See Also:
Letter of Credit
Credit Memorandum (memo)
Debit Memorandum
Trade Credit
Proforma Invoice
5 C’s of Credit (5 C’s of Banking)
Credit Letter Definition
A credit letter, defined as a letter written by a bank which declares that the account holder has enough funds to pay for something, is most commonly used during importation.
Credit Letter Explanation
A credit letter, explained as a two sided protection for both buyers and sellers, is a valuable tool for minimizing risk. With a credit letter of reference, the concerns of companies selling across boarders are put to ease. This letter serves two functions: proving that a company has the funds to pay for a shipment of products and protecting the purchasing company from loosing money. In this scenario, the bank protects the account holder by transferring funds only when it receives a document which proves that the products have been shipped.
Example
Ivan is both a Russian and American citizen. He has earned his place in the business world by relying on the experience he has gained. He now imports and exports products both to and from both nations. Ivan has a successful business and is trying to move ahead.
Ivan wants to purchase some products from Russia. Despite this, he is not able to visit the supplier. He wants to receive these products while protecting himself from the risks of international trade. To do this Ivan will use a credit letter of explanation.
Ivan talks with his bank to have a line of credit letter made. Then, he sends the letter to the supplier. After having the letter for a few weeks the company attempts to use the letter of credit without sending a shipment notice. Luckily, Ivan is protected by his bank. They refuse to transfer the payment until they received a shipment confirmation.
Ivan appreciates that his bank protected him. He could have lost a large sum of money without the line of credit letter of credit. Ivan thanks his account manager the next time he sees her.
