How to Write a Letter of Credit

“Letter of credit is a letter issued by an importer’s bank guaranteeing payment upon presentation of specified trade documents (invoice, bill of lading, inspection and insurance certificates)” (globalEDGE, 2011). GlobalEDGE defines a type of letter of credit, the Back to Back Letter of Credit, as “an arrangement in which one irrevocable letter of credit serves as the collateral for another; the advising bank of the first letter of credit becomes the issuing bank of the second letter of credit” (globalEDGE, 2011).

Wachovia uses several types of letters of credit. For example, an acceptance credit which is a letter of credit which provides a means of payment done by a time draft. Acceptance and payment is guaranteed by the bank through issuing the credit only if the documents presented under the credit conform to the letter of credit. The merit of acceptance credits is that “the beneficiary (seller) can receive immediate payment by having the draft discounted, while the applicants (buyer’s) obligation to pay is deferred until maturity of the draft”.

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The following are other examples of letters of credit used by Wachovia: confirmed, commercial, Advised, clean, negotiable, Red Clause, restricted, standby, straight and transferable. Each type of letter of credit has a different function. For instance the letter of credit, confirmed, is issued by an importer’s bank on behalf of an exporter and another bank in the exporter country commits itself to honor drafts and documents as per the letter of credit. Secondly, the letter of credit, commercial, is a document written and issued by the bank at the request of their customer to a specified beneficiary by whom the bank substitutes its own credit and that of its customer. Thirdly, letter of credit, advised, is a letter of credit which undertakes the payment of an issuing bank and is transmitted through the seller’s bank for authentication only. Fourthly, letter of credit, clean, is a letter of credit available to the beneficiary when he presents a draft or receipt only (Wachovia, 2011).

Fifthly, the letter of credit, negotiable, is for a beneficiary by negotiation of documents with the bank. The letter of credit of Red Clause is used for advanced drawings as per the beneficiaries’ written undertaking to present stipulated documents at a future date. Letter of credit, restricted, is a letter of credit available to a beneficiary by negotiation of documents with a particular bank named in the credit. Letter of credit, straight, is a letter of credit available for a beneficiary in the event of a presentation of documents to the issuing bank. Letter of credit, Standby, is issued when there’s a default by the bank’s customer on a contractual agreement between him and the beneficiary of the letter of credit and the customer outside the letter of credit itself. Finally, letter of credit, transferable, is a letter of credit that allows the beneficiary to transfer all or part of the letter of credit to another party, allowing them to present documents for payment (Wachovia, 2011).

According to National Australia Bank, the letters of credit are methods used for payment mostly by exporters (sellers) and importers (buyers) to settle payment. Provided that all the conditions of the letter of credit are met, the bank issues import letters of credit for its customers therefore enhancing commitment to pay the exporter. The various types of letters of credit provided by the NAB include the irrevocable, revocable, sight or term (documentary), confirmed, standby and transferable (NAB, 2011).

“All letters of credit issued by NAB, are irrevocable and subject to uniform customs and practice for documentary credit. Exporters are allowed to request for a letter of credit when they are unsure of importers ability to pay” (NAB, 2011). The issuing banks creditworthiness is substituted for that of the importer and security of the exporter is paramount. Consequently, importers may request letter of credit payment terms when they need goods by a certain date or they require specific documentation for importation or delivery” (NAB, 2011).

CIBC offers an import letter of credit (import documentary credit) to importers so that they can provide their suppliers with CIBC’s undertaking that they will receive payment upon receipt of documentation within a specific timeframe. As specified in the import documentary credit (import letter of credit). The import letter of credit has benefits such as reduced payment risk, improved operational efficiency and greater control over trade activities (CIBC, 2011).

Export letter of credit (export documentary credit) provides an exporter with the buyer’s bank’s undertaking that the exporter will be paid provided they ship the goods and present the required documents within the agreed timeframe. The key benefits of the export documentary credit are reduced payment risks, improved operational efficiency and greater control over your trade activities (CIBC, 2011).

Other services of letters of credit offered by CIBC include; transferable where it used when the beneficiary is the middleman or agent of the import letter of credit. The merits of using transferable letter of credit includes improved revenue, facilitates large scale business and easy access to trade finance expertise. Standby letter of credit is a letter of credit which allows payment of a specific amount of money in the event that the beneficiary or a third party does not meet specific financial or performance obligations. The advantages of using this letter of credit are improved cash flows, improved convenience and access to trade finance expertise (CIBC, 2011).