Letters of Credit

A Letter of Credit is a financial tool that can be very useful in some situations. 

A letter of credit is a document issued by a third party that guarantees payment for goods or services when the seller provides acceptable documentation. Letters of credit are usually issued by banks or other financial institutions.

Most letters of credit are import/export letters of credit, which, as the name implies, are letters of credit that are used in international trade.

Letters of credit are most often used in international trade, where they are governed by the Uniform Customs and Practice for Documentary Credits (or UCP), the rules of the International Chamber of Commerce. 

All letters of credit governed by the current UCP are irrevocable letters of credit.

A confirmed letter of credit is one where a second bank agrees to pay the letter of credit at the request of the issuing bank. 

An unconfirmed letter of credit is guaranteed only by the issuing bank. This is the most common form with regard to confirmation.

A letter of credit may also be a transferrable letter of credit. It allows the named beneficiary to present its own documentation but transfer all or part of the payment to the actual suppliers. 

A letter of credit may also be at sight, which is payable as soon as the documentation has been presented and verified, or payment may be deferred. Deferred letters of credit are also called a usance letter of credit and may be put off until a certain time period has passed or the buyer has had the opportunity to inspect or even sell the related goods.

Letter of credit transactions are not without risks. The risks inherent in these types of transactions include:

• Fraud risk, in which the payment is obtained through     the use of falsified or forged documents for worthless or non-existent    merchandise
• Regulatory risk, in which government action may prevent    completion of the transaction
• Legal risk, in which legal action prevents completion     of the transaction
• Force majeure risk, in which completion of the transaction is    prevented by an external force, such as war or a natural disaster

In addition, the normal risks inherent in transactions, such as non-delivery, shipping less than was ordered, inferior quality merchandise, early or late shipment, or goods being damaged in transit, apply.

Proof Of Funds (POF)

Proof of funds (POF) refers to a document or documents that demonstrate a person or entity has the ability and funds available for a specific transaction.

Proof of funds usually comes in the form of a bank, security, or custody statement.

The purpose of the proof of funds document is to ensure that the funds needed to execute the transaction fully are accessible and legitimate.

Proof of funds refers to a document that demonstrates the ability of an individual or entity to pay for a specific transaction.

A bank statement, security statement, or custody statement usually qualify as proof of funds.

Proof of funds is typically required for a large transaction, Basic information, such as the bank name and address, bank statement, total balance amounts, a bank personnel's signature, is required on the proof of funds document.

Proof of funds and proof of deposit are often both needed when applying for a mortgage.

Understanding Proof of Funds (POF)

When an individual or entity is making a large purchase, the seller usually requires proof of funds. This ensures not only that the buyer has the money available to make the purchase, but also has legal access to the funds, as the proof of funds comes from a verified authority, such as a bank. 

It's important to note that in the majority of instances, the proof of funds must refer to liquid capital, primarily cash.

Certain investments, such as retirement accounts, mutual fund accounts, and life insurance, do not qualify as proof of funds.

StandBy Letters of Credit

The Standby Letter of Credit (SBLC) is a guarantee issued by banks or other financial institutions for the account of the importer, in favor of the exporter, for an amount agreed at the signing of the commercial contract. It provides a guarantee to the exporter that, if due to any circumstances, the importer is unable to pay, then the bank will make the payment.

There are two types of Standby Letters of Credit: Performance SBLC and Financial SBLC.

A Performance Standby Letter of Credit is issued to ensure that nonfinancial contractual obligations are performed in a timely and satisfactory manner. These obligations can be related to quality of work, amount of work, delivery time. In case they are not met, the issuer will pay the beneficiary in full.

A Financial Standby Letter of Credit, on the other hand, is issued to ensure that financial contractual obligations are fulfilled. That means the importer pays on time provided he has received all the goods and/or services from the exporter, the beneficiary of the SBLC. 

But a Financial SBLC can also be in favor of the exporter’s bank. Standby Letters of Credit are financial most of the time.

The standby letter of credit is often preferred over a documentary credit because it presents some advantages for both parties:

The administrative formality is simple and not very constraining

It allows fast and direct shipping of documents to the buyer without going through the banks

If it is not enforced, its cost is less than that of a Documentary Credit.

Bank Confirmation Letter (BCL)

A Bank Confirmation Letter (BCL) is a letter from a bank or financial institution confirming the existence of a loan or a line of credit that has been extended to a borrower.

The letter officially vouches for the fact that the borrower—typically an individual, company, or organization—is eligible to borrow a specified amount of funds for a specified purpose.

A bank confirmation letter (BCL) validates that a bank has a line of credit in place with one of its customers.

Bank confirmation letters are typically issued to business customers vouching for their creditworthiness.

A bank confirmation letter's purpose is to assure a third party, generally a seller, that the borrower has access to sufficient financial resources to complete a transaction, such as the purchase of goods.

The confirmation letter—sometimes known as a comfort letter—is not a guarantee of payment, but only an assurance of the borrower's financial resources to make payment.

Bank confirmation letters typically require the signature of representatives of the bank or the financial institution who are authorized to issue such correspondence.

Since a letter of confirmation is issued in regard to a particular transaction or project, it's not transferable to a different transaction or project. If the bank's customer decides to enter into a different deal or purchase, the customer usually is required to obtain a new letter of confirmation. 

Regulations vary from country to country in terms of whether and to what extent a letter of confirmation must state the specific purpose for which a loan or line of credit is being extended to the borrower.

Bank confirmation letters are most commonly prepared for a business customer of the bank, vouching for the existence of a specified line of credit.

The letters often serve to reassure sellers of a large number of goods. They may also be issued for a company that is entering into a joint venture project with another company.

While the letter does not guarantee payment or provision of funds, it does provide an assurance of a high probability of the company receiving payment from the bank's customer.

A bank confirmation letter serves to assure all concerned parties in a business transaction that the bank's customer (the borrower) has, or has available, the necessary financial resources to conclude the transaction.

The letter is not a commitment to buy; it is merely a reassurance that the bank’s customer has access to funds to complete a purchase. 

Guarantees

A Guarantee is a written undertaking issued by a bank or financial institution in favour of the receiver of the goods or services, whereby it pledges to make certain payments on behalf of its client, if the latter fails to make a payment or to carry out specific functions in terms of the commercial contract. 

The guarantor’s commitment is legally independent of the underlying commercial contract.

A guarantee (bond or suretyship, as it is sometimes called) supports commercial contracts by providing trading partners with the flexibility to reduce credit and performance risk.

The guarantees are flexible and can be structured to cover a variety of needs

Below are descriptions of some of the most common types of guarantees.

Bid bond/tender guarantee

The purpose of these guarantees is to cover the risk that the company submitting a tender will not abide by its offer or deliver the required performance.

Performance guarantee

Secures the seller's/performers contractual obligations.

Advance payment guarantee

Issued when the buyer/manufacturer pays the contract price or part thereof in advance and requires security for a refund if the merchandise is not delivered, or if the delivery is not in accordance with the contract.

Warranty guarantee

Covers the buyers after goods are delivered or work is completed during any agreed warranty period.

Retention money guarantee

Ensures that the correct repayments are made if the applicant fails to meet its contractual obligations during the warranty period.

Payment guarantees

Secures the applicant’s ability to fulfill its payment obligations to the beneficiary. 

Other guarantees

The guarantees described so far help to hedge the most common risks, but there are many other different risks, for instance, loan repayment risk, risk of late payment of rent, etc., for covering of which banks issue corresponding guarantees.

Ready Willing and Able (RWA)

A Ready Willing and Able Letter (RWA Letter) is a bank instrument that verifiy’s a bank or financial institution is Ready Willing and Able (RWA) to proceed on behalf of a client in any number of various financial transactions. 

An RWA Letter is usually sent from a buyer’s bank to the seller’s bank and is commonly sent together with a SWIFT MT-799. 

While an RWA Letter is sometimes issued without a SWIFT message bank to bank, it carries more weight for buyers and investors if it is sent in conjunction with a SWIFT MT-799. 

If an RWA Letter is required by itself, and a SWIFT transaction is not required by the seller, a bank or trust can send a Ready willing and Able Letter (RWA) by other less common means as requested by the seller or the sellers bank.

With this document, the bank confirms:

The asset is good, clear, clean and non-criminal origin

The asset does not have any kind of external constraint

The activity can be confirmed by SWIFT MT799 – MT760.

To Inquire about obtaining an RWA letter to show that your bank is Ready Willing and Able.

A RWA letter is a document issued by a bank on behalf of a client to prove his readiness and his intent to participate in a financial transaction. 

The letter is issued by one bank to another, usually with Swift MT799. 

The letter RWA can be released without a swift from bank to bank, but this gives strong validity and strength to the applicant if it is done. 

If it is required a swift MT799 Letter may be issued by courier copy, by fax, Key Tested Telex, fax or secure. 

RWA Letters are sometimes referred to as Bank Comfort Letters or known as a Bank Capability letter as well.