A letter of credit is issued (opened) bank a Bank on the request of his buyer customer in favour of seller, which is an undertaking by the bank to make payment to the seller if fulfills his obligations. The process of Letter of Credit is described in the following images and also explained in simple terms below:
Why the need of a letter of credit arises?
To understand the process, suppose Mr. A (importer) in India is importing goods from Mr. X (exporter) of USA. The risk to exporter is that Mr. A might not make payment of delay payment, once goods are shipped to him. Similarly, if importer makes an advance payment, risk to him is that the exporter might not ship goods once he make payment. The solution to this problem is Letter of Credit.
Letters of credit is mostly used in international trade (import/ export). But is also used in domestic trade. LC used in international trade are called Foreign Letter of Credit (FLC) and domestic ones are known as Inland Letter of Credit (ILC).
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