The letter of credit process: a step-by-step guide

April 1, 2024

Author: Pacific Corp

In the intricate web of international trade, the Letter of Credit (LC) stands as a beacon of trust, providing assurance to both buyers and sellers. As a dynamic financial tool, it ensures seamless transactions and fosters global commerce. Let’s delve into the step-by-step guide of the Letter of Credit process, unraveling the complexities and shedding light on its seamless execution.

Understanding Letters of Credit:

A Letter of Credit (LC) serves as a financial guarantee, assuring the seller that the buyer’s payment will be received on time and for the correct amount, provided the terms and conditions are met.

Parties Involved in an Letter of Credit:

The Buyer (Applicant):

Initiates the LC process and engages with the issuing bank.

The Seller (Beneficiary):

Receives the LC and relies on it for payment assurance.

The Issuing Bank:

Issues the LC, undertaking the responsibility of payment to the beneficiary.

The Confirming Bank:

Adds confirmation to the LC, enhancing its credibility in the eyes of the beneficiary.

The Advising Bank:

Notifies the beneficiary of the LC’s issuance and terms.

Types of Letters of Credit

There are several types of Letter of Credit, each designed to accommodate different trade scenarios and needs:

Commercial letter of credit:

This is the standard LC used in trade, ensuring that the seller receives payment upon fulfilling the terms and conditions of the LC.

Usance letter of credit:

This type of LC allows deferred payment, meaning the buyer can pay at a later date, as specified in the LC.

Back-to-Back letter of credit:

Ideal for middlemen or brokers, this LC involves two separate LCs issued in favor of different beneficiaries, one based on the other.

Standby letter of credit:

Often used as a backup to ensure payment in case the buyer fails to meet their obligations, the Standby LC provides an additional layer of security for both parties.

Irrevocable letter of credit:

This type of LC cannot be altered or canceled without the consent of all parties involved, providing stability and security for the seller.

Revocable letter of credit:

Unlike the irrevocable LC, this type can be altered or canceled without the seller’s consent, which makes it less secure and less commonly used.

Revolving letter of credit:

Designed for ongoing or repeated transactions, a revolving LC automatically reinstates the credit amount as it is used, streamlining continuous trade relationships.

Confirmed letter of credit:

In addition to the issuing bank’s guarantee, a confirmed LC is also confirmed by another bank, often the beneficiary’s bank. This provides an extra layer of assurance.

Red Clause letter of credit:

This LC allows for partial payment to the beneficiary even before shipment, providing financial assistance to the seller during the production phase.

Sight letter of credit:

In a Sight LC, payment is made to the seller as soon as compliant documents are presented. It ensures a quick and straightforward transaction process.

Advantages of Using LCs:Security and Assurance:

Letter of credit provides security for both parties, ensuring timely payments and the fulfillment of contractual obligations.

International Acceptance:

LCs are globally accepted, fostering trust and confidence in cross-border trade.

Customization:

LC terms can be tailored to accommodate specific trade requirements, ensuring flexibility in agreements.