A letter of credit (LC) is a financial instrument commonly used in international trade transactions. It serves as a guarantee from a bank that a buyer’s payment to a seller will be received on time and for the correct amount. This provides a level of security for both parties involved in the transaction, particularly when they may not have an established business relationship or trust each other’s financial credibility.
- Applicant (buyer): The party that initiates the issuance of the LC.
- Beneficiary (seller): The party to whom the LC is issued.
- Issuing bank: The bank that issues the LC on behalf of the buyer.
Types of LCs:
- Revocable LC: Can be modified or cancelled by the issuing bank without the consent of the parties involved.
- Irrevocable LC: Cannot be modified or cancelled without the consent of all parties involved.
For the buyer, an LC provides assurance that payment will only be made when the seller meets the agreed-upon conditions. For the seller, it guarantees that they will receive payment as long as they fulfil their obligations.
Both the buyer and the seller may incur fees related to the issuance and processing of the LC. These fees can include application fees, confirmation fees, and handling charges.