What is Letter Of Credit (LC)

Letter Of Credit (LC)

A letter of credit is defined as a letter issued by the bank on behalf of the buyer (applicant) in favor of the seller (beneficiary); expressing its definite undertaking to effect payment for the specified amount provided the seller complies with the terms and conditions stipulated in the letter.
An LC instills confidence in the mind of both buyers and sellers because it guarantees payments to the seller if terms and conditions are complied with. Similarly, the buyer (applicant) gets goods and service as per his specification, else he will be relieved of his liability to pay the bills. Non – compliance of terms and condition is called discrepancy. If there are discrepancies, it is up to the buyer to decide whether to accept goods or not. LC has greatly contributed to the international trade.
An LC is opened at the request of the buyer. A bank takes adequate security from the buyer or should be satisfied with the credit standing of the buyer before issuing LC because it has to make payment to the seller in case of compliance of terms and conditions whether or not payment is made by the buyer. This risk undertaken by the issuing bank is called 'credit risk'.
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