Letter Of Credit

Definition

Letter Of Credit. A letter from a bank or other creditworthy institution guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount. It is a legal commitment issued by a bank or other entity stating that, upon receipt of certain documents, the bank will pay against drafts meeting the terms of the letter of credit.

Letters of credit are frequently used for risk financing purposes to collateralise monies owed by an insured under various cash flow programs such as: incurred but not paid losses in paid loss retrospective rating programs, a means of meeting the capitalisation requirements of captives, and to satisfy the security requirements of the excess insurer in "fronted" deductible or retention programs. For captives, letters of credit serve two possible purposes: they may be used in lieu of or in addition to cash or other securities as capital, and/or to securitise the fronting insurer's reinsurance receivable created by a non-admitted reinsurer.

In some states in the U.S., the issuer is not limited to financial institutions -- it is simply a written instrument, addressed by one person to another, requesting the latter to give credit to the person in whose favor it is drawn.

Involved Parties

• The Applicant is the person or company who has requested the letter of credit to be issued; this will normally be the buyer.
• The Beneficiary is the person or company who will be paid under the letter of credit; this will normally be the seller (UCP 600 Art.2 defines the beneficiary as "the party in whose favour a credit is issued").
• The Issuing Bank is the bank that issues the credit, usually following a request from an Applicant.
• The Nominated Bank is a bank mentioned within the letter of credit at which the credit is available (in this respect, UCP600 Art.2 reads: "Nominated bank means the bank with which the credit is available or any bank in the case of a credit available with any bank") .
• The Advising Bank is the bank that will inform the Beneficiary or their Nominated Bank of the credit, send the original credit to the Beneficiary or their Nominated Bank, and provide the Beneficiary or their Nominated Bank with any amendments to the letter of credit.
• Confirmation is an undertaking from a bank other than the issuing bank to pay the Beneficiary for a Complying Presentation, allowing the Beneficiary to further reduce payment risk, although Confirmation is usually at an extra cost.
• Confirming Bank is a bank other than the issuing bank that adds its confirmation to credit upon the issuing bank's authorization or request thus providing more security to the beneficiary.

A Complying Presentation is a set of documents that meet with the requirements of the letter of credit and all of the rules relating to letters of credit.

See Also

• wikipedia

Disclaimer

This entry annotates a FIBO Ontology Class. FIBO is a trademark and the FIBO Ontology is copyright of the EDM Council, released under the MIT Open Source License. There is no guarantee that the content of this page will remain aligned with, or correctly interprets, the concepts covered by the FIBO ontology.