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What Is a Letter of Credit? A letter of credit, or a credit letter, is a letter from a bank guaranteeing that a buyer's payment to a seller will be received on time and for the correct amount.
An irrevocable letter of credit should always be obtained from a commercial bank and not drafted by the importer or exporter.
Disadvantages of a letter of credit: Usually covers single transactions for a single buyer, meaning you need a different letter of credit for each transaction. Expensive, tedious and time consuming in terms of absolute cost, working capital, and credit line usage.
Types of letters of credit include commercial letters of credit, standby letters of credit, and revocable letters of credit. Other types of letters of credit are irrevocable letters of credit, revolving letters of credit, and red clause letters of credit.
For a secured revocable letter of credit, the buyer has to give a personal guarantee or mortgage security. For an unsecured revocable letter of credit, the bank checks the creditworthiness of the buyer. Please note in both instances, the bank can revoke the LC.
A clean LC is a mechanism through which the beneficiary of the credit can draw a bill of exchange that too without any extra documentation. A clean LC is irrevocable till the period of review begins.
A revocable letter of credit is uncommon because it can be changed or cancelled by the bank that issued it at any time and for any reason. An irrevocable letter of credit cannot be changed or cancelled unless everyone involved agrees. Irrevocable letters of credit provide more security than revocable ones.
Inland letter of credit is an obligation of the bank that opens the letter of credit (the issuing bank) to pay the agreed amount to the seller on behalf of the buyer, upon receipt of the documents specified in the letter of credit under domestic business transaction.