Letter of Credit is a payment method used in international trade. It is a kind of warranty to make payment for the exported goods after the required conditions are fulfilled.
Letter of Credit is a most advantageous payment method for the exporter since it warrants the payment of sales value by the bank's promise to pay, and it provides financial convenience. It is widely used in international trade as it minimizes the possible conflicts may arise between the vendors and purchasers. Payment methods used in foreign trade have different levels of risk values both on behalf of the exporters and importers.
For instance, while pre-payment is the least secure payment method for the importer, it is the most secure payment method for the exporter.
Letter of Credit (L/C) is a payment method by which such risks are limited to a certain extent for the exporters and importers. L/C ensures security by assigning certain liabilities to the negotiating banks who will perform the payment transactions. The bank does not undertake any liability concerning the payment in any other payment method, while in the L/C, the "Issuing bank" (the bank which
creates the letter of credit) is liable to pay the value of L/C created under the condition that the conditions of L/C will be fulfilled.
Letter of Credit is processed according to the standard terms around the world, and these standards are determined by ICC (International Chamber of Commerce).
L/C Process
- Exporter and importer come to an agreement and sign a sales contract.
- Importer opens a L/C based on the terms of this contract.
- Importer's bank sends this letter of credit to the advising bank in exporter's country and it requests to notify the beneficiary and confirm the L/C.
- The bank in exporter's country notifies the exporter of the L/C. Advising bank may also assume the role of the Confirming bank.
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