Letter of credit (LC)
A letter of credit (LC) is widely used in international trade, which is a financial instrument issued by a bank on behalf of the buyer (importer). This acts as an intermediary between buyer and seller in the transactions.
If the buyer and seller decide to use the letter of credit as the method of payment between them, The bank will pay the amount required to the seller, on behalf of the buyer. LC includes a set of terms and conditions to be met by the seller to get paid. The terms and conditions include details like the amount of the credit, the expiry date, the shipping documents required, and any other conditions agreed upon by the buyer and seller.
Benefits of using a Letter of credit:
- A letter of credit reduces the risks of non-payment or non-delivery.
- In the case of the buyer, the Letter of credit assures that the payment will only be done if the terms and conditions in the LC are met. This reduces the risk of non-delivery after the payment.
- The seller does not have to worry about nonpayment or delayed payment since the Letter of credit assures that the payment will be done when the terms and conditions in the LC are met.
- Reduces disputes between the buyer and seller
- A letter of credit can be used as collateral to secure financing from banks.
