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Home » Letter of Credit – What is it & How is it Used

Letter of Credit – What is it & How is it Used

letter of credit

Achieving positive vendor relationships internationally, in a world of global supply sources, is essential for local businesses to grow. All type of trade finance options helps in developing relationships as well as payments to overseas suppliers.

International trade finance facilitates timely purchasing opportunities for the sellers and allows manufacturers to export their products or services efficiently. It directly improves local businesses’ access to the latest technology, equipment, and services from international sources.

What is a Letter of Credit?

Letter of Credit is a deed that guarantees payment by a bank (or lending agency) to a third-party for a certain amount of cash. The payment is completed if specific conditions are met. This is a vital trade finance instrument through which the banks transact and finance import and export businesses.

Through a letter of credit, a bank provides its credit on behalf of its client’s credit. Mostly it is used by the import and export traders where the bank plays a mediator role and helps in completing the transaction. Here the bank or the letter of credit issuer deals only in given credentials and does not examine the products or services themselves.

A valid Letter of Credit needs to be issued:

  •         for a particular recipient
  •     for an exact amount
  •     with a definite expiration date
  •     declaration of how payment to the recipient will be made, and
  •     the detailed conditions for payment release.

What is the role of banks?

In an import and export dealing, bank as an intermediary provides further security to both parties. The letter of credit issuing bank works from the importer’s side likewise the exporter asks the advising bank. For releasing of money, the seller needs to furnish compulsory documents with the help of the advising bank to the issuer of letter of credits.

Different types of Letter of Credit:

  • Revocable L/C
  • Irrevocable L/C
  • Confirmed L/C
  • Unconfirmed L/C

How the Importers get finance through Letter of Credit?

Both deferred and term credit payment structures, grants the importer/customer the time prospect to trade the goods or services then after pay the dues with the proceeds. Through Deferred Payment option, the payment is made to the importer at a particular future date commonly for 60 days after the submission of the documents or after the shipment.

But in acceptance or term credits option, the exporter is asked to draw a draft or bill of exchange. The issued draft is received by the bank for release of payment at an agreed future date. So, the importer gets the potential time required to sell the product and make the payment at due date.

What documents are enclosed with a Letter of Credit?

As you all know, banks only verify the documents, they do not go through and verify the products or services associated. So, there are some primary documents associated with trade finance using a Letter of Credit. They are:

  • Commercial documents
  • Insurance documents
  • Transfer documents
  • Other documents

To know more about other kinds of Trade Finance and business financing options from our large range of commercial finance companies,  contact us. We look forward to assisting you soon.