Letters of Credit (LC) are payment instruments used in international commerce to give financial assurance from a creditworthy bank to an exporter. Letters of credit mitigate expenses in international commerce transactions when the buyer and seller are acquainted with each other. Your organisation can only settle for items when the seller produces proof of shipment by letter of credit.
What exactly is a Letter of Credit?
Letters of Credit Types
The issuing bank makes payments to the recipient via cash subsidy. A backup letter of credit, on the other hand, is a backup payment mechanism in which the beneficiary is paid only when the holder is unable to pay.
In this sort of letter, a consumer can make as many withdrawals as he or she wants within a set time frame.
This letter ensures that issuing banks will recognize draughts issued at specific foreign banks for receivers travelling abroad.
A verified letter of credit is guaranteed by a bank except for the one that provided the letter of credit. Usually, the verifying bank is the seller’s bank. In the event of a default by the holder or the issuing bank, the verifying bank guarantees payment under the letter of credit. This arrangement is often requested by the issuing bank in overseas transactions.
- Irrevocable vs. revocable
It relates to a letter of credit that the issuing bank can withdraw without prior warning to the beneficiary. The issuing bank has the authority to cancel or alter the contract terms. The terms and conditions of an irrevocable Letter of Credit, on the other hand, cannot be withdrawn or changed. As a result, the opening bank must uphold the promises stated in the letter of credit.
How does an LC function?
Because the LC is a negotiable instrument, the issuing bank pays the recipient or another bank immediately (nominated by the beneficiary). Banks charge a fee for their services, which is determined by the amount of the LC.
Significance of Letters of Credit
Distance, varied regulations in various nationalities and a loss of interpersonal touch are all characteristics of international trade. As a result, letters of credit are viewed as a trustworthy payment tool. Letters of credit are controlled in international payments by the ‘International Chamber of Commerce Uniform Customs and Practices for Documentary Credits.’
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