a letter issued by a bank to another bank (especially one in a different country) to serve as a guarantee for payments made to a specified person under specified conditions.
Procedure for making letter of credit
used when an importer requires a period of credit.
The importer and exporter agree to use a letter of credit.
The importer asks his bank to draft a letter of credit, on his behalf, to be sent to the exporter showing details of goods the exporter must supply, where to ship the goods, conditions or documents to be produced in order to obtain payment.
The importer then request his bank to forward this letter to the exporter’s bank.
Upon receipt of this letter, the exporter’s bank advises the exporter of this credit facility at his disposal, the exporter then ships the goods to the importer.
After shipping the goods, the exporter presents to his bank the documents ated in the letter of o credit e.g. bill of lading and certificate of insurance.
The exporter is then paid by his own bank.
The shipping documents are then sent by the exporter’s bank to the importer’s bank.
The importer’s bank remits payment to the exporter’s bank upon receipt of the shipping documents.
Finally the importer’s bank releases the shipping documents to enable the importer to claim ownership of the goods.
Importance of letter of credit
Is a document that facilitates payment in foreign trade.
Can be a documentary letter of credit if it is accompanied by shipping documents e.g. bill of lading, certificate of insurance and export invoice.
The importer is certain that ownership of the goods is assured before payment is made i.e. the importer does not make any payment until the shipping documents are in possession of his bank.
the importer requires a short period of credit.
The exporter is not willing to release goods to an unknown or untrustworthy importer before receiving payment.
The exporter is guaranteed prompt payment by his bank upon handing over the shipping documents.
The importer is financed by his bank.
This credit can be:
revocable i.e. the bank’s authority to make payment may be cancelled by the importer anytime without notifying the exporter.
Irrevocable ie. The bank’s authority to make payment cannot be cancelled without the consent of the exporter.
The exporter must be consulted first before cancellation of payment.
Confirmed ie. The exporter is guaranteed early payment by his bank on handing over the shipping documents representing the goods.