What is Letter of Credit? Why is it Important?

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Letter of credit is a very common term used in the business world where individuals carry on import export of goods and services.

This document is an assurance from a bank that the buyer will pay to the seller for the goods or services availed. If the buyer fails to pay the amount, the buyers bank will have to make the payment to seller's bank account.

What is Letter of Credit? Why is it Important?

Say for example, If XYZ company in the United Kingdom wants to import (buyer) Mangoes from India. As both parties are not familiar with each other, and due to differential laws may make it difficult to complete the trade.

So, XYZ gets a letter from its Bank, Bank of UK, stating that Company XYZ will make the payment in mentioned time, or Bank of UK will pay the Bill.

Also, ABC company must present Bank of UK with written proof of the shipment, that will include, commercial invoice, bill of lading etc.

Documents required to open?

  • Order copies/Letters of intent/Contract agreements 
  • Government approvals if required.
  • Bill of lading
  • Packing list
  • Project report containing cost of project, means of finance, expenditure incurred 
  • Many more depending on product

What are the advantages of LC?

The advantages to buyer is that, the bank will pay the amount if the seller fails to make payment.

It reduces the risk to the seller, if the buyer cancels his order or makes any changes.

On the basis of LC, one can get pre-shipment finance from banks and financial institutions. The exporter receives the money on time and helps him to facilitate proper planning.

Any dispute or discrepancy can be solved easily by following the rules and regulations penned in LC which avoid the mis communication between buyer and seller.

However, the holder of the LC should pay the margin amount as in case of default.

The margin amount depends on your creditworthiness and relation with the bank.


Read more about: letter of credit, import, export
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