What is a letter of credit?
A letter of credit is basically a guarantee from a bank that a particular seller will
receive a payment due from a particular buyer. The bank guarantees that the seller will
receive a specified amount of money within a specified time. In return for guaranteeing
the payment, the bank will require that strict terms are met. It will want to receive
certain documents – for example shipping confirmation – as proof.
Why use a letter of credit (LC)?
Letters of credit are most commonly used when a buyer in one country purchases goods
from a seller in another country. The seller may ask the buyer to provide a letter of
credit to guarantee payment for the goods. The main advantage of using a letter of credit
is that it can give security to both the seller and the buyer.
Types of letter of credit (LC):
There are five commonly used types of letter of credit. Each has different features and some are more secure than others. The most common types are:
Other types include:
Sometimes a letter of credit may combine two types, such as ‘confirmed’ and ‘irrevocable’.