A letter of credit is a bank obligation that states that if documents showing that goods have been loaded or services have been performed are presented within a specified period of time, a designated sum of money will be paid to the seller of the good or service. In short, a letter of credit is a conditional bank guarantee.
International trade entails uncertainties and risks for both the sellers and buyers since they do not know one another very well and different countries adopt different foreign exchange regimes. The seller wants to ensure the collection of receivables while the buyer wants to ensure that the goods under the sales agreement are delivered on time. If the seller does not abide by the terms of the letter of credit, the bank, under no circumstances, makes any payments. This is an assurance factor for the buyer. Therefore, the letter of credit is a payment method providing the highest level of assurance for both sides.
Advantages for the Buyer
Advantages for the Seller