The letter of credit is most often abbreviated as L/C, LC, or LOC. It is a judicial document. It has nothing in common with how we define credit; credit line, credit ratings, and credit score, for example. This document is set between exporters, importers, and banks. Primarily, it serves as a promise to pay the possessor if they fulfill the requirements outlined in the LC. LCs are often used when importers and exporters don’t know each other. That’s the reason why the LC is so common in international sales dealings—when importers and exporters are thousands of miles away sharing multiple time zones and a general language. It’s simple for banks to act as mediators, and the means for controlling this complex business deal is the LC. Letters of credit reduce uncertainty for both the parties involved. Below are some of the advantages of working the LC in an international transaction. For the Exporter: Lowered production risk in the event of change or cancellation in the order; security in case the importer doesn’t pay. For the Importer: An importer is sure to get the goods specified in the letter of credit, and it reflects safety for him and allows lowering or cancelling the first payment. LC Glossary Below is a list of terms you’ll come across during using the letter of credit. Applicant: Indicates the Importer. Beneficiary: Indicates the Exporter. Issuing Bank: Bank (importer's bank) that guarantees to pay. Advising Bank: Bank (exporter's bank) that distributes the letter of credit Irrevocable: The letter of credit can’t be altered or destroyed without the permission from all the parties involved. Practical Usage of the Letter of Credit Signing the Contract The use starts with a purchase agreement or contract signed between the importer and exporter. They match on a price, volume and other such terms, including a transportation schedule. Let’s consider that an exporter wants a Letter of Credit (LC), which gives him the confidence that he will get the payment by the importer's bank. Remark that the purchase agreement or contract is not at all related to the LC. Banks have nothing to do with the agreement between the exporter and importer. In some situations they even never see it. Importer Applying for Letter of Credit Importer (applicant) applies for an LC with his bank (i.e. issuing bank). The LC specifies in detail the exporter's (beneficiary) name and address, shipping dates, arrival dates, destination address, mode of shipping, and other such information. The exporter (beneficiary) gets the payment only after fulfilling the LC’s requirements. Importer's Bank Distributes LC The issuing (importer's) bank forwards the LC to the exporter's (beneficiary) bank. In most of the cases, the exporter and his bank are situated in the same country. However, in some complex international transactions, other banks may be involved—called mediators. Banks emphasize that every detail contained in the LC be specific and clear because it’s legitimately binding. The smallest error, for example, a wrongly spelled name or inaccurate shipping date, will deter the bank from making the payment or requesting a new LC. Exporter's Bank Checks the Document and Forwards to the Exporter Following a check of the document, the exporter's bank sends the LC to the exporter. He ensures that the details match contained in the document match the original contract. Exporter Transports the Goods to the Importer The exporter ships its shipment to comply with the terms stated in the LC. Exporter Forwards Export Papers to his Bank The exporter sends the shipping and export papers to his bank. The documents needed to co-occur with the cargo are clearly mentioned in the original LC. The bank authenticates that the documents comply with the terms and conditions of the LC. If anything is wrong—wrong spellings for example—the bank can decline to make the payment. Inspections can take up to some days and, once completed; the documents are sent to the importer's bank. Exporter's Bank Sends the Documents to Importer's Bank The importer's bank makes the same inspection on the export papers. If everything seems okay, payment is transferred to the exporter's bank. The importer's bank also sends the documents to the importer. Importer's Bank Makes the Payment Following a complete check of the export documentation, importer's bank makes the payment to the exporter's bank. Importer Takes the Ownership of Products and Pays the Bank Once the export documents are checked, the importer uses those documents to take ownership of the products. Ultimately, the importer pays its bank as per the terms stated in the letter of credit. Exporter's Bank Pays the Exporter In this stage, the exporter gets paid.
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