Documentary forms of payment settlementsKIB offers its clients all the necessary services for carrying out foreign trade activities and undertakes all kinds of documentary operations:
Letters of credit
Letters of credit are issued by the Bank on behalf of a client (buyer, importer or applicant) to the seller (exporter, beneficiary). A letter of credit is an irrevocable obligation of the issuing bank to pay against documents specified in the terms of the letter, provided that the documents are prepared with due compliance to the terms of the letter of credit.
Documents are examined by the executing bank for compliance with the terms of the letter of credit as well as the Universal Rules and Practice of Documentary Credit, No 500 issued by the International Chamber of Commerce in 1993.
Participants in the transaction:
1. Applicant (buyer or importer). This participant gives the instruction to open a letter of credit, and the letter of credit is opened/issued on behalf of the applicant.
2. Beneficiary (seller, exporter). This is the participant the letter of credit is opened for and issued to.
3. Issuing bank (emitting bank, bank of the applicant, /buyer) is the bank that is opening a letter of credit on behalf of its client.
4. Advising bank (correspondent bank, bank of the beneficiary) is the bank that notification is sent to on the opening of the letter of credit (by SWIFT of telex) by the Issuing bank. The only obligation of the advising bank is to carefully define whether the letter of credit is original before transferring the letter of credit to the beneficiary.
5. Designated bank is the bank that is authorized to review the shipment documents for their compliance to the terms of the letter of credit itself and the universal international rules (see above). The designated bank has 8 banking days to review the documents and make its sole resolution on payment/non payment against these documents.
6. Confirming bank is the bank that assumes the risk for payment if the issuing bank for some reason cannot perform payment under transaction; i.e. the confirming bank acts upon the request of the issuing bank, adding its guarantees to the letter of credit. In other words, confirmation of the letter of credit means that the bank agrees to perform payment on the letter of credit if all terms of the letter of credit are complied with, irrespective of payment receipt from the issuing bank. Confirmation of the letter of credit is performed within the frameworks of inter bank credit lines.
Types of letters of credit
Revocable Letter of Credit
Revocable letter of credit at any time can be amended or cancelled by the issuing bank, in most cases upon the instructions from the buyer or importer that gave the order to issue the letter of credit without prior notification of the beneficiary (seller, exporter). This form of settlement is recommended only for partners that have known each other for long time and relies upon complete trust in the buyer. It should be noted that if it is not specified in the letter of credit that it is revocable, it shall be deemed irrevocable.
Irrevocable letter of credit
This type of letter of credit gives the beneficiary a high level of assurance that his shipments and services will be paid for after the conditions of the letter of credit are met. Unlike the revocable letter of credit, to cancel or amend terms of the irrevocable letter of credit the beneficiary’s consent is required, together with the consent of the responsible banks. If the seller wishes to amend or cancel the letter of credit it should request the buyer to make a relevant instruction to the issuing bank.
Irrevocable Unconfirmed Letter of Credit
In case of irrevocable unconfirmed letter of credit the correspondent bank only advises opening of the letter of credit to the beneficiary. In this case it does not accept any payment obligation and therefore is not obliged to perform payment on the documents presented by the beneficiary. Therefore, in this case issuing bank undertakes to pay the letter of credit against the documents presented.
“Irrevocable letter of credit presents a solid obligation of the issuing bank if the necessary documents are provided to the executing bank or issuing bank and terms are complied with …” (Article 9(à) UCP 500).
Irrevocable unconfirmed letter of credit is the most often-used form of a letter of credit.
Irrevocable confirmed letter of credit
The correspondent bank, by confirming the letter of credit to the beneficiary, undertakes to perform payment on the documents specified in the terms of the letter of credit. Confirmation is usually necessary in cases where the exporter doubts the reliability of the issuing bank. From the exporter’s point of view, a confirmed letter of credit is more reliable than an unconfirmed one, because it obligates both banks.
“Confirmation of an irrevocable letter of credit by another bank (“confirming bank”) if such bank is authorized to do so or upon the request if the issuing bank shall be a solid obligation, additionally to bank’s obligations provided that necessary documents are presented to the confirming bank or any other executing bank and all terms orà the letter of credit are complied with …” (Article 9(b) UCP 500).
Revolving (automatically renewable) letter of credit
In case if the beneficiary performs frequent shipments of goods it is reasonable to use revolver letters of credit. They can be both revocable and irrevocable. Automatically renewable credits is a convenient payment mechanism for the parties that have significant volume of regularly trade operations.
The letter of credit can be renewable in term and amount, i.e. automatically renewable credits can be cumulative or non-cumulative:
In the case of cumulative credits, any amount unused for the previous period may be transferred for use in the following period.
In the case of non-cumulative credits, any amount unused for the previous period is lost. For the purpose of control, the majority of credits are renewable in term and are non-cumulative.
Transferable letter of credit
Transferable letter of credit can be opened in case the beneficiary (“first beneficiary”) is an intermediary in the transaction and is going to purchase goods from the manufacturer or any other third party “direct seller”, and the letter of credit is a type of settlement. In this case, later the beneficiary can appeal to the bank with a request to transfer the letter of credit in whole or in part to the third party (“second beneficiary”). Such a letter of credit can be transferred only once i.e. the “second beneficiary” does not have a right to transfer the letter of credit to the third beneficiary. Partial transfers are allowed only if the letter of credit specifies delivery by installments.
“Back-to-Back” (compensational) letter of credit
For example, if a supplier does not have direct access to the supplied goods and has to address the manufacturer of goods (“second supplier”), it is sensible to use a “back-to-back” letter of credit with allows the initial letter of credit and its value to be used again by the bank or for both to be used in parallel. In such “back-to-back” situations, various types of technical problems can arise, which is why banks thoroughly check all aspects of each separate transaction before its performance. To minimize risks, both initial and counter letters of credit must be in compliance with the terms and requirements of the documents. From a legal perspective, the initial and back to back letters of credit are completely independent from each other, even though they are a part of the same transaction. In other words, the main difference between a transferable letter of credit and an offset transaction is that during an offset transaction there are two independent letters of credit with completely independent obligations on the issuing banks.
Red clause letter of credit/evergreen letter of credit or annually renewable credit.
Red clause letter of credit specifies advance payment. That is, upon request by the seller, the buyer will agree to provide a portionof purchase price to the seller as an advance before the shipment of goods, and this advance can be issued within the frameworks of the letter of credit. This agreement stipulates the amount of the advance that must be deducted from the amount paid to the seller after the seller provides the documents. Evergreen or annually renewable letters of credit are valid within longer periods then traditional letters of credit and can be altered or cancelled only upon a due preliminary notification of the beneficiary by the issuer before the expiration of the term of letter of credit.
Bank guarantee
Bank guarantee is a document according to which the bank undertakes to pay a limited amount of money to a party named therein upon conditions specified therein.
Bank guarantee can be issued directly for the counter party in a foreign trade transaction or to the counter party bank. In the first case this would be a direct guarantee (for example – the importer’s bank gives a guarantee to the exporterthat the importer will redeem commercial papers put up for collection), and in the second case - a guarantee through the exporter’s bank is an indirect guarantee.
KIB can issue the following types of guarantees:
Guarantee of payment – to secure performance of payment obligations of the importers (principals) to the foreign exporters (beneficiaries).
Contractual guarantee (tender, return of advance and other payments, due performance of the contract) – to secure performance of obligations of the exporters to the foreign importers (beneficiaries).
Banking guarantee is an irrevocable obligation of the Bank to perform execution in a monetary form is the third party fails with such performance. Guarantee is not an independent obligation. It does not depend on relations regarding the principal amount of debt or agreement between the creditor and the primary debtor. By issuing a guarantee the Bank undertakes to pay upon the first demand is the conditions contained in the guarantee are fully met.
Types of guarantees:
In an unconfirmed guarantees, the obligations under the guarantee are secured by the issuing bank. In this case, only the issuing bank undertakes to perform payment under the guarantee.
A confirmed guaranteee, where an authorized correspondent bank is adding its confirmation to the issuing bank’s guarantee, is the same as a confirmation of the letter of credit and contains the obligations of two banks. Such guarantees are usually confirmed by first-class banks within the framework of the established inter bank credit lines.
Guarantee of performance (Performance Bond). By providing this kind of guarantee, the bank undertakes to pay the beneficiary, according to an instruction from the seller, a guaranteed amount if the supplier fails to perform its contractual obligations on single or multiple occasions. The guarantee usually amounts to 10% of the contract amount.
Guarantee of return of advance payment (Advance Payment Guarantee). Terms of payment in major export contracts often provide for payment by the buyer of an advance payment for purchase of raw material and covering expenses and costs of manufacturing. Such advanced payment is linked by the buyer with the receipt of advance payment, providing for return of the advance in the case of non-performance by the seller under contract. The amount of the guarantee is equal to the amount of advance payment. Such a guarantee must provide for repayment at the end of the process in the contract. This guarantee is issued before receipt and becomes valid only after the receipt.
Tender guarantee (Bid Bond). This guarantee is usually required for participationin a tender. Tender guarantee provides for payment of the guarantee amount if the tender bid will be recalled before certain period of time or if the contract will not be performed by the applicant after was made. Also, payment under this guarantee is performed if the bid guarantee is not replaced by the guarantee of contract’s performance after such contract was made. Usually the guarantee amount is equal to 1-10% of a total bid amount and is valid until the contract is signed or the guarantee of performance will be issued. .
Guarantee of payment (Payment Guarantee). Such a guarantee provides for settlement in case of non-payment of the open account.
Guarantee for commercial letter of credit – the document in which the beneficiary of the commercial letter assumes responsibility for non-performance of the terms of the letter of credit and undertakes to compensate money received under the letter of credit with all interests and charges.
Collection
Documentary collection means that the exporter is shipping goods to the importer but directs the shipment documents, including the documents proving the ownership rights) to the forwarding bank in order to further transfer these documents to the purchasing bank. Purchasing bank receives instructions not to transfer the documents to the purchaser until the purchaser performs payment (Document against payment, Documents against Acceptance D/P) or until the guarantee will be received that the payment will be performed within a certain period of time (Documents against acceptance, Documents against Acceptance D/A). Only after receipt of the document will ownership of the shipped goods be transferred to the purchaser. Documents against payment (D/P) or Documents against acceptance (D/A) are often used in established business relations providing for the protection of the interests of both parties in the transaction. However, upon performance of this transaction some risks exist both for both the seller and the buyer. In other words, the seller bears the risk in case if the buyer refuses to pay against the documents presented by the seller, and the buyer bears the risk of receiving unsuitable or incomplete goods. In this transaction, the bank acts as an intermediary.
Standby Letter of Credit. A standby letter of credit operates like guarantee; i.e., a standby letter of credit can be used as a security for payments in case of non-performance of obligations, unlike the commercial letter of credit, which secures payment only if the requirements are met. Standby letters of credit are often called unused letters of credit because they are only used as accessory form of payment in cases when payment on the first letter of credit is overdue. Standby or reserve letters of credit can be used for instance to guarantee payment of pledge, performance of sub contracts, or to insure payment for goods delivered by the third party.
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