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How does a letter of credit work

how does a letter of credit work


Best Answer: There are quite a few types of the Letter of Credit (or simply LC) It can be revocable, irrevocable, confirmed, unconfirmed, transferable, on sight, e.g.) The most common would be an irrevocable/confirmed one. These terms are commonly called "wording of the LC".

LC is a document issued mostly by a financial institution which usually provides an irrevocable (most of the time) payment to a beneficiary against complying documents as stated in the Letter of Credit.

Basically it works like this: First, you agree with the beneficiary on the terms (wording) of the LC, then you fill out a form at you bank, the bank approves it and deducts the money from your account. It notifies the beneficiary's bank and holds the money until all the terms are met by the beneficiary (providing all the documents, delivering the goods etc, whatever is specified in the LC (typically: goods delivery, commercial invoice, bill of lading, insurance documents) and then it releases the funds to the beneficiary's


The LC can also be the source of payment for a transaction, meaning that an exporter will get paid by redeeming the letter of credit. Letters of credit are used nowadays primarily in international trade transactions of significant value, for deals between a supplier in one country and a wholesale customer in another. They are also used in the land development process to ensure that approved public facilities (streets, sidewalks, stormwater ponds, etc.) will be built. The parties to a letter of credit are usually an applicant who sends the money, a beneficiary who is to receive the money, the issuing bank of whom the applicant is a client, and the advising bank of whom the beneficiary is a client. Nowadays almost all letters of credit are irrevocable.

Keep in mind also that your bank will charge you for servicing the LC. There's quite a few different fees and it comes up to a substantial amount of money.


Sergei · 8 years ago

Category: Credit

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