A Letter of Credit (LC) is a financial document issued by a bank on behalf of a buyer, guaranteeing payment to a seller under specified conditions. It is commonly used in international trade to reduce risks associated with transactions between unfamiliar parties. The LC ensures that the seller receives payment as long as the shipping documents are presented and the terms of the LC are met.
A Letter of Credit involves three key parties: the buyer, the seller, and the issuing bank. The buyer requests their bank to issue an LC in the seller's favor. Once the LC is issued, it details the terms that must be fulfilled for payment, such as delivery deadlines and product specifications. Upon fulfilling these terms and presenting the required documents (e.g., bill of lading, invoice), the seller receives payment from the bank, even if the buyer ultimately fails to pay the bank.
A Letter of Credit provides a layer of security for both buyers and sellers. It reassures sellers that they will receive payment if they meet the terms of the LC, which mitigates the risk of buyer non-payment. For buyers, it ensures that the seller adheres to the specified product quality and delivery terms before payment is released. This financial instrument helps facilitate smoother and more reliable transactions between parties in different countries.
