A Letter of Credit is a payment term mostly used for
long-distance and international commercial transactions.
Letters of credit are indispensable for international
transactions since they ensure that payment will be received. Using
documentary letters of credit allows the seller to significantly
reduce the risk of non-payment for delivered goods, by replacing
the risk of the buyer with that of the banks. Letters of credit
have become a crucial aspect of international trade , due to differing laws in
each country and the difficulty of knowing each party
After trade between countries made it impossible to do business
by traditional payment methods, Letters of credit make it possible
to do business worldwide.
Originally, Letter of Credit was literally a letter written by
the buyer's bank to the seller's bank promising that they
guarantee to pay the seller in case of the buyer's default.
In modern business world, a letter of credit is basically an
undertaking by a bank to make a payment to a named Beneficiary
within a specified time, against the presentation of documents
which is strictly in compliance with the terms of the letter of
That is to say, banks issue letters of credit as a way to ensure
sellers that they will get paid as long as they do what they've
agreed to do. Hence, in essence, letter of credit is a promise to
This mechanism has its own jargon:
The Buyer is the Applicant or the Account Party and the Seller
or the Ultimate Recipient of Funds is the Beneficiary.
The Bank that issues the LC is referred to as the Issuing Bank
which is generally in the country of the Buyer.
The Bank that Advises the LC to the Seller is called the
Advising Bank which is generally in the country of the Seller
Abbreviations for 'letter of credit' include L/C, LC,
and LOC .
In the very beginning, one must note that Letters of credit deal
in documents, not goods, thus the Bank scrutinizes the
'documents' and not the 'goods' for making payment
which explains why the technical term for Letter of credit is
In this context, the process works both in favour of both the
buyer and the seller. The instrument is designed to reduce the risk
taken by each party. The Seller gets assured that if documents are
presented on time and in the way that they have been requested on
the LC the payment will be made and Buyer on the other hand is
assured that the bank will thoroughly examine these presented
documents and make sure that they meet the terms and conditions
stipulated in the LC.
Letter of credit advantages for the seller
The seller has the obligation of buyer's bank's to pay
for the shipped goods;
Reducing the production risk, if the buyer cancels or changes
The opportunity to get financing in the period between the
shipment of the goods and receipt of payment (especially, in case
of deferred payment).
The seller is able to calculate the payment date for the
The buyer will not be able to refuse to pay due to a complaint
about the goods
Letter of credit advantages for the buyer
The bank will pay the seller for the goods, on condition that
the latter presents to the bank the determined documents in line
with the terms of the letter of credit;
The buyer can control the time period for shipping of the
By a letter of credit, the buyer demonstrates his
In the case of issuing a letter of credit providing for delayed
payment, the seller grants a credit to the buyer.
Providing a letter of credit allows the buyer to avoid or
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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