QS Study

Letter of Credit

A letter of credit is a document from a bank guaranteeing that a seller will receive payment in full as long as certain delivery conditions have been met. In the event that the buyer is unable to make payment on the purchase, the bank will cover the outstanding amount. It is a letter from a bank guaranteeing that a buyer’s payment to a seller will be received on time and for the correct amount. It is a safe way of payments in this bank (buyer) guaranteed to pay the cost of the product to the bank (seller). They are used to minimize risk in international trade transactions where the buyer and the seller may not know one another.

Letter of Credit (L/C) is a bank’s on the paper guarantee that it will make a customer’s (the holder) payment to a vendor (called the beneficiary) if the customer does not. It substitutes the bank credit for the credit of the customer. Example; a manufacturer gets an order from a new customer overseas. The manufacturer has no way of knowing if this customer can (or will) pay for the goods after they’re produced and shipped. Finally, the letter of credit gives you instant credibility with an exporter by demonstrating your creditworthiness.

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