Letters of Credit

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LETTERS OF CREDIT FUNDED
What is a Letter of Credit?
A letter of credit is a document usually issued by a bank authorizing the recipient of the letter (you--the bank's customer) to be able draw down money up to a specified amount, in compliance with terms and conditions specified in the LOC, to assure a new supplier ("beneficiary" of the LOC) that it will receive payment for any goods it delivers to the you--customer. It's a financial instrument issued by a bank that substitutes the bank’s credit for the credit of the bank's customer.

There are two types of Letters of Credit.

• Documentary: Requires the beneficiary to perform in accordance with the terms of the LOC before the bank will make payment.
• Standby:  A back-up for the documentary LOC in case of a default by the bank. It acts like a co-signer on a loan.

The key to having a bank issue a letter of credit is for the customer to have adequate collateral or another financial institution that is willing to issue a Standby Letter of Credit to back-up the customer's credit at the bank that issued the LOC.

You will need collateral to get a bank to issue a Letter of Credit.

An example of how to use a letter of credit:

Let's say that you were in China and wanted to purchase 1000 widgets for $100,000, with 100 delivered to you every month for the next ten months. The Chinese supplier has never done business with you before and you have never done business with the Chinese supplier. You don't want to pay for the widgets until you get them and the Chinese supplier doesn't want to deliver the widgets unless payment is guaranteed. To resolve the dilemma you can use a letter of credit. If you have good credit with your bank, your bank will give you a letter (LOC) that says that the bank will guarantee the payment for the widgets, providing they are delivered on time, in good condition, and in accordance with any other specifications in the letter. Now, of course, you will be responsible to reimburse the bank for the money the bank pays the seller on your behalf, plus any fees and interest the bank requires. The bank issuing the LOC is merely a financial convenience to you.

Before going to China it would be good business to talk with your banker about the possibility that you may need a letter of credit. Ask what amount the bank would issue an LOC for and what you will need to do to get the it. You will need to have collateral (savings, stocks, real estate, etc.) or good credit to back up the LOC. What is a standby letter of credit (SLOC)? A standby letter of credit is primarily used to guarantee an agreement or another letter of credit. For example, it could be used when a bank guarantee is required or let's say that you would have a letter of credit from a small bank and the beneficiary of the LOC requires more collateral. A standby letter of credit from a larger bank to back up the letter of credit of the smaller bank.

Check out these links for some uses for a Letter of Credit:
http://www.wisegeek.com/what-are-some-uses-for-a-letter-of-credit.htm

http://www.fraudreview-iesc.com/pdfs/Article3.pdf

http://www.crfonline.org/search/search.asp?keywords=ron+borcky

http://www.sio.org/html/SBvsLOC.html