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A Letter of Credit is a contractual commitment by the foreign buyer's bank to pay once the exporter ships the goods and presents the required documentation to the exporter's bank as proof. As a trade finance tool, Letters of Credit are designed to protect both exporters and importers.
The Letter of Credit Process The issuing bank transmits the LC to the nominated bank, which forwards it to the exporter. The exporter forwards the goods and documents to a freight forwarder. The freight forwarder dispatches the goods and either the dispatcher or the exporter submits documents to the nominated bank.
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.
A bank guarantee is a promise from a lending institution that ensures the bank will step up if a debtor can't cover a debt. Letters of credit are also financial promises on behalf of one party in a transaction and are especially significant in international trade.
An LC is a commitment by a bank on behalf of the buyer that payment will be made to the exporter, provided that the terms and conditions stated in the LC have been met, as verified through the presentation of all required documents. The buyer establishes credit and pays his or her bank to render this service.
An LC contract is an instruction wherein a customer requests the bank to issue, advise or confirm a letter of credit, for a trade transaction. An LC substitutes a bank's name and credit for that of the parties involved. The bank thus undertakes to pay the seller/beneficiary even if the remitter fails to pay.
The advising bank sends the documents to the issuing bank. The issuing bank checks the documents and if approved, the issuing bank transfers the payment to the seller through the advising bank. The issuing bank hands over the documents to the buyer.
The most common types of letters of credit today are commercial letters of credit, standby letters of credit, revocable letters of credit, irrevocable letters of credit, revolving letters of credit, and red clause letters of credit, although there are several other types of letters of credit.