Letter of credit(LC)

Definition

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 shipment 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.

 

·       History

The International Chamber of Commerce has drawn up a set of rules to which international banks have to adhere to when issuing letters of credit. These rules are know as The Uniform Customs and Practice for Documentary Credits (UCP 600 – version July 2007). All letters of credits issued should state that they have been issued in accordance with the rules of the UCP.

Specifications

Documentary credits are amongst the safest and most commonly used forms of payment in exporting (other than payment in advance). They are typically used to pay for exports to customers that you have not sold to before, as well as for customers and countries that represent particular credit risks. A documentary credit carries assurances for both the exporter and the importer. The L/C is an undertaking by a bank - the exporter therefore relies on the ability of the bank instead of the importer to pay. The importer, in turn, has the assurance that the bank will not release the money to pay for the goods until the exporter has presented the necessary documents which will include proof of dispatch of the goods to their final destination. The advantages can be listed as :

1-    L/C creates : More confident business for both parties by transferring the risks to the Banks

2-    High diversity of L/C`s creates : More convenient business

3-    Uniform / Int`l practices of L/C reduce disputes in business

4-    L/C is applicable for the business of both products & services

5-    L/C creates enough Financial Credit for both parties

6-    More convenient control and accurate policies of governments in L/C-based transactions

7-    More accurate Cash Flow in Banks` Foreign Currencies in L/C-based transactions