A written commitment
to pay, by a buyer's or importer's bank
(called the issuing bank) to the seller's or exporter's bank (called the accepting bank
, negotiating bank
, or paying bank).
A letter of credit guarantees payment of a specified sum in a specified currency, provided the seller meets precisely-defined conditions and submits the prescribed documents within a fixed timeframe. These documents almost always include a clean bill of lading or air waybill, commercial invoice, and certificate of origin. To establish a letter of credit in favor of the seller or exporter (called the beneficiary) the buyer (called the applicant or account party) either pays the specified sum (plus service charges) up front to the issuing bank, or negotiates credit.
Letters of credit are formal trade
instruments and are used usually where the seller is unwilling to extend credit to the buyer. In effect, a letter of credit substitutes
of a bank for the creditworthiness of the buyer. Thus, the international banking system
acts as an intermediary
between far flung exporters and importers. However, the banking system does not take on any responsibility
for the quality
, genuineness of documents, or any other provision
in the contract of sale
. Since the unambiguity of the terminology used in writing a letter of credit is of vital importance, the International Chamber Of Commerce (ICC)
has suggested specific terms (called Incoterms) that are now almost universally accepted and used. Unlike a bill of exchange, a letter of credit is a nonnegotiable instrument
but may be transferable with the consent
of the applicant. Although letters of credit come in numerous types, the two most basic ones are (1) Revocable-credit letter of credit and (2) Irrevocable-credit letter of credit, which comes in two versions (a) Confirmed irrevocable letter of credit and (b) Not-confirmed irrevocable letter of credit.