Detailed explanation of letter of credit payment methods in international trade

1. Definition of letter of credit and its business process

Letter of Credit (L/C) is a bank credit instrument that is issued by a bank (usually an overseas issuing bank) to the beneficiary (usually the seller) at the request of the applicant. A commitment to pay under the terms of a letter of credit.

Overview of letter of credit business process

1. Issue a letter of credit: The applicant fills out the application form for issuance of letter of credit according to the contract and submits a deposit or provides a guarantee, and asks the issuing bank to issue a letter of credit;
2. Notification: The issuing bank sends the letter of credit to the advising bank at the exporter’s location, which will then hand it over to the beneficiary after verifying that it is correct;
3. Audit: After confirming that the contents of the letter of credit are consistent with the contract, the beneficiary will ship the goods, prepare documents and issue a draft as required;
4. Negotiation: The beneficiary sends the documents to the negotiating bank, and the negotiating bank advances the payment to the beneficiary after reviewing them correctly;
5. Claim: The negotiating bank sends the bill of exchange and shipping documents to the issuing bank or its designated paying bank;
6. Payment: The issuing bank makes payment to the negotiating bank after verifying that the documents are correct;
7. Redemption order: The issuing bank notifies the applicant to pay in exchange for shipping documents;
8. Prepare documents: The bank delivers documents to the applicant after receiving the payment.

2. Business characteristics of letters of credit

Letter of credit has three distinctive characteristics: it is bank credit, a self-sufficient document and a document purchase and sale.

• Bank credit: As the first payer, the issuing bank guarantees payment based on its own creditworthiness;
• Self-contained document: The letter of credit is independent of the sales contract and is governed only by its own terms;
• Document sales: The bank only pays based on documents and does not care about the actual condition of the goods.

3. The role of letter of credit payment method

Impact on exporters

• Payment Security: Ensure bank payment by submitting documents that comply with the terms of the letter of credit;
• Financing convenience: You can apply for a package loan from the bank with a letter of credit before delivery, or apply for a money transfer after delivery.

Impact on importers

• Goods quality control: Ensure receipt of goods on time, quality and quantity by setting letter of credit terms;
• Financial Flexibility: Reduce capital tied up and obtain financing support through usance letters of credit.

Implications for banks

• Risk diversification: Reduce risk by requiring a deposit or collateral;
• Source of income: Obtain handling fees by providing various services.

To sum up, letters of credit, as an important international trade payment tool, play an indispensable role in promoting the safety and efficiency of cross-border transactions.