A letter of credit is a promise to pay. Banks issue letters
of credit as a way to ensure sellers that they will get paid as long as they do
what they've agreed to do.
Terms in LC
· Abbreviations for 'letter of credit' include
L/C, LC, and LOC
·
Applicant - the buyer in a transaction
·
Beneficiary - the seller or ultimate recipient
of funds
·
Issuing bank - the bank that promises to pay
·
Advising bank - helps the beneficiary use the
letter of credit
Process of LC
A seller only gets paid after performing specific actions
that the buyer and seller agree to.
For example, the seller may have to deliver merchandise to a
shipyard in order to satisfy requirements for the letter of credit. Once the
merchandise is delivered, the seller receives documentation proving that he
made delivery. The letter of credit now must be paid even if something happens
to the merchandise. If a crane falls on the merchandise or the ship sinks, it's
not the seller's problem.
To pay on a letter of credit, banks simply review documents
proving that a seller performed his required actions. They do not worry about
the quality of goods or other items that may be important to the buyer and
seller.
