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Letter
of Credit (LC):
Letters
of credit became necessary when trade between countries made it impossible to
simply do business by handshake. They were initially introduced by the
merchant banking system in Europe, and grew out of earlier contracts such as the
"chop" in Asia and the personal "house" emblem embossed in
hot wax used throughout Europe and Arabia.
Originally,
a Letter of Credit was quite literally that - a letter addressed by the buyer's
bank to the seller's bank stating that they could vouch for their customer, the
buyer, and that they would pay the seller in case of the buyer's default.
Nowadays,
they are formatted to provide fill-in spaces for the various requirements of
international or domestic business. It is written by a bank on behalf of
one of it's creditworthy customer, who's application for the line of credit has
been approved.
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The
sequence of information on Letter of Credit the language used is determined by
rules set by the INTERNATIONAL CHAMBER OF
COMMERCE (ICC). The rules and language are very specific and cannot
be changed, and are spelled out in the ICC's Uniform Customs and Practice for
Documentary Credits, or UCP500.
The
parties to a Letter of Credit are
(1)
the buyer (the applicant)
(2)
the buyer's bank (the issuer)
(3)
the beneficiary (the seller/payee)
(4)
the beneficiary's bank.
The
LC outlines the conditions under which payment (credit) will be made to a third
party (the beneficiary). The conditions are specified by the buyer and may
include insurance forms, Way Bills, Bills of Lading, Customs forms, various
certificates - i.e. whatever documents are necessary to safeguard the integrity
of the purchased product or service.
It
is the responsibility of the issuing bank to ensure, on behalf of its client the
buyer, that all documentary conditions have been met before the Letter of Credit
funds are released.
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In
effect, a basic Letter of Credit is a financial contract between the bank, the
bank's customer, and the beneficiary, and this contract* involves the transfer
of goods or services against funds.
*Not
to be confused with the contract between the buyer and seller. The neither
of the banks have any interest in that kind of contract.
The
Letter of Credit may be written for a short period of time, covering one
shipment of goods, or may be written for a greater amount and for a longer
period of time in order to cover say, a year's worth of shipments (Note: a
valid Letter of Credit never carries the term "one year and one day"
which is a meaningless term created by fraudsters).
The
maturity date on a Letter of Credit is the date on which the full value of the
credit is payable.
A
Letter of Credit may have a discount rate. That means that the buyer may
not have been the one to close the deal with seller. Perhaps it was
arranged by a licensed broker, the buyer's agent, or perhaps the importer's bank
acting as the buyer's agent.
In
that case, the difference between the actual amount available for purchase
expenses and the full value of the Letter of Credit is the commission earned by
the broker.
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In
any event, the buyer has to either have the funds on deposit in his bank to
cover the full value, or has to have made other arrangements with his bank to
cover the full value. A Letter of Credit cannot be purchased for only a
small percentage of the face value and then cashed across the street for the
full face value.
There
are several types of Letter of Credit: BACK-TO-BACK
LETTERS OF CREDIT, CREDIT ENHANCEMENT, IRREVOCABLE LETTER OF CREDIT, STANDBY
LETTER OF CREDIT, CONFIRMED LETTER OF CREDIT, and DOCUMENTARY LETTER OF CREDIT,
TRAVELER'S LETTER OF CREDIT, as well as documentary commercial bill, red
clause Letter of Credit, sight draft, and time draft. Once you
understand the uses for a Letter of Credit, even uses for the ones not defined
in this dictionary become self-evident.
The
Scam: Fraudsters would like you to believe that Letters of Credit are
investment securities, but as you can see, a Letter of Credit is written on an
individual basis and must be thoroughly researched.
While
a Letter of Credit may be forfaited, the financial instrument equivalent of
factoring, that is not a procedure to be taken up by the inexperienced.
Without an intimate knowledge of trade finance, trade law, and international
politics and economics, you can quickly find yourself up the creek without a
paddle.
The
usual swindler approach involves persuading you that a Letter of Credit
or similar instrument can be purchased at enormous discount in exchange for your
funds, and that a few weeks or months later this same financial
instrument will be worth hundreds of thousands more. Or can be sold for
hundreds of thousands more. Or can be turned around overnight. Or
traded for a higher value.
It
just ain't so, and now you know why.
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