ABC / Letter of credit

A letter of credit, often abbreviated as an LOC or LC, and also referred to as a documentary credit, is a document issued by a financial institution which essentially acts as an irrevocable guarantee of payment to a beneficiary. This means, that once the beneficiary has presented to the issuing or negotiating bank documents complying with the LC terms, the bank is obliged to pay irrespective of any instructions of the applicant to the contrary. In other words, the obligation to pay is shifted from the applicant to the LC issuing bank. 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 almost exclusively in international trade transactions of significant value, for deals between a supplier in one country and a wholesale customer in another. The parties to a letter of credit are usually 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. Since nowadays almost all letters of credit are irrevocable, (i.e. cannot be amended or cancelled without prior agreement of the beneficiary, the issuing bank and the confirming bank, if any), the applicant is not a party to the letter of credit.

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