International Banking
Letters of Credit

A Letter of Credit, also called an LC or documentary credit, is issued by a bank on behalf of an importer (buyer). The issuing bank substitutes its creditworthiness for that of the applicant (importer/buyer). It guarantees an exporter (seller) payment for goods or services, provided the terms of the Letter of Credit are met.

Before the Letter of Credit is issued, the importer (buyer) and the exporter (seller) agree on all of the terms and conditions in a purchase agreement. Then the importing company instructs its bank to issue a Letter of Credit in accordance with the sales contract, or proforma invoice between the importer (buyer) and exporter (seller). The Letter of Credit contains only those details that are to be reflected in the documents to be submitted by the exporter (seller) for payment.

A Letter of Credit may be payable either at sight or at extended payment terms (payment at a future date). A payment at sight means that the payment is due upon the presentation and receipt of documents after shipment of the goods and/or services are provided. On the other hand, if the exporter (seller) allows the importer (buyer) an additional period after presentation of documents to pay the credit at a future date, then the credit is payable at 30, 60 or 90 days after presentation and acceptance of documents. (Bill of Lading Date, or whatever payment terms have been agreed upon)

Advantages for the Importer (Buyer)

Reduce your commercial risk by ensuring that your supplier will not be paid until evidence has been provided that the goods have been dispatched. Import LCs also help you:

• Assure that your bank will refuse payment to the seller if the documents presented do not comply with the terms and conditions of the Letter of Credit.
  
  
• Conserve your company's cash flow by eliminating the need to make advance payments or deposits.
  
  
• Demonstrate your creditworthiness to your supplier.

Risks to Importer (Buyer)

In Letter of Credit transactions, banks deal only in documents, not in goods and services. Merchandise may not be as represented in the documents.

Advantages for the Exporter (Seller)

• Dramatically increase your export sales, not your financial risk.
  
  
• Rely on a bank's creditworthiness rather than the buyer's.
  
  
• Assure that you get paid (the bank that issued the LC is obligated to pay) upon presentation of complying documents.
  
  
• Provide greater security of payment if confirmed by First National Bank.

Risk to the Exporter (Seller)

The seller's documents must comply strictly with the terms and conditions of the Letter of Credit to ensure payment.

For further information about Letters of Credit, see Standby Letters of Credit, Checklist for Exporters, How It Operates, Parties Involved and Types