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.
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.
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.
- CRF Online: Understanding and Using Letters of Credit
- International Trade Administration. "Trade Finance Guide," Pages 7–8. Accessed April 15, 2020.
- Export-Import Bank of the United States. "How Does a Letter of Credit Work and What Is It?" Accessed April 15, 2020.
- International Trade Administration. "Trade Finance Guide," Page 8. Accessed April 15, 2020.
- International Trade Administration. "Trade Finance Guide," Page 7. Accessed April 15, 2020.
- Scotiabank. "Documentary Letters of Credit: A Practical Guide," Page 10. Accessed April 15, 2020.
- Columbia Bank. "Letters of Credit." Accessed April 15, 2020.
- Scotiabank. "Documentary Letters of Credit a Practical Guide," Page 17. Accessed April 15, 2020.
- American Express Company. "What Is the U.S. Export-Import Bank?" Accessed April 15, 2020.
- Export-Import Bank of the United States. "An Experienced Freight Forwarder Is Your Friend in Exporting." Accessed April 15, 2020.
Jack Ori has been a writer since 2009. He has worked with clients in the legal, financial and nonprofit industries, as well as contributed self-help articles to various publications.