To put it in simple terms, a letter of credit is a piece of document that serves as an instruction of guaranteed payment from the buyer to the seller. Also known as a non-fund-based documentary credit, a letter of credit is issued by the bank and acts as a promise of timely payment to the seller.
If the buyer supposedly fails to perform his due obligation, then the bank pays the seller on behalf of the buyer who in turn repays the bank.
Letter of credit was commonly used in international trade, but off late has been an instrumental tool in domestic trade to reduce the overall interest cost.
Advantages of letter of credit
- A letter of credit gives the trade partners an ability to transact with unknown partners or in newly established trade It helps in expanding their business quickly into new geographies.
- A letter of credit is safer for the seller or exporter in case the buyer or importer goes bankrupt. Since the creditworthiness of the importer is transferred to the issuing bank, the bank must pay the amount as agreed in the letter of credit. Thus, a letter of credit insulates the exporter from the importer’s business.
- Both the trading partners can put in terms and conditions as per their requirements and arrive at a mutual list of clauses. It can also be customized from one transaction to another with the same trading partners.
- The beneficiary’sright to the full amount is described in the phrase ‘pay now, litigate later by the courts.
Contact us to further understand the concept. Also, note that we provide advisory services for all your requirements for foreign trade and investments.
