Letters of credit and import collections
This article provides general information about letters of credit and import collections. Both types of bank document are often used for the purchase and sale of goods across international borders.
Letters of credit
Letters of credit are used for international transactions and help guarantee that payments will be made. A letter of credit is an agreement that is issued by a bank, in which the bank agrees to guarantee payment on behalf of a buyer, provided that the terms of the agreement between the buyer and seller are met. A letter of credit is also referred to as a documentary credit (DC).
For an import letter of credit, the legal entity is the buyer or the applicant for the letter of credit. For an export letter of credit, the legal entity is the seller or the beneficiary of the letter of credit. The following parties are involved in a letter of credit:
- The applicant (buyer) who intends to pay for the goods
- The beneficiary (seller) who will receive the payment
- The issuing bank that issues the letter of credit
- The advising bank that carries out the transaction on behalf of the applicant
The letter of credit includes a description of the goods, any required documents, the date of shipment, and the expiration date after which payment won't be made. The issuing bank collects a margin for the letter of credit.
A letter of credit can be revocable or irrevocable. The nature of a letter of credit can be transferable, non-transferable, or revolving. Typically, a letter of credit is an irrevocable and confirmed agreement that payment will be made to a specific beneficiary upon submission of complete and accurate shipping documentation.
An import collection is an agreement between the bank and the exporter (seller), in which the bank agrees to deliver the shipping documentation to the international importer (buyer). The bank is expected to deliver the shipping documentation upon receipt of payment for the shipped goods in cash, or upon receipt of a signed draft toward the payment.
An import collection helps guarantee that the seller is paid when the buyer collects the shipping documents to take delivery of the imported goods.