What Is A Letter Of Credit And Its Purpose?

A letter of credit can be defined in a variety of ways; however the most accepted definition of Letter of Credit is given in the Article 2 of Uniform Customs and Practices 500.

In the simplest of form the letter can be defined as that it is a non funded facility whereby a bank on behalf of its customers agrees to pay, or accept bill of exchange or authorizes another bank to pay or accept bill of exchange or negotiate provided the terms and conditions are complied with.

The main purpose of letter of credit is to facilitate international trade. it is because of this that the exporter and importer can come along because the bank serves as a major guarantor thus facilitating the whole trading process and the chances of default and risk is low. Moreover it is because of this letter of credit that the exporter gets prompt payment for his goods as he can negotiate with nay negotiating bank and get his payment and on the other hand the importer remains satisfied that the exporter cannot breech the contract because he has a strong guarantor which allows the trust of the exporter in the business as well. Thus both are beneficial in the end and ultimately the purpose of a letter of credit is accomplished that it facilitates the trade between the two parties.

A letter of credit is a document which is used between the two parties for the providing the security and undertaking on the behalf of the parties that they will fulfill their obligations. The abbreviation of the letter of credit is the LC and it is commonly used in the import and export of the business. It is also known as the documentary credit.  The beneficiary requests his bank that he favors the issuing bank to provide the letter of credit in the favor of the beneficiary and on the behalf of the person sending the letter of credit to the business.

The letter of credit is used for making the payment between one parties to other party which are doing in the business international level. So the deal between the two parties belonging from different countries can be making through the letter of credit by involving the banks to the parties. The bank gives the guarantee of the importer that he will make payment to the importer bank so that he can easily transact their goods from one country to another country.  Due to high boom in the international trade then the importance of the letter of credit is increasing day by day. So this is very common type of business.