A Letter of Credit (LC) is a document that guarantees the buyer’s payment to the sellers. It is issued by a bank and ensures timely and full payment to the seller. If the buyer is unable to make such a payment, the bank covers the full or the remaining amount on behalf of the buyer.

 

A letter of credit is issued against a pledge of securities or cash. Banks typically collect a fee, ie, a percentage of the size/amount of the letter of credit.

Importance of Letters of Credit

Since the nature of international trade includes factors such as distance, different laws in each country and the lack of personal contact during international trade, letters of credit make a reliable payment mechanism. The ‘International Chamber of Commerce Uniform Customs and Practice for Documentary Credits’ oversees letters of credit used in international transactions.

Parties to a Letter of Credit

1. Applicant (importer) requests the bank to issue the LC.

2. Issuing bank (importer’s bank which issues the LC [also known as the Opening banker of LC]).

3. Beneficiary (exporter).