Introduction to letter of credit

Letter of Credit

A letter of credit (L/C) is a payment mechanism used in international trade transactions. It is a document from a bank typically used to facilitate a trade between two parties in different countries. Generally, the purchaser’s bank issues a letter of credit to the seller’s bank guaranteeing payment of the purchased goods.

The bank that issued the letter of credit is referred to as the issuing bank. The issuing bank may require the buyer/importer to provide a credit underwriting prior to issuance, or “irrevocable”—a promise by the issuing bank to pay the seller/exporter upon compliance with the stated contract terms. An irrevocable letter of credit is binding and cannot be amended, modified, or cancelled without the agreement of both the issuing bank and the party the letter of credit is issued to (usually the exporter/seller).

If the importer/buyer defaults on making the payment identified in the letter of credit, then the issuing bank will typically. In this case, the exporter/seller should contact his or her own bank to determine the terms and conditions of the letter of credit.

In some cases, an issuing bank may require a recourse claim from the exporter to the importer (the buyer) in the event that the issuing bank is unable to pay. In this case, the exporter would still be paid by the importer, albeit through a different means than originally planned.

A letter of credit is often used in international deals because it provides an assurance of payment to the exporter/seller as well as protecting the importer/buyer from any potential monetary losses. It is important to note that a letter of credit should be drafted in accordance with the Uniform Customs and Practice for Documentary Credits (commonly referred to as UCP), documents that establish comprehensive guidelines governing international letters of credit transactions.

By setting out a clear and agreed upon payment system, a letter of credit enables the international deal to move forward with the confidence that both parties will complete their individual obligations under the contract. From a risk management standpoint, the letter of credit offers a degree of protection for both parties involved in the transaction, thus providing a foundation for a healthy business relationship.

A letter of credit, or L/C, is a type of banking information document issued by a bank on behalf of one of its clients that authorizes a seller to receive payment from the bank. The letter of credit is essentially a guarantee from the bank to the seller that the bank will honor its commitment if certain conditions are fulfilled by the seller. Letters of credit are widely used in international trade and financing, as well as in domestic trade transactions.

Letters of credit are often used in international trade transactions because they allow the buyer and seller to have a greater degree of security. For the seller, the letter of credit guarantees payment; for the buyer, the letter of credit should ensure that the goods are delivered in a timely manner and that they meet the quality and quantity standards specified in the contract. The letter of credit will also specify the terms and conditions of the transaction, and any applicable fees or other charges.

Letters of credit are generally issued by a bank for a specified period of time. During this time, the buyer needs to present relevant documents to the bank in order to receive payment. These documents typically include the bill of lading, an invoice, and proof of inspection. All documents must be in compliance with the terms of the letter of credit before the payment will be released.

Letters of credit are highly sophisticated and complex instruments, and banks generally require that both the buyer and seller be knowledgeable in their use. The letter of credit must be carefully drafted in order to ensure that the parties involved are fully aware of their rights and obligations. In cases where the letter of credit fails to protect either party’s interests, legal proceedings may be necessary.