What is Letter of Credit?
Letter of Credit (L/C) is a secure payment method in international trade where banks act as intermediaries. The importers bank provides a payment guarantee to the exporter in exchange for presentation of specified documents. Risk is reduced for both parties and trust is established.
Letter of credit is preferred especially in new trade relationships and high-value transactions. As it is a documentary payment method, document control is done instead of physical goods control. This guide explains the operation and application details of letter of credit.
Types of Letter of Credit
Revocable letter of credit can be unilaterally cancelled by the issuing bank. It is very rare in practice and does not provide security. Irrevocable letter of credit cannot be amended or cancelled without consent of all parties.
Confirmed letter of credit is the type where the exporters bank also provides payment guarantee. It provides additional security for the exporter. It is preferred when the country risk of the issuing bank is high.
Sight letter of credit pays immediately when documents are found compliant. In deferred payment letter of credit, payment is postponed to a certain term. Deferred payment letter of credit provides financing facility to the importer.
Letter of Credit Process
Importer requests letter of credit opening from their bank. Bank makes credit assessment and requests collateral. Letter of credit terms are based on the contract between buyer and seller.
Issuing bank notifies the letter of credit to advising bank (exporters bank). Advising bank verifies the validity of letter of credit and forwards to exporter. Exporter reviews letter of credit terms.
Exporter ships the goods and prepares required documents. Documents are sent to issuing bank through advising bank. Documents are examined and if compliant, payment is made.
Required Documents
Commercial invoice is among the main documents. Bill of lading or transport document proves shipment of goods. Certificate of origin may be required for preferential tariff. Insurance policy is mandatory under CIF terms.
Packing list contains product details. Quality certificate or inspection document may be requested. Each document must fully comply with letter of credit terms.
Discrepancy Risks
Document discrepancy can cause payment rejection. Date errors, quantity inconsistencies, missing signatures are common problems. UCP 600 rules regulate document control.
In case of discrepancy, waiver can be requested from issuing bank. This delays payment and may incur additional costs. Careful document preparation is critical.
Costs
Letter of credit opening commission is paid by importer. Confirmation commission falls to exporters share. Document examination fees and communication expenses are added. Amendment requests are also charged.
Conclusion
Letter of credit provides secure payment guarantee in international trade. Choosing the right letter of credit type and careful documentation are the keys to smooth transactions. Banking support facilitates process management.