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.
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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’.
