1) Meaning
A letter of credit (L/C) is a written promise by a bank (overseas issuing bank) to pay the beneficiary (Chinese seller) or its designated person based on the specified documents, at the request and instruction of the applicant (overseas buyer) or in its own name, under the conditions consistent with the terms of the letter of credit. In short, a letter of credit is a conditional bank payment commitment.
2) Business process of letter of credit
The process of using a letter of credit:
① The applicant fills in the letter of credit application form according to the contract and pays a deposit or provides other guarantees, and asks the issuing bank to issue the letter of credit.
② Based on the content of the application, the issuing bank issues a letter of credit to the beneficiary and sends it to the notifying bank in the exporter’s location.
③ After the notifying bank verifies that the seal is correct, it will hand over the letter of credit to the beneficiary.
④ After the beneficiary verifies that the contents of the letter of credit are consistent with the contract provisions, it shall ship the goods, prepare the documents and issue the bill of exchange in accordance with the provisions of the letter of credit, and send it to the negotiating bank for negotiation within the validity period of the letter of credit.
⑤ After the negotiating bank verifies the documents according to the terms of the letter of credit and finds that they are correct, it advances the payment to the beneficiary.
⑥ The negotiating bank sends the bill of exchange and shipping documents to the issuing bank or seeks compensation from its specific paying bank.
⑦ After the issuing bank verifies that the documents are correct, it pays the negotiating bank.
⑧ The issuing bank notifies the issuer to pay for the documents.
⑨ After receiving the payment, the bank delivers the documents to the issuer.
3) Business characteristics of letter of credit
(1) Letter of credit is a payment guarantee made by the issuing bank with its own credit.
In the letter of credit business, the issuing bank bears the primary payment responsibility, so the letter of credit belongs to the settlement method of bank credit. If the terms of the letter of credit are met, the issuing bank must pay even if the overseas buyer is unable to pay.
(2) The letter of credit is a self-sufficient document.
Although the letter of credit is based on the sales contract, once it is issued, it becomes a contract independent of the sales contract. All parties to the letter of credit business are only bound by the terms of the letter of credit. Whether the buyer and seller of the trade contract breach the contract has nothing to do with whether the bank cancels its payment commitment.
(3) The letter of credit is a document trading business.
The bank pays based on the documents and does not care about the quality of the goods. The bank is not a party to the sales contract. It only requires that the terms of the documents submitted by the beneficiary appear to be consistent with the terms of the letter of credit. It is not responsible for the actual condition of the goods, whether they are lost on the way, whether they can reach the destination, etc. The bank is not responsible for the authenticity of the documents or the loss of the documents during the mailing process.
Therefore, the condition for the overseas issuing bank to pay is that the beneficiary submits the documents specified in the letter of credit to achieve “document conformity” and “document consistency”. Therefore, when using letters of credit for payment, it is crucial for the seller to review the terms of the letter of credit and the documents submitted. Inexperienced sellers can use Alibaba International Station’s “One-touch Super Letter of Credit” service to outsource the review of letters of credit, document preparation, document review, document delivery, and foreign exchange collection to One-touch.