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LETTER OF CREDIT
Definition: Letter of Credit can be defined as a binding document that a buyer can request from his bank in order to guarantee that the payment for goods will be transferred to the seller. Basically, a letter of credit gives the seller reassurance that he will receive the payment for the goods. In order for the payment to occur, the seller has to present the bank with the necessary shipping documents confirming the delivery of goods within a given time frame. It is often used in international trade to eliminate risks such as unfamiliarity with the foreign country, customs, or political instability.
Mechanism of Letter of Credit:
Here we assume that the payment will be made by the advising bank. Here we go ahead to explain the steps:
1. Here there is a contract between the exporter and the customer in which the need for a Letter of Credit is specified.
2. Then the customer requests his bank to issue a Letter of Credit.
3. Customer’s bank then issues a Letter of Credit via the Advising Bank.
4. Advising Bank then passes on the terms of Letter of Credit to the exporter.
5. Exporter nearly always requests amendments to the Letter of Credit and copies requests to the Advising Bank.
6. Customer goes ahead and requests his bank to issue an amendment.
7. Then the amendment is issued.
8. Amendment is then advised to exporter.
9. Goods are then dispatched.
10. Documents required by the Letter of Credit are presented to the Advising Bank.
11. ...