A letter of credit is a conditional obligation of the bank to make payments to individuals and organizations at the client's request at his expense within the amount and conditions that were agreed in advance.

A letter of credit is a transaction that is carried out between one or more financial institutions in a non-cash form. The basis for the operation is a specialized application, which is drawn up in the prescribed form and submitted by the buyer in favor of the supplier of the service or product. Participating parties can only be individuals, only legal entities or both individuals and legal entities.

What is a letter of credit in plain language? This is a very convenient form of interaction, which, however, is rarely used due to its complexity. Letter of credit is a form of settlement that guarantees payment for the supplier and fulfillment of the terms of the contract for the buyer. After the delivery of the product or the provision of the service, the bank pays the cost to the seller. The buyer, in turn, returns the funds to the bank, including interest.

Letter of credit settlement can be used not only in domestic trade, but also in foreign trade. When applied in the field of international trade, the procedure is governed by the Uniform Rules and Customs for Documentary Credit, publication of the International Chamber of Commerce No. 600, as amended in 2007.

Very often, a letter of credit is compared with a bank guarantee and factoring, however, these concepts are similar only at first glance. More details about the letter of credit - in the video below.

What is a letter of credit: features of banking services

The use of this form of payments began to develop in Soviet times. Bashkir Soda Company OJSC, which produces caustic soda and is on the verge of bankruptcy, switched to a letter of credit form of interaction with customers in order to continue its activities.

The funds were credited only after the company provided the bank with documents confirming the fulfillment of the terms of the contract, which were carefully checked. In this example, it can be seen that the letter of credit provided reassurance to both parties.

Settlement scheme

Settlement participants:

• a bank client who uses the service of opening a letter of credit;
• the issuing bank, or an organization that undertakes the obligation to open;
• executing bank - an organization making payments;
• an individual or legal entity in whose favor the letter of credit was opened.

The L / C scheme is pretty simple. It includes several mandatory steps:

1. At the initial stage, the buyer and the seller conclude an agreement between themselves for the supply of products or the provision of services.
2. The buyer applies to the bank, where he draws up an application for opening a letter of credit. The application is drawn up in the prescribed form.
3. The issuing bank notifies the bank in which the seller is serviced about the opening in his name.
4. The executing bank, in turn, notifies the seller.
5. The seller delivers a product or provides a service.
6. The seller notifies the executing bank that its obligations to the buyer have been fulfilled.
7. The executing bank makes the payment in favor of the seller in the agreed amount.
8. The executing bank shall documentarily notify the issuing bank of the payment to the seller.
9. The issuing bank, in turn, compensates for the payment of the executing bank.
10. Settlement documents are transferred to the buyer.
11. The buyer examines the documentation and signs an agreement for the payment of funds to the issuing bank.
12. Withdrawing funds from the buyer's account and crediting them to the bank.

The service is provided by the issuing bank on the basis of an application, drawing up an agreement on the form 0401063. This document guarantees the supplier that the goods or service will be paid for within the agreed time frame. The buyer's funds may not be provided at the end of the algorithm, they may be pre-deposited.

Agreement: drafting, conditions, form

A competently drawn up contract includes the following points:

• names of banks, cooperating organizations or full name and passport data of individuals;
• the amount of the letter of credit for the services or products provided;
• letter of credit - non-cash or the use of cash is not allowed;
• ways of notifying the parties to the agreement;
• the period during which the contract is valid. During this period, the terms of the agreement between the buyer and the seller must be fulfilled, payment made, all documents submitted;
• responsibility of the parties that will result from failure to fulfill obligations in accordance with this legislation.

The standard list of conditions specified above may be supplemented with additions regarding the procedure for making settlements. For example, not a full payment, but a fractional payment may be used. A letter of credit can be issued for payment to one individual or organization. However, the person through whose funds the payment will be made can be changed, if it is specified in the contract - the possibility of acceptance.

Types of letter of credit

When using this form of mutual settlements, a very important point is the selection of a suitable type of letter of credit. Any varieties are opened by financial institutions, while the type is indicated in the agreement. The types are spelled out in the Regulation of the Central Bank of the Russian Federation:

• By the type of settlement of financial institutions - covered and uncovered. In the first case, the issuing bank makes cash payments at the expense of its client's funds in favor of the executing bank for the entire duration of the agreement. In the second, the transfer of funds from one financial institution to another is not performed. At the same time, the executing bank gets the opportunity to write off funds within the agreed amount, after which this is compensated by the issuing bank.
• If possible, revocation - revocable and irrevocable. In the first case, the form of interaction can be changed or rejected without prior agreement with the opposite side, in the second - only with agreement.
• Confirmed or unconfirmed. In the first case, payments are possible without agreement with the issuing bank and receiving funds from it.

Legal regulation

The letter of credit agreement is clearly regulated by this legislation of the Russian Federation and is drawn up according to the rules prescribed in the regulatory documents of the Central Bank of the Russian Federation in the event that the agreement is drawn up between domestic organizations or residents of the Russian Federation.

The following normative acts are taken into account without fail:

• Articles of the Civil Code of the Russian Federation from 867 to 873, which regulate non-cash payments under a letter of credit;
• "Regulations on the implementation of non-cash transfers by individuals in the Russian Federation", adopted by the Central Bank on 01.04.2003;
• "Regulations on cashless payments" established by the Central Bank of Russia on 03.10.2012.

It should be borne in mind that the organization in favor of which the letter of credit is drawn up has the right to refuse this form of payment.

An important point in a sale and purchase transaction is the settlement method between the parties. To avoid possible risks, the seller and the buyer often turn to the letter of credit settlement system. At the same time, it does not matter whether the payment for own funds or mortgage funds takes place.

What is a letter of credit in simple words

A letter of credit is another method of non-cash settlement that can be used by the parties to a purchase and sale agreement, supply, etc. In simple words, a letter of credit is a financial instrument offered by banks related to the control of settlement between the seller and the buyer. The bank acts as a guarantor of a fair transaction, issues funds only on condition that the contractual obligations between the participants are observed. For the period of the transaction, the money is kept in a special bank account.

Accreditation scheme

Two credit organizations can participate in such transactions: the issuing bank and the executing bank. The issuing bank opens a letter of credit on the basis of an application from its client and undertakes to make a transfer in favor of its counterparty under the agreement. For this, an order is sent to the executing bank. Such an order is possible only after documentary confirmation of the fulfillment of all agreements on the transaction. The transfer takes place on the basis of the order of the Bank's client to transfer funds to a third party. Service advantages:

1. Cashless payment. There is no need to carry a large amount with you, to recount and check for authenticity.
2. The operation is safe. The parties risk nothing. The seller is guaranteed the transfer of the full amount of funds after the fulfillment of the terms of the contract. For the buyer, this is an opportunity to buy an apartment or other real estate and not lose money. Also, return the funds in full in case of violation of the terms by the seller or termination of the agreement.

For the seller, a documentary credit is an additional guarantee from the bank in the receipt of funds under the agreement as soon as it fulfills all the conditions. And the buyer is sure that the money will be transferred after the submission of the documents named by him in the application.

Required actions to apply the service

1. The parties to the transaction conclude an agreement, where all the conditions and circumstances of the fulfillment of obligations are prescribed in detail.
2. An agreement on settlement with a letter of credit is signed at the bank. Personal and passport data of both parties must be indicated. Terms of payment of funds.
3. After signing the bank agreement, the buyer draws up an application for a letter of credit.
4. After checking the documents, the bank employee opens an account in the name of the buyer. Funds for real estate, goods, services are credited to it in full. Subsequently, they will be transferred to the correspondent's account, bank card or issued in cash.
5. The transfer to the seller will take place after the completion of the transaction. He must submit to the bank documents confirming the registration of the sale and purchase agreement and the transfer of ownership.

The letter of credit agreement fully regulates the relations between the participants. It must contain all the necessary information for the transaction:

• data of the buyer and the seller. For individuals, these are passport data, full name, address of residence. With the participation of the organization, the name, TIN, address, account details are indicated;
• guaranteed amount of funds deposited in a bank account;
• period of fulfillment of obligations;
• the size of the bank commission and the cost of additional services;
• the procedure for transferring money after meeting the conditions and submitting documents;
• the order of actions in case of unforeseen circumstances, non-payment of debts, etc.;
• rights and obligations of the parties to the transaction.

After signing the agreement, a special account is opened in the bank to reserve money. To open an account, the client writes an application with the obligatory indication of the following data:

• data of the sales contract - number, place and date of signing;
• details of the seller of real estate, supplier of goods;
• type of account, the amount placed on it and the period of its validity;
• method of transferring funds;
• information about the acquired property, goods, works, etc .;
• bank details of the executor;
• list of documents required for the execution of payment in favor of the seller

Service variety

Due to different conditions of the transaction or changes in circumstances, its participants may use different types and features of the letter of credit settlement system:

1. An irrevocable letter of credit is a condition under which an obligation is canceled by the buyer only with the consent of the seller. It is recognized as the most reliable way to conduct a transaction. Termination of banking services is possible only with a bilateral refusal. With a revocable service, the bank has the right to change the obligation or cancel it without the consent, notification of the recipient.
2. The deposited letter of credit is the right of the bank to write off the client's own and credit funds at its disposal for the period of settlement. Otherwise, this service is called a covered letter of credit. When a nominated bank is involved in settlements, money can be transferred to its account for the entire duration of the agreement with the bank.
3. Obligation with a red clause - the right of the bank to transfer authority to pay to another credit institution.
4. An uncovered letter of credit is the ability of the executor's bank to write off money from the buyer's account or use it in another way. Such an obligation is considered to be guaranteed. The executing organization is given the right to write off finances from the issuer's correspondent account.
5. Confirmed commitment is a guarantee of receiving money from the bank in the amount stipulated in the agreement. Moreover, for the seller, the fact of receipt of funds from the buyer does not matter. Usually occurs when lending.
6. Non-acceptance letter of credit - the ability to receive money without the participation of the buyer. After the end of the transaction, only the seller can contact the bank.
7. Revolving. Opens for an incomplete amount. As the fulfillment progresses, the buyer deposits the money in installments. This commitment comes in handy when purchasing items on schedule.
8. Spare. The seller receives from the bank an additional guarantee of payment execution. Convenient if the buyer is unable or refuses to make the payment in full.

Buying an apartment through a letter of credit

Such a transaction is in many ways similar to the purchase of real estate through a safe deposit box. However, using a safe is an easier way with less control from the bank. Considering the topic of what is a letter of credit in a bank when buying an apartment, it is worth keeping in mind the purchase of an apartment in the primary or secondary market. In the first case, housing can be purchased in a building under construction. When settlements with the developer are carried out through a letter of credit, the buyer receives a guarantee to become the owner of the apartment in the completed building. The developer will be able to receive funds only after the completion of construction and the commissioning of the house.

The reliability of this payment method is associated with the increased cost of bank services. On average, when making a deal, you will have to pay:

• 0.2% of the cost of the apartment specified in the contract. The minimum payment is 1000 rubles.
• with the participation of other financial institutions, the commission will be 0.3% in the range from 1,500 to 10,000 rubles;
• 2,000–5,000 rubles for servicing the transaction;
• changing the terms of the agreement in terms of time and amount will cost from 1,000 to 4,500 rubles.

The service is provided to individuals. The application indicates:

• the amount under the contract;
• type and term of the letter of credit;
• data on the parties to the settlement;
• purpose of payment;
• a list of documents for making a transfer by the Bank.

In addition to the sale of an apartment, a financial obligation can be used for transactions with other real estate (houses, land, parking spaces), expensive movable property (equipment, pieces of furniture or art). The service is convenient when paying for services: construction, repair.

The letter of credit is issued in rubles. The term is set by the buyer and is negotiated in the application. If a mortgage transaction takes place, then the average term in banks is set at 120 days. Extension is allowed, but not more than 60 days.

An important step is the control of documents and the issuance of money. In other words, the disclosure of a letter of credit is the fact of confirmation of the seller's fulfillment of the terms of the agreement. The bank reviews and verifies the submitted documents within about a week. Such a bank service is included in the coverage of the letter of credit and may be paid additionally. If the results of control are positive, the credit institution discloses a letter of credit. The former owner gets the right to collect money for the apartment. Usually they are transferred to his account.

Some banks may set limits and deadlines for receiving money. So, in Sberbank for cash withdrawal 1% of the amount is charged. If the transaction amount is more than 5 million rubles, the funds must be on the account for 1 month. If the seller withdraws funds earlier, 10% will be deducted from him.

With an obligation with acceptance, the withdrawal of money is possible after the buyer confirms the fulfillment of its conditions. The buyer informs the bank in writing that all the requirements of the agreement have been met. Credit institutions are liable for violations of the settlement process. Therefore, it is profitable for banks to accept only correctly executed documents. Consider:

• the bank is not responsible for establishing the compliance of the clauses of the main agreement between the parties with the letter of credit agreement;
• the bank does not really control the execution of the main transaction (actual transfer of property, release of the apartment by the seller, etc.).

Upon expiration of the obligation and non-receipt of the agreed documents from the seller, the letter of credit is closed. The recipient of the money is notified of this by the bank without fail.

Letter of credit transactions

Services for transactions with a letter of credit can be carried out in different ways, depending on the credit institution. Banks usually carry out the following operations:

So, the settlement system when buying real estate under a letter of credit is a reliable guarantee of compliance with the terms of the agreement. Long processing times, cash payments and cost justify the risks that participants in large-value transactions are exposed to.

A letter of credit is a form of non-cash payments that is understandable in essence, but cumbersome in execution. The main difference between a letter of credit and ordinary payments from one account to another is the greater participation of banks in contractual relations between clients.

It is more convenient to explain what a letter of credit is using examples.

Imagine that a supplier and a buyer of a product do not have sufficient trust in each other, but intend to ship the product (provide a service) and pay for it.

For mutual confidence, they involve a third party in the transaction - a bank.

The buyer instructs the bank to transfer the money to the supplier after submitting the documents for the shipment of the goods. Such a payer is called applicant, and his bank is issuer .

The bank assumes the obligation and informs the other bank serving the supplier about the terms of the letter of credit.

Supplier (recipient of money), within the framework of the transaction, he is defined as beneficiary, provides its bank with documents confirming the fulfillment of the obligation. This bank is called performing.

The beneficiary's bank receives the agreed amount from the correspondent account of the bank that opened the letter of credit.

The bank serving the payer debits the amount of the letter of credit and the transaction fee from his account.

The transaction is deemed completed.

Purpose of a letter of credit

In operations with the use of a letter of credit, the product (service) is transferred from the seller to the buyer. The payment goes from the buyer to the seller. Banks participating in transfers receive their remuneration for making a payment and providing a guarantee, which is expressed in the acceptance of responsibility and verification of incoming documents.

The costs of the letter of credit are usually borne by the buyer.

The benefit of banks from carrying out letters of credit lies in a greater remuneration than with ordinary payments.

The supplier's benefit is to be sure that his product (service) will be paid for.

Buyer's interest in transferring the risk of “payment without goods” to the bank. And also in the ability to make a deal without touching your own funds before confirming the operation.

Types and conditions of application of letters of credit

Settlements by letter of credit are often used in international trade or within one state with insufficient trust of counterparties to each other and to the situation.

Letters of credit are professional instruments of interbank relations. Ordinary sellers and buyers do not directly participate in dealing with letters of credit, they only give instructions on their opening and provide documents on the performance of transactions. Therefore, it is enough for bank clients to know what guarantees banks offer under letters of credit and the cost of these services.

In practice, it is customary to distinguish the following types of letters of credit:

• Confirmed- here the nominated bank agrees to pay the amount of the letter of credit upon the occurrence of the agreed conditions (provision of documents), even if the issuing bank does not make the necessary transfer of funds to it.
• Unconfirmed- if the nominated bank does not assume additional obligations.
• Covered- when the amount of the letter of credit from the payer's bank is transferred to the beneficiary's bank account.
• Uncovered- if such a transfer does not take place. Most letters of credit are now uncovered, since banks have each other's correspondent accounts and mutual lines of credit.
• Revolving- such a letter of credit is carried out multiple times, in parallel with the delivery and payment of consignments of goods. In demand for regularly recurring transactions.
• Transferable- this option allows the transfer of funds to other beneficiaries.
• Stand-by- such letters of credit are paid if the buyer refuses to pay for the shipped goods. This is a form of bank guarantee used in international trade.
• Pay against documents, i.e. after documentary confirmation of delivery.
• Paid on a deferred basis.

This is not a complete list of letters of credit used in the world practice. Their choice depends on the needs of customers and the willingness of banks to use certain instruments.

Nowadays, in order for an ordinary person to make any purchase, it is not necessary to have cash in his pocket. Any transaction, including the purchase of real estate, can be paid not only by bank transfer, but also on credit, by installments, or by means of a bank letter of credit.

At first glance, such a complex concept as "Bank Letter of Credit" is very difficult to perceive. But in reality, everything is very simple. As statistics show, recently this form of calculation has been successfully used not only by legal entities, but also by individuals. So what's the point? Let's figure it out.

So, in this article we will talk about what a "Bank Letter of Credit" is, what is needed to issue it, and what advantages and disadvantages does it have?

Many financial terms are not only difficult to pronounce, but often difficult to understand. In addition, descriptions for them are given in a very confusing language. In order not to be in an awkward situation, and to use the service successfully, we will explain the concept of "Bank Letter of Credit" in a more understandable language.

Bank Letter of Credit - is a kind of protection against risks associated with financial transactions. This is a way to protect yourself and your savings from possible fraudulent actions when concluding contracts. The letter of credit is especially relevant when it comes to prepayments, or transactions are made with new previously unknown persons who have not yet had time to establish themselves as reliable partners.

The essence of the letter of credit is that a special account is opened in the bank, on which a pre-agreed amount is reserved. In cases where both parties participating in the auction fulfill all the conditions stipulated by the agreement concluded between them, the bank is obliged to transfer the amount of money on the account to the seller.

In this case, the financial institution acts as a kind of guarantor and takes responsibility for transferring money to the recipient. A certain fee will be charged for the services provided. It is noteworthy that each bank sets its own rates. For example, as far as Sberbank is concerned, if a letter of credit is drawn up between two individuals, its rates are 0.2% of the transaction amount, minimum RUB 1,500, maximum RUB 5,000 per transaction.

Thus, a bank letter of credit is a form of settlement that, on the one hand, has an increased level of security, and on the other, guarantees for both parties to the transaction. It should be noted that due to the presence of these two components, the process of transferring, for example, property rights is much faster.

Types of letter of credit

Bank letter of credit, as it turned out, has several types. They differ depending on the powers of the bank and the number of parties. This information is presented in more detail in the table:

As you can see from the information provided, there is a whole mass of types of bank letters of credit. In order to familiarize yourself with each of them in more detail, and choose the most convenient one for yourself, you should contact the authorized branch of the bank in which you plan to draw up an agreement, go to the official website on the Internet, or call the institution's hotline.

Bank Letter of Credit Execution Scheme

After the reader has become better acquainted with the letter of credit, and learned its types, it's time to study the sequence of actions that inevitably occur after the corresponding agreement with the bank is signed and the compensation due to him for the work has been paid.

The scheme of work of a letter of credit is as follows: