What is 'Bank Letter Of Credit Policy'

A bank letter of credit policy is an insurance policy that allows U.S. banks to confirm letters of credit issued by foreign financial institutions, facilitating the purchase of domestic exports. The policy was established by the Export-Import Bank of the United States and insures the domestic bank against the possible default of the foreign institution.

BREAKING DOWN 'Bank Letter Of Credit Policy'

A bank letter of credit policy can reduce a bank’s risks on confirmations and negotiations of irrevocable letters of credit issued by overseas financial institutions for the financing of U.S. exports. This policy affords commercial and political coverage against the failure of an overseas financial institution, whether sovereign or private, to make payment or reimbursement to the insured bank. Coverage is also provided for the insured bank's refinancing of payments under a sight irrevocable letter of credit of the issuing bank.

A letter of credit is a payment mechanism used in international trade to perform the same function as a guarantee. The letter of credit creates a written commitment from a bank on behalf of one party that payment be made to a third-party, provided that the terms and conditions stated therein have been met. A letter of credit is extremely common within international trade and goods delivery, where the reliability of contracting parties cannot be readily and easily determined. Its economic effect is to introduce a bank as underwriting the credit risk of the buyer paying the seller for goods. In doing so,the letter of credit plays a central role in international trade by relying upon the dependability of financial institutions and their ability to pay.

Banks take on additional risk when dealing in overseas transactions. Political risk, such as warfare or government intervention, can wipe out a borrower's ability to reimburse the bank. Furthermore, in smaller, less stable nations, foreign exchange risk can be very large. A bank letter of credit policy provides coverage against losses caused by events such as war, revolution, and foreign exchange inconvertibility, and commercial losses caused by events such as insolvency of the foreign issuing bank, and failure to reimburse or to pay for other reasons.

Exclusions from Bank Letter of Credit Policy

The policy specifically excludes coverage for transactions in which there is an unresolved documented dispute between the insured and the issuing bank. Additionally, coverage is specifically excluded in situations in which the issuing bank refuses documents at the time of presentation and seeks a refund from the insured bank to which a reimbursement has already been made.

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