What is a Letter of Credit

A letter of credit is a document issued by a bank or financial institution to state the irrevocable undertaking of payment from a payer to present to a seller or third party. This document acts as a binding contract, thus guaranteeing that the buyer will complete the payment transaction for goods and services to the seller.

Features of a Letter of Credit

Letters of credit are most commonly used for international trade that involve larger sum of transactions between suppliers and customers who are located in different countries. This written contract acts as a guarantee that the buyer will pay the specified amount to the seller.

There are two parties involved in the processing of a letter of credit. The party that receives the letter of credit, i.e. the beneficiary, whilst the buyer is referred to as an advising bank. The majority of letters of credit are irrevocable, which means that they cannot be amended or cancelled without the consent of all parties involved.

Both parties must agree on the amount and currency that is specified on the letter of credit. Furthermore, the seller must comply with all the conditions mentioned in the letter and provide all relevant documents outlined in the letter of credit.

A letter of credit acts as a guarantee that the payment will be completed within a certain time period. However, the bank or financial institution that issues the letter of credit does not have any responsibility in terms of the quality of goods/services or on the other specifications of the written contract.