What is a letter of credit?

A letter of credit is a banking mechanism which allows importers to offer secure terms to exporters

All letters of credit contain these elements:

a payment undertaking given by a bank (Issuing bank) on behalf of a buyer (applicant)
to pay a seller (beneficiary) a given amount of money.
on presentation of documents specified in the letter of credit, representing the supply
of goods
within specified time limits
these documents conforming to the terms and conditions set out in the letter of credit
the documents to be presented at a specified place

Put simply, banks who issue letters of credit (Issuing banks) have two main roles:

To give a binding undertaking to the seller that if compliant documents are presented, the bank will pay the seller the amount due. This offers security to the seller - the bank says in effect "We will pay you if you present these documents (XYZ)"

To examine the documents, and only pay if these comply with the terms and conditions set out in the letter of credit. This protects the buyer's interests - the bank says "We will only pay your supplier on your behalf if they present the documents (XYZ) that you have asked for"

Note that letters of credit refer to documents representing the goods, not the goods themselves! Banks are not in the business of examining goods on behalf of their customers.

Typically the documents requested will include a commercial invoice, a transport document such as a bill of lading or airway bill, and an insurance document, but there are many others.

Letters of credit deal in documents, not goods.

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