Letter of Credit is a Valuable Document in International Trade, Know the Types and Uses

Kapanlagi.com - In the world of business and economics, there are many foreign terms that may be difficult for the general public to understand. However, with the development of technology, especially in the world of business and investment, various specific terms in the business field are slowly becoming known to the general public. Letter of credit is one of them.

Perhaps for some people, this term has become a common term used in everyday life. However, for others, this term may still be difficult to understand. So, what is a letter of credit actually?

Generally, a letter of credit is a type of service product in the form of a letter issued by a bank. In general, this letter of credit is used to settle financial transactions in exports and imports. Therefore, this bank product can be used for international trade transactions.

In addition to the above description, there are still some interesting details about the letter of credit to be noted. For that, summarized from liputan6.com, here is a brief summary of the letter of credit.

1. Understanding What is a Letter of Credit

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A letter of credit is one of the banking services products that can be used for international trade transactions. In more detail, Bank Indonesia (BI) also defines a letter of credit. According to BI, a letter of credit is an agreement in the issuing bank to pay a certain amount of money to the exporter as long as the conditions of the letter of credit are fulfilled.

In his book titled Banks and Other Financial Institutions, Totok Budisantoso refers to L/C as one of the services provided by banks for the purpose of purchasing a product. This service can be in the form of payment deferral for the buyer (importer) from the time the L/C is established until a certain period of time as agreed in the agreement.

In short, a letter of credit is a document-based credit letter issued by a bank to guarantee that the buyer's transaction with the seller will be conducted in a timely manner and in accordance with the agreed amount. However, if the buyer is unable to make the payment, the bank is obliged to cover the remaining unpaid purchase.

2. Users of Letter of Credit

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As mentioned earlier, a letter of credit is closely related to export and import transactions. This means that not just anyone can be involved or carry out transactions with this letter of credit. Only a few parties can use a letter of credit. The parties involved in using a letter of credit are as follows.

1) Applicant

The applicant is the party who requests the bank to open a letter of credit for the benefit of the letter of credit recipient (beneficiary/seller/exporter).

2) Beneficiary

The beneficiary is the seller/exporter who is given the right to withdraw a certain amount of money according to the amount stated in the letter of credit, with the required conditions, or in other words, the party who benefits from the issuance of the letter of credit.

3) Issuing Bank

The issuing bank is the bank authorized to open a letter of credit for the beneficiary's benefit. The letter of credit will include the required conditions requested by the opener. These requirements must be fulfilled by the beneficiary.

4) Advising Bank

The advising bank is the bank that receives and forwards the letter of credit to the beneficiary or another bank designated in the letter of credit.

5) Negotiating Bank

The negotiating bank is the bank responsible for taking over the documents required in the letter of credit. Therefore, in this case, negotiating means taking over to make the payment in advance to the beneficiary for the documents required in the letter of credit, and then reimbursing the opening bank of the letter of credit by sending the taken over documents.

6) Confirming Bank

The confirming bank is the bank that guarantees the authenticity of a letter of credit at the request or authorization of the issuing bank.

3. The Uses of Letter of Credit

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As a valuable document, letter of credit has its own uses. Especially as we know, international trade involves many factors such as distance, different legal regulations in each country, and communication or personal contact constraints during international trade. Therefore, letter of credit can be a reliable payment mechanism.

In addition, there are two main functions or uses of letter of credit, namely as payment and as a guarantee. Regarding payment, letter of credit will provide security to the recipient if the conditions of the letter of credit have been fulfilled. Meanwhile, as a guarantee, letter of credit provides security to the guaranteed party if the implementation of the underlying contract guaranteed by the L/C cannot be performed by the guaranteed party.

Furthermore, letter of credit can also protect the buyer. For example, if the buyer pays someone to provide a product or service, and then fails to deliver it, at that moment payment can be made using standby letter of credit. Such payment can also serve as a penalty for companies that fail to fulfill it. The concept is similar to a refund.

4. Types of Letter of Credit

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More in-depth and specific, it turns out there are several types of letters of credit. To find out more, the types of letters of credit are as follows.

1) Sight letter of credit

Sight letter of credit is faster than other forms of letters of credit. This type of letter of credit is a document that can be paid when seen or after presenting the correct documentation. For example, a businessman can provide a bill of exchange to a lender along with a letter of credit and immediately take the necessary funds.

2) Revocable and Irrevocable letter of credit

Revocable letter of credit is a credit whose terms and conditions can be changed or canceled by the Issuing Bank. This cancellation is done without prior notice to the beneficiary.

Meanwhile, Irrevocable letter of credit is a credit that is conditional and has terms that cannot be changed or canceled. Therefore, the opening bank is bound by the commitment given in the letter of credit.

3) Confirmed irrevocable letter of credit

Confirmed irrevocable letter of credit is a banker other than the issuing bank, adding their own confirmation to the credit. If LC This type of letter of credit is considered the most perfect and safest from the beneficiary's point of view. Because the payment or settlement of a bill drawn under an L/C is fully guaranteed by the opening bank as well as the advising bank.

4) Unsance letter of credit

An unsance letter of credit is a credit that is only paid after a certain period of time. It is also known as an acceptance letter of credit. For example, a company that buys materials from a supplier and receives the goods on the same day. The invoice is sent together with the shipment, but the company still has 30 days to make the payment.

5) Transferable Credit

Transferable Credit is a credit that gives the beneficiary the right to request the designated bank to make payment or acceptance to any bank authorized to negotiate, in order to transfer the rights to the credit wholly or partially to a third party or more.

6) Back-to-Back credit

In Back-to-Back credit, the exporter (beneficiary) can request their banker to issue an LC to support their supplier in obtaining raw materials, goods based on the received export LC.

Those are some summaries about letter of credit. Hopefully, it is useful and can broaden your knowledge!

(kpl/psp)