Letter of credit types
A letter of credit is an agreement which is separate from the sales contract or other document having the effect of an agreement on which it is based.
There are the following basic types of documentary letters of credit
- A covered letter of credit – one secured by the payer's own funds.
- An uncovered letter of credit – one not secured by funds of the payer as per the moment of opening
- A confirmed letter of credit – implies adding payment obligation by a bank other than the issuing bank, where documents are provided meeting the letter of credit conditions.
Letter of credit transactions
PrivatBank performs the following operations involving international documentary letters of credit:
- Opening an import letter of credit – as instructed by the importing customer PrivatBank issues an international documentary letter of credit for the benefit of a foreign supplier company under the customer's foreign trade contract
- Advising a letter of credit – official notification by the bank as to opening, amending or cancelling a letter of credit opened by a foreign bank for the benefit of the exporting customer
- Executing a letter of credit – verification of documents under the letter of credit provided by the beneficiary (supplier of goods or services) followed by payment pricessing, provided the documents comply with the letter of credit conditions. In the event a letter of credit is not confirmed, payment is pricessed by the issuing bank on demand from the nominated bank.
In which cases is a letter of credit used?
In terms of foreign economic activity, companies are faced with a high level of risks having the following peculiarities:
- Difficulty of correct risk assessment due to territorial remoteness of the counterparty; difficulties associated with obtaining information about the counterparty and analysis of political and macroeconomic situation in its country
- Complexity of resolving economic disputes between the parties arising from the high cost of organising the arbitration process, different juridical personalities of parties to the contract, complexity of applying rulings of one State within the territory of another
- A great degree of foreign markets mobility caused by intense competition and fluctuations of market conditions
- A higher level of losses in case of a counterparty failure to fulfil obligations under penalties imposed by the State regulatory authorities for violation of currency laws
Letters of credit are applied exactly with the purpose of reducing the risks caused by the above factors.
Most often, a letter of credit is used for payment settlements in the following cases:
- Business partners have established a new, untried business relationship
- The seller is not confident about the buyer's solvency, while the buyer is not confident as to the seller's capability to deliver goods/perform work/provide services
- The contract subject implies large-scale projects or tailor-made products.
Benefits of using an international letter of credit
- A letter of credit provides reliable insurance against many risks faced by a company engaged in foreign economic activity
- You gain a very flexible settlement instrument that can be used for settlements in a variety of transactions
- The rules of using letters of credit have been defined by an authoritative international organisation and are recognized all around the world. It is convenient both for customers and banks, as each party to a transaction has clear understanding of its rights, obligations and standard requirements imposed on all parties to a transaction
- A letter of credit is useful as a short-term financing instrument.
What are the benefits of opening an international letter of credit in PrivatBank?
If you decide to open an international letter of credit with PrivatBank, our specialists will provide you with expert assistance regarding the following:
- Drafting contracts which provide for documentary forms of payment
- Developing individual settlement schemes using letters of credit
- Developing non-standard schemes of documentary operations, such as transferable or standby letters of credit.
Fees on operations with international letters of credit
|Letter of credit's issue or increase of its amount||0,2% |
(min 100 USD, max 2000 USD)
|Payment under letter of credit||0,15% |
(min 100 USD, max 1000 USD)
|Obligation fee under an uncovered transaction||min 2% per annum — covered by the pledge of rights on deposit; |
min 3% per annum — covered by the pledge of property or real estate;
min 3.5% per annum covered by other kind of pledge or uncovered.
(min USD 20 per month)
|Sending of payment documents between banks||Calculated as per fees of the courier service|
|Letter of credit advising / amount increase advising||0,15% |
(min 100 USD, max 500 USD)
|Examination of documents under a letter of credit||0,2% |
(min 100 USD, max 1000 USD)
|Acceptance of a letter of credit||With a coverage in PrivatBank - 0,15% (min 100 USD, max 500 USD) |
Without coverage – from 2% per annum (not less than 20 USD per month)
|Sending of payment documents between banks||Calculated as per fees of the courier service|
|Advising of amendment||50 USD|
Frequently asked questions
What is a letter of credit used for?
A documentary letter of credit is an instrument for settlements and risk mitigation widely used in the international trade.
A letter of credit for importer is:
- a guarantee of fulfillment of shipping obligations by the supplier;
- reliable receipt of duly executed shipping documents necessary to receive goods and for customs clearance;
- saving money in case the supplier fails to fulfill his/her obligations under the contract;
- a possibility to make payments by installments upon shipment/completion of a stage of works;
- an instrument for obtaining import financing.
A letter of credit for exporter is:
- receiving payment immediately upon shipment/submission of documents;
- availability of a bank guarantee of payment for the period from signing the contract to readiness for shipment of the goods of long-term manufacturing;
- possibility to offer the buyer a postponement of payment upon shipment against bank commitment under the letter of credit.
Which basic document governs the work with an international documentary letter of credit?
The basic document recognized by all countries, banks and participants of foreign economic activity is currently the Uniform Rules and Practices for Documentary Letters of Credit, ICC publication No. 600, version 2007 (UCP600).
The rules developed by the International Chamber of Commerce apply to all documentary letters of credit (including standby letters of credit, to the extent that the rules can be applied thereto) and are binding upon all stakeholders in the absence of explicit agreement on contrary. They are included in each documentary letter of credit by direct reference therein stating that this letter of credit is subject to the Uniform Rules and Customs for Documentary Letters of Credit.
What is a standby letter of credit?
A standby letter of credit is essentially a bank guarantee issued in the form of a letter of credit and the bank’s commitment to pay the guaranteed amount to the beneficiary under the letter of credit in case of a guarantee event (i.e. failure of an applicant of standby letter of credit to fulfill obligations towards the beneficiary).
What is the term of receiving proceeds under export letter of credit after documents are submitted?
The term of receiving proceeds depends on many conditions of a letter of credit (which bank is a nominated bank, which terms and other instructions on money transfer are specified by issuing bank, etc.):
- If the documents meet the conditions of a letter of credit, the proceeds can be received within 3-10 business days after the documents are submitted. This term may consist of the period of document verification, the period of receiving money from the issuing bank, the period of delivery of documents to the nominated bank (depending on which bank is a nominated bank).
- If the documents are found not to meet the conditions of a letter of credit, the payment requires the consent of the applicant, which significantly increases the payment period.
Which should be the list of documents in a letter of credit?
A letter of credit shall imply the list of documents sufficient for the seller to confirm fulfillment of terms and conditions of the contract.
The list of documents usually includes:
- commercial invoice;
- shipping document (testifying acceptance of the goods by the carrier for transportation);
- different certificates (origin, quality, third-party inspections, etc.);
- certificate of insurance.
The specific list depends on shipment terms, type of transport, requirements to documents for customs clearance of this type of goods. It is recommended to include in the list the documents issued by independent third-party organizations (carriers, chamber of commerce and industry, insurance company, inspection service) – this will reduce the probability of document forgery and gives additional confirmation of parameters of the goods shipped (quantity, quality, etc.).
It shall also specify:
- a number of document counterparts (originals, copies, photocopies);
- a party issuing the document;
- a consignee according to shipping document;
- availability of necessary seals;
- language of the documents.
Which will be our expenses under a letter of credit?
While working with a letter of credit, the banks shall charge certain fees for various transactions under the letter of credit (opening, advising, modifying, checking the documents, sending messages, etc.).
The total amount of banking fees under a letter of credit depends on many factors:
- availability of confirmation;
- number of banks involved in servicing the letter of credit; - an amount of the letter of credit, quantity of shipments (packages of documents provided under the letter of credit);
- number of changes in the letter of credit;
- conditions of distribution of fees among the applicant and the beneficiary.
What is needed to open a letter of credit?
To open a letter of credit with financial coverage it is necessary:
- to provide the bank with signed foreign economic contract;
- to fill in an application for opening a letter of credit;
- to transfer coverage in the amount of the letter of credit onto the coverage account;
- to pay fees for opening a letter of credit.
The procedure for opening a letter of credit without the financial coverage is more complicated, since it is necessary to provide documents for assessment of financial position, execution of a contract for opening a letter of credit and security contracts.
How to properly prepare the payment section of the contract, draft letter of credit?
In payment section of the contract, it is recommended that the conditions of the letter of credit (terms, participating banks, list of documents, etc.) be fully stated so that after opening there is no need to make changes in the letter of credit that takes some time and increases banking fees. It is sometimes advisable to include in the contract a schedule with a draft letter of credit (with all its conditions).
When does the 180-day period commence for settlements in the form of a letter of credit?
Opening a letter of credit constitutes the bank’s commitment to pay for properly executed documents, rather than the fact of money transfer outside Ukraine. Until payment, an amount of money transferred to the bank as coverage for the letter of credit is kept on your special coverage account. The report of legally established payment period (180 days) commences on the date of payment by the issuing bank under the letter of credit, rather than on the date of issuing the letter of credit.
What is advising?
Advising means sending an official notification letter to another party to the letter of credit deal regarding performance of certain transaction (issue, modification, cancellation, etc.).
What kind of checking is implied in the “Checking of documents” fee?
This implies the bank’s checking of documents provided by the seller and confirming shipment of goods, their quantity, quality and other parameters for compliance with all conditions of the letter of credit and the Uniform Customs and Practice for Documentary Letters of Credit (UCP600) requirements. In the event of non-compliance with the conditions of the letter of credit or other discrepancies, the bank is entitled to refuse payment under the documents. A fee for checking of documents is charged for letters of credit received by PrivatBank (export letters of credit), if PrivatBank is a nominated bank.
What is a “commitment fee”?
This is a fee charged as remuneration to the bank for risks and assumed commitment (i.e. commitment to pay under the letter of credit) not covered by the customer's financial funds. As a rule, this fee is expressed in percent per annum.