About Letters of Credit

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What is a Letter Of Credit?

Letters of Credit (LC) are an integral part of international business. A LC is a bank's promise to pay a seller on behalf of a buyer, providing the seller meets the terms and conditions stated in the credit. Banks act as intermediaries and have no actual contact with the goods bought and sold.

The LC serves as a guarantee that the buyer will receive the merchandise specified and that the seller will be paid in a timely manner. Each LC transaction generally involves four parties: the two parties to the transaction (buyer and seller) and the bank for each of these parties. The LC transaction occurs between two parties at a time: buyer and seller, buyer and issuing bank (which issues the LC on behalf of the buyer), issuing bank and advising bank (which authenticates the credit and manages the LC process on behalf of the seller), advising bank and seller.

All LCs contain details of the payment undertaking given by the bank (issuing bank) on behalf of the buyer to pay a seller a given amount of money within a specific timeframe and at a specified place. The LC also outlines the terms and conditions of the transaction.

How Letters of Credit Are Used:

• To protect against seller risk - payments are executed only after the required documentation is presented to a bank to show compliance with the buyers terms.

• To protect against buyer risk - If the buyer's creditworthiness is unknown, then the seller has the security of the bank's payment undertaking.

• To protect against country risk - The buyer may be willing and able to pay, but economic or political conditions in the buyer's country may prevent or delay payment. To protect against these risks, a confirmed letter of credit will be necessary. A bank in the seller's country will (for a fee) add its own payment undertaking to that of the issuing bank.

• LCs are also used as part of exchange control or import control regimes operating in the buyer's country. In such cases the use of a LC is mandatory, even if not required by the seller for security reasons.

About LCs
About the Process