How does a transferable letter of credit work?
A transferable letter of credit is a financial instrument that provides a secure and reliable method of payment for international trade transactions. It works as an agreement between an exporter, an importer, and a bank, ensuring that the exporter receives payment for their goods or services before they are delivered. This type of letter of credit is particularly beneficial in situations where the exporter and importer are unfamiliar with each other or operate in different countries with different legal systems. In this article, we will explore how a transferable letter of credit works and its key components.
The process of a transferable letter of credit begins with the importer and the exporter entering into a sales contract. The importer, who is the buyer, applies to their bank, known as the issuing bank, for a letter of credit. The issuing bank then sends the letter of credit to the exporter’s bank, referred to as the advising bank, which informs the exporter about the terms and conditions of the credit.
Once the exporter receives the letter of credit, they review it to ensure that all the terms and conditions are acceptable. If the exporter agrees to the terms, they proceed to fulfill the contract by shipping the goods or providing the services specified in the sales agreement. After fulfilling the contract, the exporter presents the required documents to the advising bank, such as invoices, bills of lading, and packing lists.
The advising bank verifies that the documents comply with the letter of credit’s terms and conditions. If the documents are in order, the advising bank forwards them to the issuing bank. The issuing bank examines the documents and, if everything is in line, makes the payment to the exporter.
The key feature of a transferable letter of credit is the ability to transfer the credit amount to a third party, usually another exporter. This is particularly useful when the importer needs to purchase goods from multiple suppliers, and the suppliers want to ensure they receive payment for their goods. The importer’s bank authorizes the transfer of the letter of credit to the suppliers, allowing them to present the required documents to the advising bank and receive payment directly.
To transfer the credit, the supplier’s bank, acting as the nominated bank, notifies the advising bank about the transfer. The advising bank then sends the transferred letter of credit to the nominated bank, which performs the same verification process as the original issuing bank. Once the nominated bank confirms the documents are in order, it makes the payment to the supplier.
In summary, a transferable letter of credit is a financial instrument that ensures payment for international trade transactions. It involves an agreement between the exporter, importer, and their respective banks, with the key components being the issuing bank, advising bank, and nominated bank. By providing a secure and reliable payment method, transferable letters of credit help facilitate international trade and reduce the risks associated with cross-border transactions.
