A letter of credit is a banking mechanism which allows importers to offer secure terms to exporters
All letters of credit contain these elements:
- a payment undertaking given by a bank (Issuing bank) on behalf of a buyer (applicant)
- to pay a seller (beneficiary) a given amount of money.
- on presentation of documents specified in the letter of credit, representing the supply of goods
- within specified time limits
- these documents conforming to the terms and conditions set out in the letter of credit
- the documents to be presented at a specified place
Put simply, banks who issue letter of credit (Issuing banks) have two main roles:
- To give a binding undertaking to the seller that if compliant documents are presented, the bank will pay the seller the amount due. This offers security to the seller - the bank says in effect "We will pay you if you present these documents (XYZ)"
- To examine the documents, and only pay if these comply with the terms and conditions set out in the letter of credit. This protects the buyer's interests - the bank says "We will only pay your supplier on your behalf if they present the documents (XYZ) that you have asked for"
