contains misprints (e.g., in names, addresses)? Typically, this is regarded as discrepancy and leads to the nominated bank contacting the applicant with request to provide instructions on further processing the documents containing discrepancies (such as: effect payment regardless of discrepancies, return with payment denied to the beneficiary, keep on hold until further instructions from the applicant), or in case the bank had been already provided with respective instructions from the applicant in respect of documents with discrepancies, the bank should act accordingly. Sometimes a letter of credit may contain the condition stipulating payment regardless of misprints, but such action remains at discretion of the nominated bank, since there is no common approach or a uniform list of "misprints in letters of credit".
What are the key regulatory documents the Bank is governed by when working with letters of credit?
1. Resolution No. 22 "On Approval of the Instruction on non-cash payments in Ukraine in the national currency" dated 21.04.2004 by the NBU, as amended and supplemented.
2. Uniform Customs and Practice for Documentary Credits, 2007 revision, International Chamber of Commerce publication No. 600.
- What is advising? Advising implies sending an official notification letter to another party to the letter of credit deal regarding performance of a certain operation (issue, amending, cancellation, etc.).
- What kind of verification is implied under the This implies bank's verification of documents provided by the beneficiary under the letter of credit, i.e. whether the documents provided relate to the goods for payment of which the letter of credit is issued. To this end, the bank compares the data on goods in the shipping documents, invoice registers and other documents submitted by the beneficiary to the data specified in the letter of credit application.
- In case of detecting discrepancies, the bank has the right to refuse payment.What is a This implies a fee charged as remuneration to the bank for the risk and commitment provided (i.e. commitment to pay under the letter of credit) with the commitment not covered by the customer's financial funds. As a rule, this fee is expressed in percent per annum.
- What is implied by sending messages to other banks? Sending messages to other banks implies the service of sending messages by special authenticated channels (NBU mail, SWIFT or TELEX). Such messages include the following: letter of credit opening notifications, reports on the results of verification of documents, customer instructions, etc.
- What do the preliminary activities imply? The preliminary activities may include drafting of a letter of credit, advising the customer on drawing up the payment section of the contract, etc. The preliminary activities may include drafting of a letter of credit, advising the customer on drawing up the payment section of the contract, etc.
What is a payment under letter of credit?
Payment under letter of credit implies payment effected on demand to the benefit of the beneficiary at the expense of the Bank. These payments are effected subject to decision of the bank legal department as to eligibility of such a demand.
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