When dealing with international trade, buyers and sellers often use letters of credit. A letter of credit allows the buyer and seller's respective banks to act as middlemen for the transaction. The buyer's bank approves a loan to him for the amount of the transaction and notifies the seller's bank, which forwards the payment to the seller and receives a reimbursement from the buyer's bank. The seller can nominate a bank — usually his own bank — to receive funds from this transaction.
Chosen by Beneficiary
Beneficiaries of letters of credit may choose any bank they wish to receive the funds from the issuing bank. The bank the beneficiary chooses is called the nominated bank. Once the issuing bank approves the letter of credit, the nominated bank sends a request to the issuing bank to transfer funds into the nominated bank, where the beneficiary can then access them.
Not Issuing Bank
The nominated bank cannot be the same as the issuing bank. The issuing bank is the bank that approves the letter of credit and transfers funds to the nominated bank upon request. Thus, the issuing bank cannot be the nominated bank, as it would be transferring funds to itself. The issuing bank can, however, transfer funds to a nominated bank in another location that is a different branch of the same bank.
Negotiability
If the letter of credit is negotiable, the beneficiary can change the nominated bank at any time after the letter is approved and before funds are transferred. The nominated bank must take the letter of credit on good faith and be willing to work with the issuing bank. If the letter is non-negotiable, however, the beneficiary can only involve the bank listed in the letter of credit in the transaction, and cannot transfer the letter to any other bank.
Process
Once the buyer's bank approves a letter of credit, it forwards the letter to the nominated bank, which then verifies the credit and transfers it to the seller. The seller must provide such evidence as invoices and bills of sale to the nominated bank to prove the transaction is legitimate, after which the nominated bank contacts the issuing bank for repayment of funds and transfers the funds to the seller.
