What Is A Letter Of Credit

A letter of credit is commonly used in overseas payments and transactions. It is a document issued by banks and can also be considered the equivalent of a certified check and can be honored by the issuing bank. If you are familiar with personal credit reports, this is somehow the equivalent for business credit profiles.

When a company intend to buy goods and services from another company from a different country, the buyer needs to get a letter of credit issued by the bank. The bank will reviews the company’s records and provides a guarantee of payment for the seller, in case the buyer actually defaults. The party that receives the letter of credit is considered the beneficiary, which is the seller of goods and services here. Letters of credit are usually irrevocable, although some banks do issue revocable letters of credit which means that these can be canceled without notifying the beneficiary.

To get a letter of credit, usually some form of collateral is required by the banks. For example, the SBA Export Express loan program offers funding for letters of credit for small businesses in the US to facilitate trades from foreign suppliers.

There is also a standby letter of credit, which is a general letter issued by the bank to provide in principle funding for the stated company for a specific period of time. Note the difference as the main one is issued only for a specific transaction.

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