What is a Letter of Credit and How it Works?

In the arena of international trading, a letter of credit (LC) is a vital financial tool that helps streamline the export-import process and build credibility. To define, it is a letter from a reputable bank or financial institution that guarantees the exporter will receive payment from the importer on time and for the right amount as agreed upon. In case the importer is unable to make the purchase payment, the responsibility of paying the full or remaining amount rests upon the bank extending such letter of credit.  

Herein, the bank serves as an “impartial” third party whose key purpose is to ensure payment protection and facilitate hassle-free international trade process. There are specific conditions and obligations that the client must meet to get an LC from the bank. Similarly, the payment is released only when certain conditions are fulfilled.  

Taking into consideration the complexity of international trade finance – varying laws prevalent in the countries, distance and lack of trustworthiness –letter of credit has emerged as an integral aspect of export and import.  

How a Letter of Credit Works?

Depending on the type of international trade that a business is involved in, they can choose between LC 90 days, LC 60 days or LC 30 days. This means the payment amount promised in the LC is due for 90 days, 60 days, and 30 days respectively.   

Seller Protection: When the buyer and seller involved in a trade are from different countries, the seller may be apprehensive about exporting the goods because there is the risk of a payment default. This is especially true for new importers who haven’t yet built strong credibility in international trading.  
 
The letter of credit works by guaranteeing both payment and time on behalf of the importer. Internationally-recognised financial institutions such as SUISSE BANK ensure seller protection by issuing an LC, wherein if the importer is unable to make the payment by the stipulated period or later, the bank will pay the same if the exporter fulfils all the conditions mentioned in the letter. 
 
Buyer Protection: Banks also ensure buyer protection through Standby Letter of Credit (SBLC). If the importer has already made full or part payment to the exporter and the latter fails to deliver the product or service, then the bank guarantees paying you back using the SBLC. This either works as a penalty to the seller who failed to perform as per the conditions in the LC or by allowing the buyer to pay some other seller to get the items needed.  

Types of Letter of Credit  

1.Commercial Letter of Credit: The issuing bank directly makes the payment to the beneficiary.  
 
2.Standby Letter of Credit: It is a secondary payment process wherein the issuing bank only pays when the holder is unable to make the payment.  
 
3.Traveller’s Letter of Credit: Designed for travellers, it ensures that the bank will seamlessly honour all drafts made at some foreign bank.  
 
4.Revolving Letter of Credit: The LC allows the client to make multiple draws during a particular period of time and within a specific limit.  

SUISSE BANK aids in swift and reliable issuance of Letter of Credit, helping businesses flourish in their international trade ventures.