Letter of Credit
A Letter of Credit (L/C) is a financial instrument issued by a bank that guarantees payment to an exporter, provided all specified shipment and documentation conditions are met. It acts as a secure payment mechanism in international trade, reducing the risk for both buyers and sellers. The bank commits to paying the exporter on behalf of the buyer once compliant documents are presented. This creates trust between parties who may not have an established trading relationship.
Under an L/C, the buyer’s bank outlines detailed terms such as shipping dates, required documents, cargo descriptions, and compliance standards. The exporter must strictly follow these conditions when shipping the goods and preparing documents. Banks assess documents—not the physical goods, so accuracy is critical. Even small discrepancies can delay or prevent payment.
Letters of Credit are commonly used in cross-border transactions where payment risk, distance, or regulatory complexity exists. They provide exporters with payment security and give buyers confidence that payment will only be made once agreed conditions are met. This structured process helps manage financial risk and supports smooth international trade.
Overall, an L/C offers a reliable and transparent payment framework for global transactions. It protects both parties by aligning payment with documented performance. When managed carefully, it facilitates secure trade, improves cash flow confidence, and reduces the risk of disputes.
Frequently Asked Questions about Letter of Credit
Clear answers to the most common questions people have when learning about Letter of Credit.
It reduces payment risk by ensuring exporters are paid only after meeting all agreed shipment and documentation conditions.
Common documents include the Bill of Lading, commercial invoice, packing list, insurance certificate, and any certificates specified in the L/C.
The bank may treat it as a discrepancy, which can delay payment or require buyer approval before funds are released.