Mitigating Techniques for Commercial Risk/Letter of Credit

Unit 3.5-Mitigating Techniques for Commercial Risk

Introduction | Commercial Banks | Loans | Letter of Credit | Draft Collection | Accounts Receivable | Governments | Factoring | Forfaiting | Banker's Acceptances | Credit Insurance | Summary | Resources | Activities | Assessment Go to Unit 3.1 | Unit 3.2 | Unit 3.3 | Unit 3.4 | Unit 3.5 Return to Trade Finance Module 3: Commerical Risk

Letter of Credit

The letter of credit process begins after a buyer and seller conclude a sales contract providing for payment by a letter of credit. The buyer then instructs his bank--the issuing bank--to issue a letter of credit in favor of the seller. The sales contract may call for either a

• sight letter of credit pursuant to which the issuing bank agrees to make payment upon presentation of a sight draft and the required documents, or
• time letter of credit pursuant to which the issuing bank agrees to accept a time draft and pay at maturity upon its presentation with confirming documents.

The issuing bank then delivers or transmits the credit to a bank in the seller’s country--the advising bank--that may also be the asked to confirm the credit. The advising/confirming bank notifies the seller that the credit has been issued. Once the seller has been advised that a letter of credit has been issued in his/her favor and is certain that he/she can satisfy the stated terms and conditions, the goods are shipped and required shipping documents assembled.