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Letter of Credit:How Letters of Credit Work
Sources:International Trade Law, Time:2015-01-06 15:30, Click:, Comment
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Letter of Credit - How Letters of Credit Work

 

A letter of credit is a promise to pay. Banks issue letters of credit as a way to ensure sellers (and sometimes even buyers) that they will get paid as long as they do what theyve agreed to do.

Letters of credit are common in international trade, but they are also used in domestic transactions. Either way, a bank acts as an uninterested party between buyer and seller and guarantees that a payment will be made if certain conditions are met.

The concept of a letter of credit can be complicated. The easiest way to get a handle on things is to see an example with visuals.

Importers and exporters regularly use letters of credit to protect themselves. Working with an overseas buyer can be risky because you dont necessarily know who youre working with. Your buyer may be honest and have good intentions, but business troubles or political unrest can delay your payment (or put your buyer out of business). In addition, communication can be difficult across thousands of miles and different time zones. A letter of credit spells out the details so that everybodys on the same page.

 

Letter of Credit Lingo
To better understand letters of credit, it may help to know the following:

•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
•Irrevocable - the letter of credit cannot be changed or cancelled without permission from everybody involved
In addition to the terms above, you might hear about different types of letters of credit, and you might want to read more about the names of everybody involved.

  The Money Behind a Letter of Credit
A bank promises to pay on behalf of a customer, but where does the money come from?

The bank will only issue a letter of credit if the bank is confident that the buyer will pay. Some buyers have to deposit enough money to cover the letter of credit, and some customers use a line of credit with the bank (in other words, a loan is created when the payment is made).

Sellers must trust that the bank issuing the letter of credit is legitimate, and that the bank will pay as agreed. If sellers have any doubts, they can use a "confirmed" letter of credit, which means that another (presumably more trustworthy) bank will guarantee payment. Sellers typically get letters of credit confirmed by banks in their home country.

Executing a Letter of Credit
A beneficiary only gets paid after performing specific actions and meeting the requirements spelled out in a letter of credit.

For international trade, 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

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