Letter Of Credit - For Your Read

 A letter of credit (LOC) is a financial instrument that provides a guarantee of payment from a bank or other financial institution. It is commonly used in international trade transactions to reduce risk and provide security for both the buyer and seller.


In this blog, we will explore the basics of a letter of credit, including how it works, types of LOC, and its benefits.

How a letter of credit works

A letter of credit is essentially a document issued by a bank on behalf of a buyer, which guarantees payment to a seller. It serves as a promise of payment, ensuring that the seller will receive the agreed-upon amount of money if they fulfill the terms of the agreement.

Here's how it typically works:

The buyer and seller agree on the terms of the transaction, including the price, quantity, and delivery date.

The buyer applies for a letter of credit from their bank, providing all the necessary information about the transaction.

The bank issues the letter of credit to the seller, guaranteeing payment once the seller provides the required documentation.

The seller ships the goods or provides the service, and then presents the required documentation to the bank.

If the documents are in order, the bank releases the payment to the seller.

Types of Letters of Credit

There are several types of letters of credit, each with its own unique features and benefits:

Revocable Letter of Credit: The terms and conditions of a revocable letter of credit can be amended or cancelled by the issuing bank at any time without prior notice to the beneficiary.

Irrevocable Letter of Credit: An irrevocable letter of credit cannot be amended or cancelled without the consent of all parties involved. It provides more security to the beneficiary than a revocable letter of credit.

Confirmed Letter of Credit: A confirmed letter of credit is a guarantee provided by two banks: the issuing bank and the confirming bank. The confirming bank adds an extra layer of security for the beneficiary.

Standby Letter of Credit: A standby letter of credit is used as a backup payment option if the buyer fails to make payment for any reason.

Benefits of a Letter of Credit

One of the primary benefits of a letter of credit is that it reduces the risk for both parties in an international transaction. The buyer is assured that the seller will fulfill their obligations, and the seller is guaranteed payment once they have provided the required documentation. Additionally, a letter of credit can be used to provide financing for the seller, as the bank may offer pre-shipment or post-shipment financing.

In conclusion, a letter of credit is an important financial instrument that provides security and reduces risk for both buyers and sellers in international trade transactions. By understanding the basics of how it works, the different types of LOC available, and its benefits and drawbacks, individuals and businesses can make informed decisions when conducting international trade.

Arasan, Trade Finance Consultant +91 9345516057



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