How Letter of Credit Works?

What is Letter of Credit?

A letter of credit (LC) is a document issued by a bank that guarantees the payment to a seller on behalf of a buyer, if certain conditions are met. 

In Internal Trade Since you don’t know about the supplier and creditworthiness .Mainly due to distance and due to differing laws of each country. It becomes important to secure the payment.

So, Letter of Credit becomes the only secure payment mechanism for both buyer and seller:

Here are the Steps for Letter of Credit issuance!

1-Purchase and Sale Agreement:

Both Buyer and seller enters decides on the Material specification, quantity required, terms of shipment, payment terms, Delivery date etc

2-Issuance of the LC:

The buyer applies for an LC from his bank, specifying the amount, the currency, the expiry date, and the documents required to prove the shipment and delivery of the goods. The bank then sends the LC to the seller's bank, which notifies the seller. Seller will check the authencity of the LC, he will verify if all the conditions & documents can be met,if not he will ask for amendment/modification in the LC

Step 3 - Shipping of goods:

Once the LC is received according to his requirement, he will start arranging for the shipment of material and arranging for the shipment document ie commercial invoice, packing list, country of origin,bill of lading/airway bill etc

Step 4 - Presentation of the document:

Seller starts arranging for the required documentation and presents to advising bank as  described condition in the LC. The exporter’s bank reviews documentation to ensure letter of credit terms and conditions were met. If approved, the exporter's bank submits documents to the Importer’s bank

Step 5 - Settlement of payment from importer and possession of goods:

Importer bank collects the amount by debiting the account and releases the shipping documents against amount collect. So  its the win win situation for both the parties.