Letter of credit

Bills of exchange

A bill of exchange is an order from one person to another to pay a certain amount at a certain time. The money can be paid either to the person who gave the order or to a third party. Bills of exchange can be used for either domestic or foreign trade.

A payment transaction made by bill of exchange generally proceeds the following way. The drawer makes out the bill of exchange and sends it to the drawee (the person who has to pay it). He may send two copies (the first and second bill of exchange) in case one gets lost.

The drawee has to accept one of the bills by signing the front of it. If two copies are sent, the copy which the drawee does not sign automatically becomes invalid. A bill of exchange which hasn’t yet been accepted is called a draft; an accepted bill of exchange is called an acceptance.

The drawee then sends the accepted bill of exchange to the payee, who may be the drawer or a third party. At maturity (the date on which the bill of exchange has to be paid), the payee presents the bill for payment and gets his money. The payee can also negotiate the bill of exchange, but has to endorse it first.

Each bill of exchange belongs to a certain category, depending on the time at which it matures (has to be paid). A sight bill includes the words “Pay at sight”. The drawee has to pay as soon as the draft is presented (as soon as he sees it).

(1380)

A letter of credit is a promise made by the buyer’s bank to send a certain sum of money to the sellers bank to be credited to the seller provided he fulfils his part of the sales contract.

The types of letter of credit are the following. A revocable letter of credit can be cancelled or changed without seller’s agreement. As this does not offer the seller much control over payment, this type of letter of credit is rarely used. An irrevocable letter of credit can be cancelled or changed, but only with the agreement of all parties. A confirmed letter of credit is always irrevocable.

If the seller feels that the risk of not receiving payment is still to high, for example, because the buyer’s country’s economy is unstable, he can arrange for a bank in his own country to confirm the letter of credit. This means that the seller will receive his money from the confirming bank, regardless of whether or not his invoice is paid in the buyer’s country.

First when paying letter of credit buyer and seller agree on all terms and conditions of the sales contract. The buyer fills out an application form to open a letter of credit at his bank. The buyer’s bank opens the letter of credit and sends it to the seller’s bank. The seller’s bank tells the seller that the letter of credit has been opened. The seller checks that all the terms and conditions are correctly listed in the letter of credit and collects all the necessary transport documents. He gives the transport documents to his bank and can get his money now if the letter of credit is confirmed. The seller’s bank checks that all the documents are correct and sends them to the buyer’s bank. The buyer’s bank in its turn checks the documents again and sends the payment to the seller’s shipping documents in return. With these he can collect the goods from the carrier in his country.

(1900)

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