A Letter of Credit (L/C) is a financial document issued by a bank that guarantees payment to a seller in the event that the buyer is unable to make the payment. It is often used in international trade transactions to provide security for both the buyer and seller.
The L/C acts as a guarantee from the buyer’s bank to the seller that payment will be made once the seller has provided proof of shipment or delivery of goods. The seller is assured that payment will be made as long as they fulfill the terms and conditions specified in the L/C.
The L/C process typically involves several parties, including the buyer, the seller, the issuing bank, and the advising bank. The buyer applies for an L/C from their bank, which then issues the L/C to the seller’s bank. The seller’s bank verifies the L/C and advises the seller to ship the goods. The seller ships the goods and provides proof of shipment to the issuing bank. The issuing bank then releases payment to the seller’s bank, which in turn releases payment to the seller.
L/Cs can be either irrevocable or revocable. Irrevocable L/Cs cannot be changed or canceled without the agreement of all parties involved. Revocable L/Cs can be changed or canceled by the issuing bank without the agreement of the seller.
L/Cs provide security and reduce risk for both buyers and sellers in international trade transactions. Buyers are assured that they will receive the goods they have paid for, while sellers are assured that they will receive payment for the goods they have shipped.